Yearly Archives: 2021

Preventive measures to protect companies from hostile takeover in Armenia: regional approach

Much has been written about the methods and technologies of hostile takeover. However, the issue of protection against acquisitions remains insufficiently developed. The problem is that of the companies are fully confident in their invulnerability or in the absence of potential aggressors’ interest in their companies as a possible asset, which entails neglecting elementary means of corporate protection and legal prevention. However, this often leads to the fact that the owners of the company begin to worry about protection only when the attack has already been successfully carried out and they have completely lost control over the company.

What are the main tools that can be used by a company that has become the target of an attack or may become one soon?

The system of protective measures can be roughly divided into two main blocks:

• Strategic or preventive measures aimed at creating reliable corporate protection and minimizing the risks of hostile takeover.
• Tactical or operational actions, the main purpose of which is to prevent the seizure of control over the business in the context of an attack by the aggressor.

Let’s take a closer look at preventive measures, since they are the key to ensuring reliable corporate protection. These activities include:

1. 1. Monitoring the information environment around the companies.

The emergence of unwanted interest in the business from a third party usually manifests itself in a series of characteristic signals, which, if detected in a timely manner, the business owner can take the necessary measures to repel an attack. Such characteristic indicators include attempts to buy up a part of the company’s shares, requests from minority shareholders to hold extraordinary shareholders’ meetings or to provide documents, shareholders challenging the company’s transactions, unexpected inspections by regulatory and supervisory authorities, acquisitions in each industry, etc.

1. 2. Legal diagnostics.

The beginning of any hostile takeover is the collection and analysis of information about the target company – about its corporate structure, main shareholders, management, informal leaders, assets, partners, counterparties, administrative resources, etc. The volume and quality of the collected information by 90% determines the further takeover strategy that the acquiring company will choose. Thus, the potential acquiring company conducts a kind of diagnostics of the company – the goal, and its owners and management often do not even know about it. As a result of diagnostics, the main “pain points” of the company are determined and a program of actions is developed to eliminate or minimize them.

1. 3. Business restructuring.

A weakly protected business is characterized by the consolidation of ownership, management, and operational functions in one company, which simplifies the task of the aggressor (acquiring company) – to effectively absorb the business, the aggressor needs to intercept control in one single company. Therefore, one of the most effective preventive measures aimed at protecting a company from hostile takeover is restructuring. The implementation of such a restructuring makes it possible to solve several problems at once: to remove the main production assets of the business from the risk zone, to optimize financial flows and to ensure the protection of the business owners directly.

1. 4. Amendments to the charter and other documents of the company.

All contradictions, gaps, and shortcomings of such internal documents as the charter and internal regulations on governing bodies are always skillfully used by aggressors to achieve their goals. Typical shortcomings of such documents in practice are contradictions with peremptory norms of the law, excessive procedural encumbrances, lack of proper regulation of complex corporate aspects.

1. 5. Protection of information.

This block of protective actions includes the development and implementation of a regulation on the protection of confidential information of the company. It may determine the procedure for providing documents and information to any third parties, communication with the press, etc.

1. 6. Creation of a consolidated block of shares and a “cross-ownership” scheme.

The following picture is classic for hostile takeovers: the target company has a “loose” authorized capital, in which, in the absence of a powerful consolidated package belonging to the business owner or top management, a significant number of shares are dispersed among minority shareholders, most of which are current or former “members” of the company. In this situation, the aggressors (acquiring company) simply carried out an active purchase of shares from minority shareholders, who happily got rid of unnecessary “pieces of paper”. As a result, within a short period of time, a certain block of shares required by the law was formed, allowing the aggressor to hold a repeated extraordinary meeting of shareholders and take over the management of the company.

1. 7. Legal protection of fixed assets (property).

As a rule, the end goal of the aggressor is to gain control over some attractive asset, most often real estate, and much less often the acquiring company is attracted by a working business as such. In this regard, in the complex of preventive protective measures, one of the key positions is taken by measures for the legal protection of the main property assets of the company.

1. 8. Accounts payable management.

Overdue and poorly managed company accounts payable – targets often become the main starting point at the beginning of a corporate attack by an acquiring company. The existing debt claim rights are bought by the acquiring company at a significant discount from the company’s creditors.

1. 9. Working with top management, employees, and partners of the company.

Almost any company has some actual or potential conflict, for example, a conflict between the main shareholders of the company, conflicts between shareholders and management, conflicts between management and employees. Any of these conflicts, if it is serious enough, may be used by the acquiring company which may try to activate it as much as possible and use it for its own purposes. By participating in unleashing a conflict, the acquiring company can attract one of the conflicting parties to its side or receive all the information that needs.

Private Equity and Hedge Funds in Armenia

In the western legal culture both PE and HFs are set up as either a limited partnership or limited liability corporation. The limited partnership is the traditional US instrument. Limited partnerships are also used in Europe, often with modified features to reflect the local tax and regulatory requirements․

According to the law of the Republic of Armenia “On Investment Funds” funds can be created and structured as:

• Contractual fund (majority operating in Armenia): group of assets that are pooled based on contractual investment fund management contracts; or
• Corporate fund: fund with the status of a legal entity, assets are being pooled only by the underwriting stocks or other stock securities.

In the case of HF and PEs, including VC, in addition to joint-stock companies, the organizational and legal form of a partnership founded on trust is provided by law.  Partnership founded on trust can be named as the Armenian analog of limited liability partnerships where general partners bear liability for the obligations of the partnership, and limited partners bear the risk of losses within the limits of amounts of investments provided and do not take part in the entrepreneurial activities conducted by the partnership.

What about investment structures?

• Venture capital (VC) invests in early-stage or expanding businesses that generally have limited access to other sources of funding.
• Leveraged buyouts (LBO) that tend to invest in more mature businesses, usually taking a controlling interest and leveraging their equity investment with substantial amounts of third-party debt. Buyout funds are typically significantly larger than venture funds, which reflects the relative size of their target investments.
• Growth capital refers to equity investments, most often minority investments, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change in control of the business.
• Distressed and Special situations։ Distressed or Special Situations is a broad category referring to investments in equity or debt securities of financially stressed companies.

The focus of HFs is on maximum short-term profits, so investments are primarily in highly liquid assets. Hedge funds by design are empowered to invest in a wide range of investments, with various funds focusing on derivatives, distressed firms, currency speculation, convertible bonds, emerging markets, merger arbitrage, and so on whatever the fund manager sees as offering high potential returns in a short period of time.

There are some requirements on the investment structure in Armenia:

Additional risk (HFs) and PE funds, including VC, are considered specialized funds. which means that total assets or a part thereof, but not less than 30% are targeted to be invested in certain types of assets.

In the case of the PE funds not less than 50% of the fund’s assets shall be invested in securities not allowed for sale in the regulated market.

If the PE fund acts as a VC, in the case according to the fund’s rules or charter, not less than 50% of the fund’s assets shall be invested in

• securities not allowed for sale in the regulated market and issued by organizations that are newly created or
• are in the early stage of their development, for the purpose of their growth, development or
• enabling their securities to be sold in the regulated market.

The assets of the hedge fund shall be mainly formed:

• Through issuing unlimited amount of debt and using derivative instruments and/or
• Through the sale of such assets that the fund does not possess at the time of the transaction (short sale).