M&A | How To Identify and Deal With “Skeleton in the Closet” in Brazilian M&As

The process of equity investment in Brazil, such as M&A, Angel Investment, Venture Capital and Private Equity, is long, unpredictable and complex, and cases of “skeletons in the closet” that emerge after closing impose additional challenges on the buyer are common. 

For this reason, projects of this nature have 2 important stages to reduce unwanted surprises, which are (i) Due Diligences and (ii) the terms of the Stock Purchase Agreement. 

1. Due Diligence: in this stage, the buyer audits the target company from a legal, accounting, operational, environmental, technological standpoint, among others, according to the particular sector. It is the moment that seeks to identify not only relevant facts and circumstances spontaneously informed by the target/seller, but also what may be omitted and which has a chance of becoming a “Trojan Horse” in the days, months and years that will follow the closing. 

2. Stock Purchase Agreement: the SPA, which is the key legal instrument in equity transactions, must contain a clear and objective structural backbone to detail (i) the acquisition price, ( ii) form of payment (including whether a portion of the price will be paid in escrow), (iii) the conditions for closing, and (iv) the seller’s indemnification clauses to deal with “skeletons in the closet”.

Indemnification clauses need to incorporate language on how to treat facts either identified in the Due Diligence, or (and especially) not identified and only discovered after closing.

Regardless of size, skeletons in the closet always permeate equity transactions in Brazil (and elsewhere). Be it M&A, Angel Investment, Venture Capital and Private Equity, Due Diligences and Contracts need to have efficient mechanisms to identify them so that their impact is properly assessed and eventually indemnified, reimbursed and/or reduced in the price paid.


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