In this article, Amy Jones discusses 6 major issues in M&A transactions that can derail a Deal.

Mergers & acquisitions are complex transactions that need to be handled carefully in order to close them successfully. Issues in M&A transactions can arise at all stages right from the beginning at the negotiation phase to even after the successful closure of a deal. There are various factors to be considered in such arrangements and enterprises need expert assistance to minimize risks and improve the chances of success. Pricing of the target organization is merely one aspect of M&A deals and numerous other topics like the structuring of the transaction or post-closure escrow details are intensely debated by both sides before they arrive at an agreement. Companies engage M&A law firms and other expert agencies to get assistance on the matter but even then the success rate of such deals is not too high. Let’s take a look at the major issues that organizations need to avoid for a successful M&A transaction.

Issue 1 –  Unsuitable Deal Structure

Many deals are called off right after initial negotiations because parties disagree on structuring the deal. There are three possible ways to structure a deal namely by stock purchase, asset sale or merger of both organizations. One of the biggest issues that cause a difference of opinion is the transfer of liability. In case of a stock purchase, complete liabilities are transferred to the acquirer. In a merger, the surviving entity has to take responsibility for the liabilities but in an asset sale, only specifically assigned liabilities are passed on to the buyer. There are tax consequences to be considered which affect both parties. Buyers prefer an asset sale as it provides them an opportunity to reset the basis. An unsuitable deal structure which is unfairly favoring one organization will lead to a breakdown of talks.

Issue 2 – Failure To Agree On The Final Price

Another common issue that can arise is differences over the final price of the target company. The method used to assess the worth of a business becomes important in such cases. It is not only buyers who conduct the valuation but sellers also do the estimation to get an idea about the value of their enterprise. There are various factors that are considered in order to assess a fair price. These include the future prospects of the business, the risks associated with it and the expected returns. Companies must engage advisors to get guidance on valuation so that there is not much difference between the estimates of both sides and the transaction can be closed successfully.

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Issue – 3 Mode Of Payment

The method of payment used for settling the deal can also be a potential cause for an issue. The easiest way to make payment is through cash. Sellers prefer this method as least risk is associated with it but it can affect the acquirer’s capital structure or debt rating. Another way is to pay the acquirer’s equity to the target’s stockholders at a determined ratio relative to the target’s value. This may positively affect the buyer’s debt rating. The final decision of the payment method depends upon whether the buyers feel their share is overvalued prompting them to use equity for closing the deal. They use cash if they feel that seller company is undervalued.

Issue – 4 Disagreement on Escrow Details

A part of the total purchase price amount is held in an escrow to protect buyers from losses occurring due to the breach of representation and warranties by the seller. The terms of an escrow can cause disagreement between both the parties. They can differ over the percentage of the final price that will be held in the escrow apart from the complete period of the holdback. Target company owners want the escrow to be the only remedy for all breaches but sellers want to exclude fraud from the arrangement. Negotiations can also break down on the composition of the escrow- whether it will be all cash, only stock or a combination of both.

Issue 5 –  Terms of Seller Representation and Warranties

One of the major issues in M&A transactions is caused by differences over the framing of representations and warranties. Sellers want to include detailed information on financial statements, tax, authority, liability, contracts, employee matters etc. covering all elements of the target organization. Sellers are wary of what is being included in the document as a breach will lead to indemnification claims by the buyer. Mergers and acquisition lawyers advising target company owners do not like the inclusion of broad terms that can have different interpretations. On the other hand, any hesitance in providing information by the seller will be treated with suspicion by the acquirer. Engaging experienced M&A specialists will help to remove doubts and inclusion of suitable terms in the document for both parties.

Issue 6 –  Differences Over Indemnification Provisions

One of the most intensely discussed topics in any M&A is the finalizing of target indemnification provisions. The conditions put in the document which will have to be fulfilled by sellers on breach of representations, warranties or other terms can significantly reduce their returns from the sale. While buyers want the scope of the indemnification to be wide and go beyond representations and warranties, sellers want it to be limited in scope as well as duration. They also want a cap on their obligations but buyers want different caps for specific matters like a higher one for intellectual property claims.

Conclusion

The best way to avoid issues in M&A transactions is to engage professionals who have considerable experience in assisting business organizations to successfully close such complex deals.