This article is written by Aanchal Shrivastava, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction 

Mergers and Acquisitions (M&A) need no introduction in today’s corporate world. There has been a tremendous upsurge in M&A activities in India, in terms of both, numbers and value. During 2009, Indian companies were involved in a total of 356 M&A deals amounting to nearly $16.3 billion as compared to an all time high of more than 1,640 transactions valuing to over $129.4 billion in 2018, with the Walmart – Flipkart deal being the largest in a decade. M&A deals have enabled corporations to consolidate their value and performance to achieve synergies and to create a strong market position around the globe. While Mergers and Acquisitions are touted to be the quickest way of inorganic growth in the contemporary world, however, by no means they can be considered a foolproof road to success. According to a study by KPMG, a vast number of as many as 75% of deals fail to create substantial value to the shareholders. The biggest examples of failed deals such as “Tata Steel Ltd. – Corus Group PLC”, “Apollo Tyres Ltd. – Cooper Tyre & Rubber Co.” and “Bharti Airtel Ltd. – Zain Group” are a testament to the problems that can crop up during mergers and acquisitions. These problems may seem to be relatively minor, but can have seismic consequences and cause devastating results. In this article, we will discuss some of the challenges faced by the parties to mergers and acquisitions, during pre-closing as well as post-closing of the transactions –

Pre-closing challenges 

• Identification of the right Target – Acquisitions bring the opportunity to take major leaps in terms of size, market and profitability of the business in a relatively short span of time and cost, but all comes to naught when companies acquire the wrong target, at the wrong time and in the wrong deal. Being wired to believe that success means closing an acquisition, acquirers sometimes fail to recognize the importance of choosing the right target based on their desired benefits and objectives. Moreover, companies are persuaded to go ahead with the transaction after reaching a certain point, thereby overlooking the importance of pulling the plug on the deal when it is manifest. Thus, targeting the wrong company has become one of the key reasons for failure of mergers and acquisitions. 
• Inadequate Due-Diligence – Due diligence is the most integral and longstanding element to a successful commercial transaction and cutting corners in this process can have catastrophic consequences on the transaction. Due diligence involves the investigation of legal and financial health of the target company, to quantify the growth potential of the business. A poor due diligence can produce significant fallout on the functioning and the reputation of the company, leaving an indelible impact on the organization. One such example is the acquisition of Autonomy by HP, where overlooking serious issues such as faulty financial statements and cash flows of Autonomy, resulted in overpricing the company and eventually led to significant losses to HP. In the case of McLeod Russel India Limited vs. Regional Provident Fund Commissioner, Jalpaiguri & Others, the Hon’ble Supreme Court ruled that the transferee entity shall be liable for any default committed by the transferor entity even if there is an agreement to the contrary, thereby emphasizing the importance of profound due diligence. The risks associated with negligent due diligence easily outweigh the associated costs, therefore, significant time and resources must be invested by the acquirer for conducting a thorough due diligence.
• Tax and Regulatory Issues – There are a myriad of industry specific laws and regulations applicable during a merger or acquisition transaction and the non-compliance to these can cause a serious dent to the viability of the deal. The regulatory requirements may vary depending on various factors such as whether the companies involved are private or public; listed or unlisted; the type and structure of the deal; and the size and market share of the companies. The most prominent regulations which govern merger and acquisition transactions in India include –  SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011; the Competition Act, 2002; the Companies Act, 2013; the Income tax Act, 1961 and where one of the parties is a foreign individual or entity, the Foreign Exchange and Management Act, 1999 also comes into picture.
• Employment Challenges – Mergers and acquisitions have manifold considerations, and the entities involved often slip up when it comes to the human side of the transaction. Issues may crop up when either the founders want to stay and the acquirer wants them to leave or the founders may want to leave but the acquirer wants to retain them in the organization. In this regard, a great deal can be learnt from the acquisition of Kentucky Fried Chicken (KFC) by PepsiCo, where a large section of KFC’s top management as well as employees ended up leaving soon after the acquisition, owing to communication and cultural issues. Furthermore, there is a loss of employee productivity and it may take up to as many as 3 years to reinstate the pre-acquisition engagement levels. Therefore, it is critical that human resources are kept in loop and periodically updated regarding the decisions that may affect them.
• Intellectual Property Issues – One of the most classic examples of how a prospective acquirer can encounter unprecedented losses if the intellectual property of the target company is neglected during the transaction is the Volkswagen – Rolls Royce deal of 1998. Volkswagen, being unaware that it had merely acquired the right to make and sell Rolls Royce vehicles but not the ownership over the name and brand Rolls Royce, paid a superfluous amount of $790 million for the returns it received from the deal. In the present-day “Idea Economy”, acquirers must ensure that the target company is vested with the ownership and the rights to transfer the intellectual property which is critical to its current and anticipated business, more particularly in the case of e-commerce industries. They may further seek indemnification for the losses incurred in respect of intellectual property rights or licenses owing to failure in obtaining material consents and approvals from the requisite stakeholders.

Post-closing challenges 

• Integration of Business – Much time and effort is expended in the completion of a merger or acquisition deal, however there is a strategic distinction between making an acquisition and making an acquisition work. During the merger of Daimler AG of Germany and Chrysler Corporation of the US, there was a terrific clash of culture, beliefs and attitudes among the employees of both the organizations which led to either resignation or the replacement of key executives of Chrysler with their German counterparts. Consequently, the anticipated synergies went up in smoke as the company faced major setbacks and the deal was deemed to be a fiasco. Integration challenges can have far reaching consequences on the longstanding performance and value of the resultant entity and cripple the fruition of a merger or acquisition transaction. Therefore, the planning and implementation of business integration i.e. integration of teams and cultures, must be established as early as possible for a seamless transition and for the deal to live up to the predicted value of the parties involved.
• Non-Compete and Non-Solicitation Issues – Retaining lucrative talent and maintaining customer relationships are integral to an organization’s continuing success. In the context of M&A, a covenant to not compete or solicit refers to a restriction on the selling shareholders from (i) engaging in a business activity which is similar or competitive with the target company, and (ii) hiring employees or luring away customers or clients of the target company, for a certain period of time and within reasonable geological limits, after the cessation of employment with the target company. Such restrictions ought to be supported by consideration. Non-compete fees must be taken earnestly by the acquirer to prevent the selling shareholders from circumventing these covenants and cause a dent in the attainment of desired results in the transaction.
• Escrow & Earn Out Challenges – Escrow provisions in an M&A transaction guard the acquirer against any post-closing financial losses on account of breach of any representations and warranties given by the target company. Earn outs refer to the additional purchase price paid to the selling shareholders for future performance of the business based on predetermined financial metrics such as future revenue, working capital adjustments, etc. and are used to bridge the valuation gap between the buyer and the seller. Escrow and earn out provisions are complex to negotiate and tend to be the source of post-closing disputes, since the profitability of the target company can be affected by many unrelated factors such as market environment and variation in business culture. Thus, these provisions should be meticulously drafted and the contingencies to the payment of escrows and earn outs must be clearly indicated in the M&A agreements.

Conclusion

Given the importance of India as an attractive investment destination around the globe due to its high economic growth rate, merger and acquisition transactions will continue to be prevalent in India. However, there is no such thing as a free lunch, and many pitfalls continue to contribute to the high rate of M&A failure. Stumbling blocks such as cultural clashes, failed integration and overestimation of synergies can destroy the very essence of the transaction including contraction in shareholders’ value, and cause irreparable harm to the transacting parties. Thus, it is imperative that both, the buyer and the seller, carefully gauge the viability of the transaction and endeavor to plan the acquisition strategically. 

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