Posted by Nabila Kazi, corporate payments and escrow expert at Legal Futures Associate Shieldpay
More often than not, an M&A deal can present like an episode of Takeshi’s Castle – a challenging obstacle course almost designed to ensure failure, where only the strongest, most persevering and therefore most formidable succeed.
The perfect corporate presentation of the Darwinian evolutionary theory of survival of the fittest, M&A, just like Takeshi’s Castle, takes stamina and strength and is not for the faint hearted.
Of course, the chance to even try and scale the obstacle course only comes once general market conditions are overcome. Take 2020, which Luke Bergstrom, global head of M&A at US firm Latham & Watkins, called a “tale of two halves”.
Thanks to Covid-19, the first half of the year suffered an intense slowdown in M&A activity, highlighting that uncertainty of any kind is a key deal killer. For context, in Q2 2020, transactional volume and number of deals fell to their lowest point since 2004. With a 50% drop in H1 2020 activity compared to the same period in 2019, clearly the market was all but paralysed.
But by H2 2020, there was a strong resurgence in activity as the market not only acclimatised but seemed to flourish as the pandemic presented opportunity in spades – particularly for businesses within the thriving technology and life sciences sectors.
The pandemic has catalysed several of emerging trends in the market, so the growth and upward trajectory of strategic M&A and private equity opportunities looks set to continue deep in to 2021 and beyond.
However, despite the landscape being rich with opportunity with plenty of deals to be done, we’ve looked at three of the Takeshi’s Castle-like obstacles which commonly arise over the course of negotiations:
Regulatory scrutiny is a key consideration point for both buyers and sellers. Despite the best planning, sometimes what is required and how long it might take shifts dramatically. Additionally, there is always the risk of conditions to closing being imposed upon the transacting parties that might formatively change the commercial terms of the transaction.
At times, the issues and complexities caused by regulatory notifications leaves everyone involved with little to no appetite to complete the transaction because it is too complicated, too expensive and too prolonged a process to wait for regulatory permissions to be granted.
Importantly, the longer these issues go on for, the deal risks losing the opportunity to surprise the market or indeed, to capitalise on any anticipated market conditions in conjunction with the original target completion date.
Time is a serial deal-killer, and every effort must be made to engage with the best advice possible to help navigate regulatory nuances and requirements to ensure this element of the process does not become protracted and ultimately derail the entire deal.
Deviations from initial understanding
Whilst letters of intent or heads of terms are agreed early in the conversation to ensure complete clarity over the most fundamental aspects of a deal, deviations can arise once negotiations are in full swing.
There is increased probability of this occurring where one of the parties falls into the classification of being unsophisticated, and is extremely problematic if deal parameters are drastically changed to such a degree that it becomes untenable for the other party to pursue the deal, despite best intentions to do so.
It could even be a simple case of sellers getting cold feet – whether the initial motivation to sell stemmed from negative industry changes, lack of profitability or even owner burnout, as completion draws closer, there is always the risk that sellers behave more impulsively and rethink selling altogether.
Where unprofessional behaviour is encountered by either party during negotiation, it’s probably an important sign to heed and appropriate measures should be taken to shore up commitment from both parties to the deal because ultimately, the deal isn’t done until the ink is dry.
Due diligence surprises
One of the most important and lengthy processes within an M&A transaction is the due diligence. It’s also the stage with the highest probability of the deal falling over. Whilst painstaking, it is integral and can unearth issues and complexities that the buyer wasn’t aware existed.
When deals do not come to fruition following intensive analysis during due diligence, it usually signifies that the buyer’s initial cognisance of the seller’s business did not correlate with the findings. Sellers will always put their best foot forward and position their business in the most favourable light, while buyers and their advisors are naturally inclined to be on the lookout for red flags.
Buyers expect full transparency during negotiations and discovering unanticipated issues could result in questioning of trust and credibility. Sometimes, issues and/or liabilities that have been uncovered can be dealt with by apportioning the risk between both transacting parties, eg by seeking warranties and indemnity protection by ring-fencing funds in escrow to mitigate the impact of any risks arising in the future.
Due diligence is a two-way street. Sell-side parties must also take care to thoroughly investigate who they’re dealing with, perhaps by seeking introductions to parties the buyer has previously deal with to ensure what they are seeing is what they will ultimately get.
Interrogate financial integrity and ensure proof of funds or proof of funding commitments are in place to complete the transaction – in the specified timeframe – before investing too much time and money into the process.
For a cash rich but time poor society, transparency is critical to the success of an M&A transaction and will exponentially increase the chances of successfully closing the deal. Though sometimes, even with all the will in the world, sometimes there just isn’t a way to win: according to a recent Harvard Business Review report, the failure rate for M&A deals sits between 70% and 90%.
With statistics like that attached to it, much like Takeshi’s Castle, the M&A process is almost designed to ensure failure, but again, the most formidable and committed contenders will always succeed.