Image by Pavel Danilyuk
The mergers and acquisitions (M & A) failure rate is commonly pinned at around 70% to 90%. Large deals have a failure rate of about 10% each year. You might even remember some more well-known failures, such as America Online and Time Warner, Sprint and Nextel Communications, and Kmart and Sears.
With such vast numbers of failed deals, it should come as no surprise that the M & A process is wracked with challenges. There are many issues that can and do arise during an M & A deal, and sometimes, even the most experienced companies fail to address them appropriately.
Hence, to successfully navigate mergers and acquisitions, it is crucial to first identify and understand both general and deal-specific issues. There is, of course, a very long list of challenges that can crop up during the M & A process. However, we have compiled some of the key issues so you know what to look out for.
Table of Contents
Introduction
M & A offers many benefits. Companies undertake M & A to diversify product and service offerings, increase market share, and heighten value to stakeholders. Indeed, the M & A process can save banks that might otherwise cease to exist.
However, as established, M & A deals are not always successful – or effective. How can companies weigh the advantages and disadvantages to know whether a deal is worth going through with?
Ideally, when negotiating terms, parties should address major issues up front, at the letter of intent stage or soon after its execution. Both acquiring companies and target companies should bear in mind the following challenges and issues when considering a transaction.
Mergers and Acquisitions Challenges and Solutions
Before we dive into specifics, note that one of the main reasons that the M & A process fails is due to a lack of clear motivation for the deal.
Institutions must have a compelling and clear “why”. To obtain this, they need to focus on strategic planning and determine if an M & A deal is the best method to meet their goals.
1. Threats to Security
NextGen has written about accounting fraud and security threats before – with good reason. When companies integrate, there is a lot of sensitive information that is shared with all parties involved.
Technology not only enables M & A, but also drives the new operating models. This leaves companies vulnerable to cyberattacks. This can delay the M & A process and in certain cases even break deals.
However, there are various measures you can take to reduce such security threats:
Identify and understand the potential cyber risks and associated costs from the outset.
Conduct daily reconciliation, preferably with a robust reconciliation automation software such as CrushErrors.
Determine how much liability there is.
Use valuation and contract terms to offset potential security threats during negotiations.
2. Earn-Outs & Escrows Indication
Any escrows and earn-outs, plus any other contingencies, should be indicated in the letter of intent.
An indemnification escrow is meant to give recourse for acquirers in case of any breach of warranties and representations made by the target. (Or in specific other events).
Even though escrows are standard in M & A, their terms can vary greatly. Typically, there will be an escrow dollar amount between 10% and 15%, with a period of 12 to 24 months from the closing date.
Special escrows may sometimes be set up to address certain issues that arise during the due diligence process, such as data privacy or sales tax concerns.
On the other hand, provisions for earn-outs are not as common. They also give additional contingent payments from acquirers to targets or their shareholders. Often, these provisions are utilized to bridge potential gaps on valuation.
When drafting terms of earn-outs, it is crucial to include a dispute mechanism and make the milestones as objective as you can.
Remember, from the viewpoint of the target, the issue with earn-outs is twofold. One, the target loses control of the company post-closing. Two, post-closing, the decisions made by the acquirer may have a large impact on the capacity to achieve the established milestones.
3. Unrealistic Expectations or “Big Company Let-down”
Sometimes, entrepreneurs and small-business owners believe that working for or selling to large companies will end up solving their challenges or problems, mainly because large companies have bigger budgets and more resources.
However, it is important to note that, while big companies do bring solutions to the table, they can also bring more challenges. For example, they do not move at a fast pace the way start-ups do, and there tend to be many layers of decision-making and bureaucracy.
Typically, management and top-level executives at these companies are occupied with “more important tasks”. This means that smaller companies and start-ups will likely get “lost” in the large company, unless there is a documented agreement that details guaranteed support.
It is hence recommended that start-ups and smaller companies carefully weigh the pros and cons of M & A deals before going through with them.
4. Working Capital Adjustments
The M & A process typically includes working capital adjustments as a part of the purchase price.
As an acquirer, you want to ensure that you acquire a target with sufficient working capital to meet business requirements post-closing. This will also include obligations to trade creditors and clients/customers.
What’s more, you’ll want to give consideration for the asset infrastructure of the target that generated profits and enabled the business to operate.
You calculate working capital by subtracting current liabilities from current assets, as per the balance sheet. Assets will include inventory, cash, and accounts receivable (AR). Liabilities will include interest owed, wages, accounts payable (AP) and taxes.
Some atypical or unusual factors, cyclical items, add-backs and “one-offs” will also be considered for the calculation of the working capital.
Dispute procedures should be set in the definitive agreement, should disagreements arise about the calculation between the parties involved.
5. Incomplete Due Diligence
It is easy for even the best lawyers and advisors to miss something important during the due diligence process.
Furthermore, sellers will try to present things from a rose-tinted perspective. This is why you need proper warranties and seller representations documented in the agreement for your protection.
Conclusion
To help manage the M & A process, it is always prudent to conduct daily reconciliation. NextGen Accounting offers credit card reconciliation services, bank reconciliation services, reconciliation automation, and consulting services to large firms.
To give you the most accurate and fastest reconciliation, we use our patented software CrushErrors, which you can also obtain as a product if you’d rather conduct reconciliations in-house.
NextGen Accounting’s management team has decades of experience and includes former executives of Barclays Bank, Bank of America, and ICBC. Contact us today for reconciliation services or book a free demo if you’d like to get CrushErrors!