Getting it done: avoiding closing delays and deal failure

February 2020  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

February 2020 Issue

No matter the size of the companies involved or the experience level of the professionals leading the transaction, closing a merger or acquisition is always a challenge. Deals can fall through at any time. Plenty can go wrong in any deal. There is often a lengthy period between the announcement of a definitive agreement and deal completion. Many factors, such as regulatory approvals and third-party contractual consents, among others, must be satisfied to get over the line.

The amount of time it takes to complete deals varies significantly. Overcoming all the necessary hurdles can span anything from weeks to months. According to Gartner, the average time taken to finalise a deal following announcement has risen to 38 days, up 31 percent compared to 2010. For mid-size deals, the average duration is 106 days, while large deals average 279 days.

Transactions can be slowed by the need to obtain regulatory approval. Acquirers that operate across multiple jurisdictions may need to seek approval from each nation’s government. The more countries involved, the longer and more arduous the process is likely to be. Different domestic regulators will have their own priorities, scrutinise various aspects of the merger and may take a contrasting view on the same operational variables. In these cases, acquirers should enter the deal with a realistic idea of timescales, as failure to do so can cause negotiations to break down.

There can be many reasons why a transaction fails or runs into delays. According to McKinsey, about 10 percent of all large M&A deals are abandoned before they reach the closing stage. These deals fail for a number of reasons, including value-creation prospects, regulatory roadblocks and political intervention. Acquirers often make mistakes or operate on presumptions which end up being false, which can either delay or derail a transaction.

Regulatory approvals can be a major hurdle to overcome. For large-cap public transactions globally, deal timelines have materially increased over the last 10 years and key regulatory bottlenecks have begun to form around competition approval and foreign investment approval particularly. “Regulatory obstacles have probably been the key factor in increased deal timelines, as well as more generally in announced deal failures, in recent years,” says Forrest Alogna, a partner at Darrois Villey Maillot Brochier. “For example, there has been quite a bit of change around the world as regards foreign investment regimes in recent years, with the EU implementing a foreign investment screening regime, Germany instituting its own foreign investment approval regime, and the US recently expanding the Committee on Foreign Investment in the United States (CFIUS) regime, as well as much more vigorously enforcing that regime, in particular vis-à-vis certain jurisdictions.”

‘Gun-jumping’ and other related antitrust risks can jeopardise transactions if they are not tackled. If a transaction is subject to pre-closing merger review in the EU or the US, the parties are bound by a standstill obligation imposed under the EU Merger Regulation (EUMR) and the Hart-Scott-Rodino Antitrust Improvement (HSR) Act, which requires them to act as independent companies until they obtain clearance. Failure to do so amounts to ‘gun-jumping’, which can carry significant penalties. In April 2018, the European Commission (EC) imposed a record fine of €125m on telecommunications company Altice for implementing its acquisition of control over Portugal Telecom prior to receiving EC approval.

Material adverse events (MAC) can also jeopardise a transaction. “Historically, there were relatively few court cases enforcing MAC clauses, but that appears to be changing,” says Mr Alogna. “Although unexpectedly disappointing results may not constitute a MAC, they may nonetheless trigger a renegotiation of deal terms, such as those seen in the Lafarge and Holcim, and Safran and Zodiac transactions.”

While the stock market has rewarded M&A acquirers frequently in the post-financial crisis world, there has been a recent uptick in investor pushback. “This has been seen in recent headline transactions including Bristol-Myers and Celgene, United Technologies and Raytheon, and Occidental Petroleum and Anadarko,” says Scott B. Crofton, a partner at Sullivan & Cromwell. “This activity is often, but not always, instigated by activist investors and has gained a degree of institutional holder support in some cases. Advisers are well advised to present boards with a balanced threat assessment of potential interlopers and activists during the deal negotiation process.” Companies can take steps to speed up the process. During negotiations, both acquirers and targets should carefully address closing structure and post-closing obligations with an eye on placating activist investors.

A solid contractual framework can also help to reduce delays. It can solidify the business understanding between the parties, allocate risks, act as a fact-finding mechanism and clearly establish consequences for each party in the event that something goes wrong.

Importance of due diligence

If acquirers hope to successfully conclude M&A deals they must be fully aware of what they are buying. Due diligence allows acquirers to investigate, verify and audit a target to confirm all relevant facts and financial information. It should encompass a variety of areas, including the target’s financials, technology and patents, strategic fit into the acquirer’s corporate structure, any legal issues it may be facing, and its marketing strategies, among many others.

Another way to reach the closing phase of a transaction as quickly as possible is through due diligence. This key process, contained within the legal framework, can interpret data to support the viability of a transaction. Acquirers must devote sufficient time to organising and structuring their due diligence effort and bringing their team together.

Due diligence helps acquirers to understand how the target, its owners and its management operate. Sufficient time must be committed to organising and executing the due diligence phase, regardless of time constraints. “At the most basic level, this includes identifying key risks in addition to relevant regulatory approvals that need to be resolved,” says Mr Alogna. “But it is not enough to simply identify such risks; it is also crucial for parties to negotiate how such risks will be allocated if they come to pass.”

Sellers, for their part, should consider key potential issues relating to diligence well before negotiations begin. “Diligence issues can evidently have a material impact on the value of the business,” says Mr Alogna. “Thorough diligence on the asset it plans to sell will also permit the seller to anticipate issues specific to a given buyer, including possible regulatory obstacles to closing.”

Mistakes made during due diligence could have a detrimental effect on the transaction. For example, some acquirers follow a standardised due diligence process without considering complexities specific to the target company. Others may pour time and resources into particular aspects that ultimately do not matter to the deal. Poor communication can also hinder due diligence. If acquirers hope to avoid these and other pitfalls, they must pay attention to important details from the outset. Sound contracts and purchase agreements are vital to the M&A process, but well planned and executed due diligence can make the difference between the long-term success or failure of deal.

Post-closing preparations

Post-closing considerations also have a part to play in avoiding deal failure. The obligations of the parties are not discharged once the deal has closed. There are often covenants which impact the behaviour of both the buyer and seller for a period of time. The acquirer, for example, may be required to keep certain locations open, ensure that the transaction qualifies as a tax-free reorganisation, or elect a representative of the seller to the buyer’s board for a period, post-closing. For the seller, covenants may include a non-compete clause designed to protect the target company or its employees.

Other typical post-closing obligations include making certain state filings (such as articles of merger or an amendment to the party’s certificate of incorporation to change the company name), filing press releases, and obtaining third-party consents not received at closing. Public companies must also comply with reporting requirements in certain jurisdictions.

Companies should also be conscious of price adjustments and indemnification claims. “Price adjustments are a common source of post-completion conflicts,” says Mr Alogna. “One simple way to avoid such conflicts is through a locked-box structure, although that approach is not adapted to all transactions and is generally more common in continental Europe. Another common strategy is to be sure to involve the finance and accounting team closely in the drafting of the price adjustment clause, as well as providing a sample calculation in an annex, in both cases to try to minimise ambiguity. For indemnification claims, recourse to warranty and indemnity (W&I) insurance is increasingly common as a means of curtailing disputes between the seller and the buyer, but it is not a panacea.”

Another source of post-closing obligations arises from transition services agreements. “Carve outs are increasingly common, but they often involve continuing a post-closing relationship between the buyer and seller groups in the form of transition services agreements,” says Mr Alogna. “Transition services agreements are less common in the sale of a standalone business, but they certainly do arise in that context as well. In whatever context they arise, such agreements can be a source of significant post-closing tensions. The transition services may be critical to the sold business’s ability to function effectively, but post-closing those services may be far less of a priority for the seller group. Close cooperation between lawyers and businesspeople is crucial to the successful negotiation of such agreements.”

Companies can take a number of steps to drive post-deal value creation, reducing the chance of deal failure. But according to Mr Crofton, while post-closing earn-out mechanisms can be an effective tool to bridge valuation gaps, they often come with strings attached for buyers. “The provisions often include covenants that dictate the buyer’s conduct after closing, and these commitments can require a buyer to operate consistent with past practice, prevent affirmative integration steps that would make financial targets hard-to-measure, or require affirmative actions and milestones to be hit that a buyer may determine would not otherwise be advisable. In deciding whether to offer up an earn-out, buyers should balance its potential attractiveness from a valuation perspective with the challenges it could present from an integration perspective,” he adds.

To help avoid expensive and time-consuming delays or outright deal failure, it is vital that the right steps are taken throughout the transactions process.

© Financier Worldwide

BY

Richard Summerfield