Mergers and Acquisitions Are Alluring But Risky. Here’s a Risk Management Roadmap That Should Cool the Burn
It’s that feeling of success mergers and acquisitions professionals get after a deal goes through. There’s lot of it going around these days, because M&A professionals are busy and deals are moving along at a healthy clip.
What’s the catalyst? From low profit margins to generational transfers to low volume sales—many companies are looking to sell and others are looking to expand their business portfolios.
But the decision to buy or sell a business can be difficult. It requires careful consideration of the many factors involved as well as finding key specialists who can provide advisory services to complete the deal.
Top mergers and acquisitions professionals have advised hundreds of companies worth billions of dollars to offer assistance in pricing the business, setting the terms, professionally marketing the business, screening potential buyers and negotiating and evaluating offers — all with the goal of reducing unnecessary financial risk.
In addition, risk managers are key players in helping mitigate costly exposures and increase confidence during all stages of the investment cycle. The experienced mergers and acquisitions specialists know what works in the selling and purchasing of businesses and they share this knowledge with their clients to get deals done at maximum value.
As Eileen Yuen, managing director, financial practice at Gallagher explained, the current environment for mergers and acquisitions shows signs that executives feel confident that a strong economic recovery is underway, with low interest rates continuing to provide access to affordable capital.
“Emerging from COVID-19 lockdowns, we see a focus on deals intended to bring innovation and technological advancement to those seeking them; in a way, a focus on resolving those disruptions to business seen during the pandemic,” Yuen said. “Many deals are about adding capabilities.”
With the increasing M&A activity come challenges aplenty including challenges in deal pricing, regulatory scrutiny and due diligence.
Yuen pointed out that cross-border or international deals declined over the past two years and currently continue to face some headwinds, initially stemming from a variety of sources like Brexit, the change in the U.S. administration and anticipated regulatory change, to name a few. The COVID-19 pandemic has also contributed to this uncertainty.
Obviously, when it comes to M&A activity, reducing unnecessary financial risk is top of mind for private equity firms.
“A key to reducing unnecessary financial risk is considering the purchase of transactional risk insurance, including Reps & Warranties coverage,” Yuen said. “This coverage is available for both buyers and sellers and serves to protect deal participants from certain breaches of the representations and warranties in a transaction.”
One of the most important considerations to pay attention to is cyber security. As Yuen explained, this pertains both to the due diligence on the target as well as the manner in which the deal is executed, particularly with increased use of virtual platforms.
“A deep-dive due diligence process should include a cyber analysis, as this can serve to protect the buyer from both financial and reputational risk,” Yuen said. “Equally important is planning the integration strategy relative to the combining of networks, to minimize vulnerabilities.”
Steps to Take
Some key steps to take to help mitigate M&A risk are important to follow. Some key considerations in mitigating risk would include having a written execution plan, thorough due diligence process and the transfer of risk via transactional insurance.
“Just as every deal is different, there is no one-size-fits-all approach to managing risk,” Yuen said. “This is a critical time to reach out to your broker to discuss the terms of your particular transaction to construct a custom risk management plan, together.”
That said, Yuen recommended the following key steps that need to be taken:
• A company who is seeking to engage in M&A should develop an internal blueprint or execution plan that outlines the high-level steps they’d engage in for any transaction.
• A company should have a formalized due diligence process, with a deep dive into financials, existing insurance policies, claims history, company bylaws, etc. Be sure to include cyber security due diligence in this process.
• With regard to existing insurance policies, there should be a review of terms and conditions to identify if there may be any deficiencies or gaps, including analyzing available limits of insurance, deductibles or retentions, as well as any endorsements or exclusions, etc.
• With regard to claims, Yuen suggested an analysis of open claims and reserves, recently closed claims and amounts of payments and any potential issues on the horizon. There should be an evaluation of how future claims may be handled as well, both during the transaction process and going forward, post-closing.
• Review indemnification agreements and/or requirements. Identify where tail or run off coverage may be necessary.
• Explore transferring or mitigating the transaction risk through reps and warranties insurance, tax liability insurance, or other products that may make sense for your specific deal.
In addition to following the above checklist, it is also vital to avoid common mistakes as they relate to reducing financial risk within the M&A market. These include:
• Underestimating the complexity of a deal or timeframe for completion
• Poor due diligence or the lack of deep dive in the due diligence process, which includes attention to cyber security and intellectual property
• Not giving the integration process and culture a high priority as the deal progresses and/or closes
“With the new administration in office in the U.S., we’re keeping an eye on President Biden’s tax plan and antitrust focus,” Yuen said.
Recently, the Federal Trade Commission Chair warned of a more aggressive stance to block deals, continuing to point to the potential for a more restrictive environment within mergers and acquisitions.
“This is consistent with what is occurring in the UK and other jurisdictions as well,” Yuen said. “Companies may expect longer merger review processes, more challenges and possible court cases. With regard to the proposed corporate tax hikes, sellers in the M&A market might expect higher valuations to offset these costs.” &