Neil Millar, partner at Minter Ellison Rudd Watts talks to Gill South on the ins and outs of mergers and acquisitions.
When you are considering acquiring another business what do you need to think about?
Buying a business is a decision not to be taken lightly. Studies have shown that corporate marriages fail to increase shareholder value more often than they succeed. Whether this scary truth will apply to your hook up will depend on getting the fundamentals right. Ask these questions: Are there solid strategic drivers for the proposal? Do the numbers stack up? Is there a good cultural fit? Do you have the time and energy? If the answer to any of these questions is no, think again. And it will take a lot longer than you think. A good process can take six months. If things get complicated it could take a lot longer.
What sort of legal work is required?
It's highly specialised. Make sure you get a lawyer with experience in this area. The work will include:
• A short letter of intent, setting out the proposed commercial terms of the deal.
• A due diligence exercise - a review of the operational, financial and legal position of the target.
• A sale and purchase agreement (or SPA), setting out how the business will change hands.
• A shareholders agreement if the seller will be shareholder in the merged business.
• Settlement of the transaction.
• Tax and structuring advice
• Employment advice
• Potential competition and/or overseas investment office approvals.
What are the key terms of a Sales & Purchase Agreement?
Every deal is different, but a good SPA will usually deal with:
• The purchase price, how it will be paid and adjusted.
• What conditions must be satisfied before you part with the cash.
• An appropriate restraint of trade.
• Transitional arrangements.
• Appropriate protections for the buyer (warranties and indemnities)
What do sellers have to reveal to buyers in a merger?
The short answer is almost nothing at all unless you require them to. That's why it's important to conduct a thorough due diligence exercise. But asking the right questions is only half the battle. You need to have some comfort that the answers are correct. A good SPA will contain warranties - contractual representations about the financial, legal and operational affairs of the target. If the warranties turn out to be incorrect, you'll have a claim for damages.
How do business owners respond to due diligence?
They don't like it! Due diligence can be very detailed and hugely time consuming. For many business owners it's the first time the business has gone under the microscope. Couple that with the fact that your accountants and your lawyers might be asking the same questions and you may end up with a very frustrated seller. The key is to manage their expectations - you have every right to ask the questions - and force your advisors to work together to avoid double up and ensure a sensible attitude to materiality.
How can you protect yourself if the deal fails?
If there is a breach of warranty you may have a claim for damages against the seller. But that isn't much use if they blew the lot in Vegas! The use of retentions, escrow arrangements or warranty insurance can mitigate this risk.
You can limit the downside by using an 'earn-out' - a mechanism by which the price is drip fed over time and the amount varies according to the performance of the business post-deal. But be careful. Earn-outs can be complicated and can drive some bizarre behaviour as sellers try to maximise their pay-out.
The reality is that most failed deals are the responsibility of the buyer. Either because it didn't do its homework, it failed to properly integrate the business or it simply paid too much. There is little remedy available for buyer remorse.
What makes a good deal?
A good deal means no surprises. It means that the seller engages specialists well ahead of its exit so that the business is prepped for sale when the time comes. The buyer does its homework and builds a strong relationship with the seller. The seller stays in the business post-deal and is properly incentivised to ensure the success of the merger. Finally, both sides come away with a sense of a fair and reasonable deal.
When does it go wrong?
The worst deal I've been involved in was doomed from the start. The sellers were ill prepared for the process and so the business looked shambolic. The buyer conducted a huge due diligence exercise with advisors completely losing sight of materiality. The sale negotiation was devoid of compromise. By the time the marriage was consummated, whatever goodwill had existed had completely evaporated. The sellers, who were supposed to have stayed in the business to help drive it forward, were gone within six months.
So many SME owners are running their businesses in the moment, they are too busy trying to succeed to think about how they will move on from the business at a later stage. A large number of business owners have given little thought about succession if their company is still sustainable and has a good future.
Tell us your stories of your exit plans, how you are readying the company for the next incumbent. Email me, Gill South, at the link below: