Mergers and acquisitions (M&A) can be a
powerful tool for businesses looking to expand their operations,
enter new markets, and achieve economies of scale. However, M&A
transactions are complex and involve significant risks and
challenges. These challenges could be due to a variety of factors,
including strategic, financial, and legal issues, which can derail
the success of the deal if they are not adequately managed. In this
article, we will discuss some common pitfalls that companies should
avoid when engaging in M&A, with an emphasis on poor legal due
diligence.
COMMON PITFALLS IN MERGERS AND ACQUISITION.
1. OVERVALUATION OF THE TARGET COMPANY
One of the most common pitfalls in M&A strategy is
overvaluing the target company. This may occur due to a number of
factors, including unrealistic growth progression, emotional tie to
the deal, or being overly optimistic about prospective synergies
and the financial benefit that might result from the deal.
Overvaluing the target company can lead to paying too much for the
acquisition, which can result in reduced returns, financial strain,
or even bankruptcy.
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Hence, it is important to conduct a thorough assessment of the
target company. This would aid in detecting potential issues and
provide the opportunity to address any discrepancies early in the
process. This typically involves conducting a careful analysis of
the company’s financial statements, market position and growth
prospects.
2. INCOMPATIBLE CULTURES AND MANAGEMENT
STYLE.
Corporate acquisitions often involve combining two or more
companies with different cultures and management styles.
Incompatible cultures and management styles can lead to significant
challenges, such as employee turnover, resistance to change,
reduced productivity, cost overruns, and reduced synergies.
To avoid this pitfall, it is essential to consider cultural and
management compatibility early in the acquisition process. This
should involve a thorough assessment of the two companies’
cultures, values, communication strategies and management styles,
as well as a plan for addressing any differences or challenges. It
is also important to involve key stakeholders from both companies
in the integration planning process, to ensure a smooth and
successful integration.
3. POOR FINANCIAL DUE
DILIGENCE:
The valuation of the target company cannot be done without
proper financial due diligence. Financial due diligence is a
detailed investigation of the targeted company’s financials and
accounting policies so as to understand its business and financial
health as well as identify factors that could affect its business
and investment risk. It provides valuable information to support a
fair purchase price and ensures the appropriate warranties and
representations are included in the purchase agreement.
Avoiding or conducting poor financial due diligence can result
in being financially liable for the past non-compliance of the
target company under applicable laws. It can also lead to other
unexpected surprises that can derail the success of the M&A as
all financial risks of the target company are passed to the
acquiring company after a successful merger or acquisition
process.
4. POOR LEGAL DUE DILIGENCE
M&A deals are subject to various regulatory and legal
considerations, depending on the specific industry and state. Legal
due diligence typically covers a wide range of legal areas,
including but not limited to corporate and business structure,
review of contracts and agreements, intellectual property,
taxation, employment and labour matters, legal disputes and
insurance coverage.
Legal due diligence can help identify past or potential legal
risks and liabilities, allowing the acquiring company to negotiate
appropriate indemnification clauses, representations, and
warranties, or even reconsider the decision to proceed with the
transaction altogether. Additionally, it identifies elements that
may impact the acquiring company’s operations, reputation, and
financials after the transaction is completed. For example,
regulatory compliance issues may arise if the target company has
not been thoroughly assessed for compliance with applicable laws
and regulations. This can result in regulatory penalties, fines,
and other legal consequences for the acquiring company, affecting
its reputation and financial performance.
Further to the above, issues such as undisclosed litigation,
pending regulatory investigations, or contractual breaches can come
to light after the transaction is completed resulting in unexpected
legal disputes, financial losses, reduced returns on investment and
reputational damage that could have been avoided with proper legal
due diligence.
CONCLUSION
The legal concept of “caveat emptor,” which means let the buyer
beware, dominates M&A transactions. Hence, an acquiring company
needs to have a thorough understanding of the target company and
must not stop at the surface. Due to the technicalities involved in
mergers and acquisitions, it is important that an acquiring company
engage qualified professionals with expertise in the relevant areas
to conduct comprehensive and accurate research on target companies
before the acquisition takes place. The correct data and insights
can help all parties make better decisions based on a thorough
understanding of the full range of risks and opportunities.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
