Thursday, August 14, 2014

Mitigating Common Deal Risks in Acquisitions

Last week we reviewed some common deal risks in acquisitions.  Today's posts deals with ways to handle these risks.  The original post is copied below along with thoughts on mitigating the risks.  We've written in more detail on many of these items in other posts but provide an overview here.

       One of the topics that draws considerable interest in our Amsterdam, acquisition finance course is mitigating deal risk in acquisitions.  In shortened version, here are some of the major risks involved in acquisitions.   

       1. The deal takes too long to settle (increasing the risk of material changes). The longer it takes to work through a deal the less likely it will be completed.  

     Some of the ways to handle this problem involve using cash (as it is faster than stock due to approvals, etc.).  Of course, deadlines help as well.  Material adverse clauses won't solve this problem but are certainly important in mitigating some consequences of lengthy transactions.

2. The cash flows don’t play out as expected.  
We acquire firms assuming a set of cash flows for the future.  In many cases these cash flows don't play out.  It is also common for the seller to have more optimistic expectations about the future than the buyer.  It is necessary to bridge the gap between these expectations to complete the deal. 

       One solution to this problem is the use of contingent payouts.  Earnouts can bridge the gap between seller and buyer expectations and help in completing a deal. But earnouts are also associated with other problems and should be handled with care - especially for sellers who may be giving up control of operations and hence influence on the payouts.  

3. One party abandons the transaction.  
This is particularly problematic.  For sellers, it can mean a lost opportunity to cash out.  For bidders, it can mean the loss of time, money and opportunity spent courting a target firm.  

        Termination fees are often used to reduce the pain associated with this problem.  

4. Another bidder acquires the firm.  
Similar to the above, this can be problematic for bidders not only because of lost time, money and opportunity but because a rival bidder (likely a competitor) has won and is now stronger. 

       Termination fees are also useful here.  Another solution involves the use of toeholds.  If another party acquires the company, the original bidder gains on the appreciation of shares.

5. The stock price of one of the parties changes before closing.  
Particularly problematic in stock deals.  You think you have a deal arranged but at the time of closing find that the share exchange ratio you agreed upon now produces less than optimal terms.  For example, a one for one deal looked fine when the bidder''s stock price was $40, but doesn't look so good at closing when that price has dropped to $30.  

       Collars are useful in protecting against this problem and can give more price assurance to both bidders and sellers.  A typical collar places a ceiling (maximum) and floor (minimum) on the price that will be paid.

       All the best,


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