M&A Deals - Failed Acquisitions

Why Do Some M&A Deals Result in Failure?

After the closing of an M&A deal, it is up to the buyer to ensure the success of the transaction. However, it’s only fair to say that not all of the work comes post-closing! In fact, the most successful buyers expend a lot of time and effort before the closing.

There are several reasons why acquisitions fail, but this generally occurs for two primary reasons. The first is that the buyer was overly optimistic about the potential synergies of a transaction. Thorough due diligence and analysis, before closing, is imperative to avoid these types of failures. Second, and this happens more than we’d like to see, the buyer is not able to competently manage the newly acquired business or underestimates the amount of time the transition will take.

When the buyer is overly optimistic about possible synergies with the target company and possible economies of scale, it can lead to a failure. Similarly, if the newly acquired company’s products or services do not grow as anticipated, there’s a chance for failure. Furthermore, if the buyer has underestimated the strength of the market competition, the amount of capital needed to grow the business, or other associated costs related to the transition of ownership or overestimated potential cost savings, it will be very difficult to ensure the success of the newly acquired company.

If the buyer is unable to properly manage the business it will almost certainly lead to a failed acquisition. The management team needs to have a strong understanding of the business being acquired. Furthermore, the acquiring company needs to make sure that it retains key management and other employees to ensure the operations run as planned. If the corporate cultures of the acquiring and acquired companies are vastly different, it can lead to poor chemistry between the employees of the two companies, which can cause tension in the workplace. This tension deteriorates the team effort and can cause financial losses.

In order to complete a successful acquisition, thorough due diligence is an absolute must. Such diligence must include a complete assessment of the buyer’s own strengths and weaknesses and a detailed analysis of the expected financial results. While there are too many conflicts of interest to have your investment banker complete the due diligence, the bankers are certainly well equipped, or should be equipped to help guide the process. A well experienced investment banker certainly knows about the potential pitfalls related to doing an acquisition and can help the buyer avoid them. When the proper diligence and analysis is done, the result is a successful acquisition.
M&A deals can be exhilarating for both the buyer and the seller, if done properly.

M&A transactions sometimes require financing, and buyers must carefully weigh their financing options to ensure a successful acquisition, i.e., one that will not jeopardize their financial condition. It’s also helpful for sellers to understand why buyers offer equity versus cash or sometimes ask the seller to finance part of the purchase.

Two of the most common forms of financing for acquisitions are the use of debt or the issuance of equity to fund the acquisition. Given that there are advantages and disadvantages to each form, many buyers use a combination of the two.

Financing an M&A transaction through the use of debt can be appealing since it is typically cheaper for the company to issue debt compared to equity, which usually carries a much higher rate of return expectation from investors. Issuing debt has tax benefits because the interest payments are tax deductible, and the increased leverage can also boost a company’s return on equity. Another benefit of issuing debt is that no additional shares are issued, and so there is no dilution of ownership. On the other hand, there are many notable downfalls to financing through debt. The issuance of too much debt will hurt the company’s credit rating, which would hinder its ability to borrow money in the future and would lead to an increase in the company’s cost of debt. Debt issuance may also be limited by existing lender covenants that set a restriction on the amount of debt the firm can assume. This might make it impossible for some companies to borrow enough money to make a large acquisition.

When equity financing is utilized, a buyer can either offer its stock to the target firm’s shareholders or offer cash, which would be generated by the proceeds from an equity offering. Despite the higher cost of equity, it is still very common in M&A transactions because of the flexibility it provides the issuers. Some of the benefits of equity include (i) no mandatory interest payments, (ii) no principal that must be repaid, and (iii) no restrictive covenants related to its issuance. Financing an M&A transaction with equity has no impact on a company’s credit rating, therefore allowing them to issue debt in the future if needed. Equity offerings can however have negative side effects. Issuing stock can hurt a firm’s earnings per share and return on equity as it becomes less leveraged. Furthermore, the volatility of a company’s share price can cause uncertainty about the exact acquisition valuation, which in turn can increase the amount of time needed to reach a closing or even destroy the planned transaction.

Frequently, public companies use equity financing as their preferred form of payment in M&A transactions. Nevertheless, debt still plays an important role because of its cost effectiveness and the advantages of leverage.

An experienced M&A advisor can help buyers and sellers figure out the best combination of debt and equity for any particular transaction.

Versailles Group, Ltd.

Versailles Group is a Boston-based boutique investment bank that specializes in international mergers, acquisitions, and divestitures.

Since 1987, Versailles Group’s skill, flexibility, and experience have enabled it to successfully close M&A transactions for companies with revenues greater than US$2 million. Versailles Group has closed transactions in all economic environments, literally around the world.

Versailles Group provides clients with both buy-side and sell-side M&A services and has been completing cross-border transactions.

More information on Versailles Group, Ltd. can be found at

www.versaillesgroup.com

For additional information, please contact

Donald Grava

Founder and President

+617-449-3325

In M&A transactions, an escrow or a holdback is used to ensure that certain conditions are met by the seller before an agreed amount of funds is released. These structures help allocate risk between buyer and seller and are common in middle-market business sales.

If an escrow is used, a third party known as the escrow agent holds the funds until receiving instructions that certain obligations have been satisfied and the funds can be released. Most of the time, the escrow agent is a large, reputable bank or trust company that provides this service.

In middle-market transactions, escrow and holdback structures are often heavily negotiated and can materially impact a seller’s net proceeds, timing of payment, and overall risk exposure.

How Escrow Accounts Work

The escrow agent holds the funds pursuant to an escrow agreement executed at closing. That agreement governs how claims are submitted, the required notice procedures and timelines, dispute resolution mechanisms, the conditions for release of funds, and the investment of escrowed funds along with the allocation of interest.

In most transactions, escrow funds are invested in low-risk instruments. The interest earned is typically paid to the seller upon release, although this is negotiable.

Despite the fact that escrow accounts are very common in M&A transactions, the specific terms can vary greatly. The average escrow amount typically ranges between 10 percent and 20 percent of the purchase price. The holding period generally ranges from 12 to 24 months following closing. In certain situations, however, both the percentage and the duration may be increased depending on the perceived risk of the transaction.

Why Escrows Are Used

Escrows are designed to protect buyers against unforeseen financial losses after closing. Buyers are often concerned that undisclosed liabilities may surface once the transaction is complete.

Funds are typically released to the seller at pre-agreed times. Sometimes, partial releases occur as early as six months after closing. It would be unusual for the entire escrow to be released that early, but buyers and sellers frequently agree to release portions after six or twelve months if no claims have been made.

The funds are released only if all agreed obligations have been fulfilled. If unknown liabilities arise, or if the seller fails to meet certain pre-agreed conditions outlined in the Purchase and Sale Agreement, the buyer may have the right to recover amounts from the escrow.

Provided the agreed conditions are met, escrow funds ultimately belong to the seller. Buyers do not expect escrow funds to be returned to them. Rather, the escrow serves as a protection mechanism in the event issues arise.

Because the funds are held by a neutral third party and can only be released in accordance with the escrow agreement, escrows can reduce a seller’s risk of not being paid.

The Alternative: Holdbacks

The alternative to an escrow is a holdback. In this structure, the buyer simply retains a certain percentage of the transaction consideration instead of depositing it with a third-party escrow agent.

In some transactions, a holdback is used to secure a specific known risk such as a pending tax matter, while general indemnification risk is covered through a separate escrow.

The primary risk of a holdback is that the funds remain in the buyer’s possession. If the buyer were to go bankrupt or otherwise become unable to pay, the seller could face increased credit risk. While such situations are uncommon, this risk is one reason many sellers prefer the added protection of a formal escrow arrangement.

Representation and Warranty Insurance (RWI)

In recent years, representation and warranty insurance, often referred to as RWI, has become more prevalent in middle-market transactions. RWI allows an insurance policy to cover certain breaches of representations and warranties, which can reduce the need for larger escrow amounts.

For sellers, this can increase cash received at closing, reduce post-closing exposure, and improve overall deal competitiveness. However, RWI does not eliminate escrow entirely and often excludes known risks. It is typically used as a complement to traditional escrow structures.

Escrow accounts and holdbacks are important tools for allocating risk in M&A transactions. While they are standard components of many deals, their structure, size, and duration can significantly affect a seller’s ultimate proceeds and risk profile.

Written by Don Grava

Versailles Group, Ltd.

Founded in 1987, Versailles Group is a boutique investment bank that specializes in international mergers, acquisitions, and divestitures. Versailles Group’s skill, flexibility, and experience have enabled it to successfully close M&A transactions for companies in the middle and lower-middle market. Versailles Group has closed transactions in all economic environments, literally around the world.

Versailles Group provides clients with both buy-side and sell-side M&A services and has been completing cross-border transactions since its founding in 1987.

More information on Versailles Group, Ltd. can be found at

www.versaillesgroup.com

For additional information, please contact

Donald Grava

Founder and President

+617-449-3325