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Executing the deal
Understanding the M&A lifecycle
Signing the deal to buy or sell a company is often the most memorable moment for those involved in an M&A transaction. However, it is only one of the stages within the M&A lifecycle, in which each step impacts the other ones. In this article we will take a closer look at the third step: the execution of the deal.
Optimising the value
Now that the due diligence investigation has been completed and the outcomes have been interpreted, we move on to what is probably the most exciting step towards a successful transaction: the binding offer, followed by the execution of the deal. This stage of the M&A cycle includes a number of pivotal steps, such as drawing up the share purchase agreement (SPA), submitting notifications about the transaction to regulators, drawing up the transaction financials, and preparing for Day 1. It may seem that the end of the transaction is near, but actually there are still a number of things to consider and to accomplish before we get there. The better you execute the deal, the more value the transaction will eventually deliver – such as a fair settlement amount and a good starting point after you take over ownership.
Share purchase agreement (SPA)
Drawing up the SPA is often considered as a formality for lawyers. To a certain extent this is true, since many of the paragraphs in the SPA contain legal aspects such as warranties, guarantees, and resolution of potential disputes. However, the SPA first and foremost includes the financial terms that define how the transaction will be settled, with details on the settlement mechanisms (we will explain the locked box and completion accounts mechanisms below). It protects you from unforeseen circumstances by agreeing the most appropriate guarantees and warranties, and definitions and standards to narrow down interpretations, e.g. in locked box, permitted leakage, bonuses for staff, dividends, and capital expenditure.
Locked box or completion accounts?
There are two main mechanisms to determine the purchase price: completion accounts and locked box. Completion accounts is the mechanism that was traditionally used – and still is favourite in the US and Asia. It is based on the financial statements of the acquired company at (a future) closing date. This means that after the closing date there is still some work to do to determine the price. Currently, we see that more and more deals are completed under the locked box pricing mechanism. In this case, the parties agree on a fixed price based on the balance sheet of target at an effective (economic ownership) date prior to signing date. Since the locked box mechanism constitutes a delay between economic transfer and payment for the transaction, the buyer pays interest over this period to compensate the seller for the late payment. Further, seller needs to compensate buyer for leakage of value that occurred in the same period, which relates to money flows to seller in the period of buyer’s economic ownership.
The locked box mechanism is mostly used in Europe and recently large American private equity firms have started to adopt the locked box as well. Even though locked box presents some additional risks for buyers (as control for the period between locked box date and closing is still with the seller), it offers the benefit of more clarity of financing flows at signing. Since drafting an SPA based on locked box is less complex, saves time, and also limits the need for another set of financials to be prepared, the management team can focus more time on employing the integration benefits and realising the business plan.
When the SPA has been signed, there is another important matter to consider: informing the regulatory authorities in all relevant markets. We already discussed this in the article about due diligence. Sometimes, decisions of regulators are based on political reasons that are almost impossible to predict. But usually, potential obstacles can be identified beforehand. So before issuing any offer, it is advisable to do a detailed analysis to determine any objections to the deal.
Realising the foreseen benefits
At the same time, mobilisation and set-up of the integration will be key. When identifying the right deal, you consider the key objectives of an acquisition. Now that the first part of your strategy (realising an acquisition) has materialised, how can you ensure that the foreseen benefits are realised? You will soon receive the “keys” to your new asset. And just like the day when a house-owner gets the keys to a new home, you should already know what to do with the asset. The same is true for acquiring a business. What is the strategic and financial rationale for the deal? To what degree will the two organisations be integrated? What are the key milestones to be achieved in the first 12 months? How will it be structured and resourced? What are the major risks, and is effective mitigation in place? An integration blueprint is often set up in the early weeks of an integration process to build alignment between both sides and to set out a roadmap for the integration.
Preparing for Day 1
However, before you receive the keys, when the transfer of legal and financial ownership will take place, all legal and statutory requirements must be met, financial controls must be in place and the two companies must be able to continue day-to-day operations successfully and without interruption. In fact, most integrations require the completion of 200 to 350 separate tasks before this day, from changing bank accounts and aligning stationery with the corporate identity to customer contract novations and having a communication plan in place. Which actions are crucial before handing over the keys? Are there any interdependencies with other deliverables? Assigning ownership and tracking progress of all these tasks is coordinated by the integration team.
A longer-term effort
A successful Day 1 will set the tone for the rest of the integration program, providing momentum and positive direction. However, the integration of two companies is usually not completed on Day 1. This is a longer-term effort, enabling the key objectives of the acquisition to be achieved. As integration contains the largest risk of destroying value in a deal, it is crucial to have the right resources in place. You will need a clear integration strategy to deliver the promised returns of the deal. This is the topic of the next article in this series and the final stage of the M&A cycle.
The M&A cycle in a nutshell
Below we have embedded a picture of the M&A lifecycle and a short description of each phase. In the coming months we will publish a series of articles on each step of the M&A lifecycle, sharing stories and thoughts about each of these phases of the M&A lifecycle to offer you insight in the entire process and help you benefit from the promised returns of a deal. In the lifecycle we will emphasise the integration of your steps and actions, and what might happen if you deal with every step in isolation.
Identify the Right Deal. Either through active selection of companies or business units, or by reacting to offers in the market (one-on-one or by auction). This phase involves setting corporate strategy, identifying growth areas or selling non-core activities.
Pricing and offer. Initial pricing of a company and assessing how easy or difficult integration or separation is going to be, as well as which legal and tax structure will be most suitable (and its impact on pricing).
Perform due diligence. What do we buy? It is crucial to assess the real value of the company, the presence of ‘skeletons in the closet’, financial aspects such as balance and cash flow as well as non-financial analyses (e.g. company culture, integrity, operational synergy benefits, and operational analysis of real estate).
Execution. After the due diligence phase, a Sales and Purchase Agreement is drafted, the relevant authorities are informed and consulted, and the ‘closing’ procedures are executed.
Deliver the Promised Returns. After the transaction has been completed, the expected results must be achieved – how to realise synergies and to prevent that in a future strategic re-assessment the new business will be considered as a non-core activity and be resold (without any added value). And the final step: Post-Merger Integration.
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