Deal Or No Deal? Protecting Assets And Enhancing Value In M&A Deals
Faced with increasing volatility, organizations may find organic growth harder to achieve – merging with or acquiring another company is one way to expand. This past year has seen little to no slowdown in mergers and acquisitions (M&A) activity, which hit record levels in the first half of 2018.
From companies evaluating inorganic growth strategies to large-scale technology buys – including the recent $33 billion announcement by IBM, every region in the world saw significant deal activity during the year’s first half.
Whatever the reasons for an M&A deal, no transaction is without risk, and organizations must strike a balance between minimizing the risks and maximizing the value right up to when contracts are signed – and beyond.
Worldwide, the total value of M&A hit more than $2.5 trillion in the first six months of 2018, according to data compiled by Thomson Reuters. U.S. deals represented more than $1.0 trillion of that total, with North America representing 45.2 percent of the world’s total M&A value during the first six months – an increase of 27 percent over the same period last year. Both the number and value of first-half deals were down in the Middle East and Africa from the same period last year. Asia-Pacific, excluding Japan, saw a 33.1 percent increase in deal value. M&A activity involving Japanese firms was up dramatically – nearly quadrupling – in the first half. Deal value was up 62.3 percent year over year in Central and South America, and up 10.9 percent over the same period last year in Europe.
Outlooks into 2020 suggest that M&A activity in the Americas will be driven by large strategic transactions and growth might slow due to trade tensions. Despite Brexit uncertainty, growth in Europe is expected to be modest due to improving labor markets and an increase in consumer spending.
In addition to strengthening economies and a desire for growth, other factors such as technology acquisition, product diversification, and market expansion are driving the M&A market.
Many of 2018’s largest deals have been in the media and health care sectors. Notable have been efforts by many media companies to look to M&A as a way to compete with massive tech companies looking to control both the content and the way it’s consumed. Bids by Comcast and Disney to acquire assets of Twenty-First Century Fox Inc. – and their battle won by Comcast for Britain’s Sky – are examples of that trend.
In tech, the pace of deal activity in 2018 is coming off the record highs of the previous two years. The lion’s share of deals have been in the U.S., with tech giants Apple, Facebook and Google leading the way.
For some companies, including those in financial services and technology, the goal of an acquisition is to gain intellectual property (IP). At $19 trillion, more than 80 percent of the S&P 500’s market is represented by intangible assets, such as IP. Gaining IP – as well as protecting it during a transaction – is critical: “Having an understanding of IP asset value is essential to business and an absolute necessity when firms are looking toward mergers and acquisitions,” states Lewis Lee, CEO of Aon’s Intellectual Property Solutions group. Lee goes on to state that quantifying value is advantageous for both buyer and seller. Companies that quantify this can have a competitive advantage and realize maximum return during an M&A transaction.
Understanding And Managing M&A Risks
For any company looking to successfully complete an M&A deal, few aspects can be key to the transaction: expertise, due diligence and critical talent retention.
Enlisting M&A Expertise
Any organization considering any type of M&A activity should understand the types of expertise and skill sets required for a successful deal, including post-close integration. Businesses should build up their M&A capability, including enlisting external M&A experts to help evaluate potential targets. This will help them identify any potential gaps that could jeopardize a close. Understanding the full expertise needed across targets, securing investments, managing risks and enhancing returns are critical for organizations to achieve the expected return on investment.
Conducting Due Diligence
Conducting comprehensive due diligence is key to ensuring the organization manages risks that can make, shape or break the deal. This includes identifying liabilities, one-time costs, compliance risks, protecting intellectual property and identifying critical talent.
Identifying And Retaining Critical Talent
Critical talent has significant impact on deal success, and an important factor to address early – including during due diligence. Dawn Conrad, executive vice president, Strategic Advisory at Aon, underscores the role of critical talent throughout the transaction: “From revenue leakage, to missed synergy objectives, to even delayed integration, critical talent leaving an organization impacts overall deal success.” Conrad notes that identifying the critical talent and understanding how to retain them is essential. “Organizations who are most successful tend to identify their critical talent early. They use multiple retention approaches, including financial retention packages, personal communication, meaningful roles and access to top leaders.”
Protecting Assets, Enhancing Value: Ensuring A Successful M&A Transaction
In many quarters, insurance solutions are the preferred means to protect against various risks involved in an M&A deal. Such insurance programs are eclipsing traditional protections involving escrowed funds, indemnifications, clawback provisions and other contractual measures.
- Representations and Warranties (R&W) insurance: Also referred to as “Warranty and Indemnity” in Europe, the Middle East and Africa and Asia-Pacific, R&W allows a buyer in an M&A deal to recover from the insurer for losses resulting from breaches in the seller’s contractual representations. R&W can replace the escrow funds that might be required of the seller, thus improving the buyer’s offer. Jeremy Liss, partner at global law firm Kirkland & Ellis LLP, notes the role R&W insurance has played in M&A deals: “R&W insurance has had a transformative effect on deal structuring and M&A risk allocation, forcing historically immovable strategic buyers to think outside the box and reconsider large indemnity caps and escrows in favor of insurance.”
- Tax insurance: Tax insurance protects buyers against adverse tax rulings related to the seller’s previous tax positions. Among the expenses it covers are tax, interest, penalties and costs associated with contesting the taxing authority’s action. “Tax insurance continues to be a powerful tool for M&A professionals where uncertainty around taxes can create a hurdle in the deal,” said Gary Blitz, senior managing director, Transaction Solutions at Aon. Tax insurers’ risk appetite has expanded to include a willingness to insure the accuracy of numbers and valuations as well as more traditional tax opinion matters. Tax insurance can also be flexibly used as a corporate risk management tool outside of M&A.
- Litigation insurance: Pending or potential litigation can expose buyers to significant risks and financial liability. Litigation insurance can offset that risk or limit the buyer’s liability exposure once the deal is complete. “Litigation insurance helps sellers avoid substantial escrow requirements and allows buyers to ringfence the cost of damages from an adverse judgment,” says Michael Schoenbach, senior managing director, Transaction Solutions at Aon. “Along with tax insurance, litigation cover can also be used to protect companies from catastrophic loss from an adverse judgment.”
2019 And Beyond: Looking To The Future of M&A
There are signs that 2019’s level of M&A activity might slow from its current pace, due to geopolitical issues such as Brexit and trade and tariff concerns. Others, however, point to private equity capital and U.S. companies’ post-tax reform cash stockpiles as reasons M&A might continue at a healthy pace.
Whatever the overall pace of M&A activity, companies embarking on an acquisition will need to assess risks they might encounter and take the necessary steps to address them.
“As we look to increased activity in the M&A space, leaders are looking for ways to best protect their assets and enhance value as deals close,” said Brian Cochrane, global CEO, M&A and Transaction Solutions at Aon. “There are proven techniques and tools available to those business leaders to help them achieve success and meet their M&A goals.”