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A recent study by Mergermarkt shows that global M&A remains largely stagnant in terms of year-over-year activity. In this news flash we briefly touch on (i) challenges, (ii) the different role due diligence has in the current economic climate, and (iii) the importance of alignment of sellers and buyers.

Challenges

Macro-economic

Most important factors contributing to the 2013 decline in M&A activity are tightening monetary policies and political uncertainty. Especially in the EU zone crisis, instability and political disunity are perceived as a threat. This (and other risks associated with M&A) causes boards to be wary and rather focus on core business than diversify into new areas. As from the start of 2014 there seems to be a great level of improvement.

Financing

Low interest rates have kept bank lending as a preferred source for funding M&A deals; highly-rated borrowers have cheap bank debt available. Interestingly enough, in the US an estimated USD1.24 trillion sits on corporate balance sheets.  Shareholders demand that money should be put to work or should else be returned to shareholders.

Regulation

Finally, regulatory challenges may also slow down M&A activity. A recent example is the AIFM directive, which became effective despite much resilience by financial institutions.  In a global context, complex anti-trust regimes and foreign ownership limitations result in increased risk to expand business.

Different role due diligence

Flexibility

On a practical level, the above tends to create gaps in buyer’s and seller’s expectations; sellers often expect higher multiples than buyers. In our daily practice, we often stress the need to be flexible during deal making to tackle these gaps. In addition, deals may not be closed if an extensive approval process still needs to be completed. Our suggestion therefore is to remove as much approvals in advance as possible.

Early stage involvement

Due diligence undertaken by buyers is conducted much more in advance and more in-depth.  More time is spent with the management of the target to learn about the business. As buyers are more selective, focus is on real added value.

(Post) completion

In our global study (“The M&A Blueprint: From inception to integration”) we show that deal due diligence does not focus enough on post deal integration. In addition, the study shows that little or no focus beyond the deal transaction to post-integration is compromising the benefits and value of cross-border M&A. Legal advice is currently brought in too late and not at a strategic level. Integration went as expected for 86% of businesses who involved their in-house legal teams in the transaction early enough, compared with only 63% who brought them in too late.

Aligning buyers and sellers

Lock in seller

As described, buyers experience cultural, financial and political risks as a big factor to ‘wait and see’ instead of doing a deal. Tools to mitigate such risks is to lock in seller after the transaction (e.g. by means of earn-out schemes and/or escrow arrangements), or having the seller retain a large minority stake (up to 49%) in the company.

Ongoing alignment

We experience that buyers also require increased protection in the sense that management must commit to continue to deliver (financial) results after the transaction. Milestones are regularly used, and often in more detail than before, in order to ensure targets are identified in advance. Delivering and executing the business plan is essential in that respect.

Creating value

Underperforming parts of a company undermine the share price significantly. Backed by data from a recent study by Mergermarket, we note a trend towards spin-offs and demergers to unlock shareholder value.  It allows corporate resources to be allocated in accordance with each company’s strategic alliances. This in turn allows investors to align their holdings with investment objectives.

Rob Faasen

Miriam Ee, van

Tom Wijngaarden, van