Tips to Make That Merger Work


The current economic downturn and market focus on the quality of corporate earnings highlight the problems of companies that overpay for assets. Recent studies have shown that more than half the mergers and acquisitions during the 1990s actually diluted shareholder value within the first year. Corporate CPAs on M&A teams can offer these suggestions to executives at acquisitive companies to help their deals achieve long-term success.

BEFORE THE DEAL
Here are some steps a buyer can take before signing a commitment letter:

Involve top management early in the due diligence process. Senior executives must play an integral part in determining whether the target’s business will fit well with existing operations. For acquisitions within the same industry, senior management can use its experience and objectivity to evaluate the strength and ability of the target’s management to perform after the merger.

Make sure due diligence is thorough. Before bidding, the due diligence team should request access to all the target’s relevant accounting records and arrange meetings with key management personnel. If the target has multiple international sites, the team should visit all key operating locations and meet with local management. The team should obtain board meeting minutes, calculations of accrued liabilities, legal opinions on unrecorded liabilities, fixed asset analysis, inventory and receivables aging and independent audit workpapers. The acquirer must have an in-depth understanding of the target’s operations and any risks involved before deciding whether its bid for the company is in the right ballpark.

Critically evaluate information from due diligence process. Management must assess the due diligence findings and review the earnings projections the seller’s investment bankers prepared because they tend to make overly optimistic forecasts to drive up the target’s price. For example, management should ask what would happen to earnings projections if in the next 12 months interest rates moved up 50 basis points, thereby increasing the target’s cost of capital. The buyer must believe completing the deal makes sense against all probabilities.

Be aware of “troubled companies.” Companies are not always what they seem. Acquirers frequently will hedge undisclosed risks by placing a portion of the purchase price into escrow for a period after the acquisition. If the parties resolve these problems after closing, the seller can draw on the escrow for the unpaid balance of the purchase price. However, if the risks result in damages, such as an unfavorable settlement of a pending lawsuit, the buyer keeps the escrowed funds to cover any losses.

Involve the integration team early. The acquirer must have a sound business integration plan in place before closing. Members of the integration team from the legal, finance and risk areas each can use their perspectives to help identify and address potential problem areas such as the target’s historical accounting practices and disclosure of its earnings projections.

Negotiate tight purchase agreements. Without extensive due diligence, buyers have only the seller’s representations to protect themselves from hidden liabilities at closing. Purchasers need proper representations and indemnities from the seller with respect to environmental, tax, employment and other liabilities that may be present but unknown—the contract should specify that all liabilities at closing (whether known or not) remain with the seller.

Include material-adverse-change clauses. M&A contracts can take months to negotiate, and a material-adverse-change (MAC) clause protects the buyers between signing and closing the agreement. If a material adverse change occurs, the purchaser has the right to lower the offer or, in some cases, walk away from the transaction. Although MAC clauses are standard in the M&A world, sellers generally want one defined as narrowly as possible; buyers want a broader view so they can alter the price if the underlying business results change significantly before closing—due to a natural disaster, for example.

AFTER THE CONTRACTS ARE SIGNED
CPAs should remind clients that postclosing activities should include

A formal policy for postclosing audits. Acquirers should ensure that someone outside the deal team, such as the internal audit department, performs independent audits at the deal’s close and each year thereafter. The audit provides assurance that early writeoffs of, for example, goodwill or excess inventory charges have not been taken in purchase accounting areas to enhance either the reported results of the acquisition or an assessment of the target’s performance against what the board used to approve the deal.

M&A professionals as part of the integration team. Many acquisitive companies assign members of the M&A team directly to the integration process to ensure that the planned synergies actually get implemented within the combined company’s operations. Employees at the target company appreciate having members of the M&A team whom they’ve come to know continue on as part of the integration. Staying on through the implementation makes the M&A team members accountable and provides them with recognition when the deal works.

Source: Adapted from “Fundamental Issues Surrounding Failed Acquisitions,” by Robert Stefanowski, CPA, managing director of GE Capital’s merchant banking business in New York City. His e-mail address is robert.stefanowski@gecap.com . He would like to thank Anshuman Ray ( anshuman.ray@yahoo.com ) for his assistance.

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