Driven by mega-deals and a healthy spike in U.S. mergers and acquisitions (M&A) transactions, thus far 2019 has been an exceptionally active year in the global M&A market. Through the end of Q3 2019, deal volume reached $2.49 trillion, with the average deal size at a record $424.6 million, according to Mergermarket. In the first half of 2019, the biggest M&A transactions —so-called “mega-deals” valued at $10 billion or more—had grown 27 percent in terms of both deal volume and deal count compared to 2018, according to statistics from Dealogic.
More Than Just Finances
As the surging number of mega-mergers shows, deal making is involving ever-larger and complex M&A targets—many of them spanning the globe.
The pace of deals is unlikely to slow: With fears of a recession rising and continuing political uncertainty, companies are feeling even more pressure to complete transactions—and quickly. During such a fast-moving and competitive climate, companies might be tempted to sacrifice deep reputational due diligence in favor of simply getting their deals done.
They should resist that temptation: while examining financial matters is important, so, too, is investigating the target company from a legal and reputational perspective. A solid profit margin won’t do much for an acquirer if the merger target is covering up a host of #MeToo accusations, for example.
Indeed, short-changing nonfinancial due diligence during the deal-making process is a critical mistake that can end up costing a company significantly in the long run. A company that has failed to conduct appropriate diligence to identify problems will find itself owning issues like a bribe hidden on the acquisition’s books or a CEO sued multiple times for sexual harassment. On the other hand, a comprehensive, independent assessment of the counterparties involved in a transaction can help uncover risks that could result in millions of dollars of damage after a merger closes.
As a result, an objective investigation to identify potential reputational, financial, or legal risks should be a critical component of a company’s merger or acquisition protocol. Such due diligence can be even more important in global deals where a U.S. company’s M&A target operates under different legal and regulatory regimes.
The Advantages of an Early Start
When in the M&A life cycle should a company start the due diligence process? From an investigator’s perspective, the answer is obvious: as early as possible. Ideally, the due diligence process will begin even before negotiations, when the acquirer is still considering a potential target. While this may increase investigative expenses, doing diligence early can help identify hidden risks that might nix a potential deal. Investigation costs are a pittance relative to the legal, reputational, and financial costs the company could face if a deal blows up or if the deal goes through and the company is on the hook for potential liabilities that went unidentified.
Moreover, the longer investigators have to conduct due diligence, the more information they can provide their client and the more time the client has to analyze and digest the information. Unfortunately, the fast pace of deals and the seemingly tedious nature of an in-depth investigation can often lead deal makers to push off nonfinancial due diligence until the last minute—with potentially expensive and embarrassing consequences.
Consider this example: A client of ours had been working for a year and a half on a planned acquisition. Just weeks before the deal was to be announced, and as the press was getting wind of the proposed transaction, our team was asked to perform reputational due diligence on the acquisition target and a number of its principals, who were slated to stay on to manage the new entity.
That is, until our investigators started digging. Even in the unusually brief period of our investigation, we identified so many red flags that our client decided it wouldn’t going through with the deal as originally envisioned. Suffice it to say, this was a major crisis on the verge of the public announcement that could have been avoided if diligence had been conducted far earlier in the process.
Of course, due diligence does not always identify information that ends up scuttling a deal. But even in less extreme cases, a diligence effort that identifies risk early may help the acquirer and the merger target find solutions to mitigate issues before a final deal is signed. And the information gathered during an investigation might provide an acquiring company with additional leverage that can help it gain an advantage in negotiations.
The Closing and Beyond
Even after the deal closes, the due diligence process shouldn’t stop.
Indeed, as companies integrate during a post-acquisition period and have even better access to information than they had during the M&A process, they have an opportunity to continue diligence efforts and identify previously undetected issues. While it shouldn’t take the place of extensive diligence prior to a deal closing, a post-deal due diligence effort can help identify and mitigate issues that may have been missed during a fast-paced deal process.
From a regulatory and compliance perspective, transactions enter something of a “grace period” just after completion. During this time, companies that find issues and bring them to the attention of regulators like the U.S. Department of Justice may be able to insulate themselves from penalties for the acquired company’s previous misconduct. However, if the company either waits too long or fails to make a good-faith effort at identifying and mitigating issues, it owns them.
Nor should the due diligence process be limited just to pre- and post-deal snapshots in time. Instead, due diligence is most effective when it is an ongoing process aimed at reducing risk over the long term. Along the way, the process should be periodically refreshed to reflect changes in the business. Putting this kind of ongoing monitoring in place can help ensure the long-term financial and business success of the newly formed company.
- https://www.mergermarket.com/info/3q19-global-ma-report-legal-league-tables
- https://www.dealogic.com/insight/ma-highlights-h1-2019/
- https://www.wsj.com/articles/asian-stocks-gain-on-tariff-delay-11565769562?mod=searchresults&page=2&pos=10
- https://www.cnn.com/specials/brexit
- https://www.justice.gov/opa/speech/assistant-attorney-general-brian-benczkowski-delivers-remarks-33rd-annual-aba-national
This article originally appeared in Law360 on October 15, 2019.
