5 Hidden Deal Killers & How to Disarm Them
Negotiating a sale or merger can be an emotionally exhausting process. As such it is immensely frustrating when deals fail because of bickering over materially insignificant items, especially after countless hours have already been invested towards reaching agreement on the big issues.
Trivial disagreements can have a cascading affect on the goodwill of an entire negotiation. A party may re-evaluate their position on previously agreed items as a dispute over a minor term erodes their confidence and trust that the other side will continue to act in good faith.
These items are landmines in the negotiation process, and like their real world equivalents have three distinct characteristics:
They are small
They are explosive
They are well hidden
It is therefore vital that you acquaint yourself with the common trap issues in the setting of mergers and acquisitions. When dealt with proactively in advance, otherwise volatile situations are easily defused.
The following list details five of the most common M&A landmines as well as how to prevent them blowing up your deal.
1. Definitional Disagreements
Transactions rapidly go awry where parties appear to have reached agreement but subsequently discover they have ascribed different meanings to key words.
An easy example here is definition of “revenue”. Parties must be on the same page about whether this is defined gross or net of service tax and whether fees received for client disbursements are included in revenue. Financial planning businesses also distinguish between recurring and upfront revenue as well as applying different multiples for different types of revenue.
Where there is room for doubt about how something could be defined it is important to discuss this in the open. It takes longer to double check that everyone is on the same page about things which seem obvious but the old carpentry adage of “measure twice; cut once” is one well worth remembering.
2. Staff Contracts
Staff members are often a key component to the successful implementation of a merger or acquisition. Yet many times staff employment contracts are dealt with as an afterthought. A lack of effort in this area can create huge conflict and parties are rarely likely to proceed if they feel they will have an open insurrection on their hands.
The single biggest observed mistake is issuing incumbent staff with standard employee contracts that are generally only used for new hires. For instance where a staff member is essentially staying in the same role on the same pay, they may be offended if the employment contract offered by new management stipulates a six month probation period and half the usual lunch break.
Most such incidents are completely unintentional; however it is worth spending a moment to consider whether any of the standard terms in pro-forma employee agreements are inappropriate in the given context.
3. Lawyers & Immaterial Risk
When advising on a merger or acquisition, it is a Lawyer’s duty to identify risks in order to insure their client against potential loss. Lawyers occasionally seem to forget that an acquisition or merger is an intrinsically risky exercise. It is therefore impossible to completely insulate either party from risk.
Whilst identifying an incredibly nuanced risk in a contract might be evidence of a rigorous legal intellect, this advice is of little value if both the likelihood of the triggering event and the magnitude of the risk are infinitesimal.
The bitter irony here is that in seeking trivial amendments to regulate their client’s risk, a lawyer may inadvertently put the entire transaction at risk.
In the context of an acquisition, there are two main points of legally introduced conflict. The first critical point is where the contract is prepared by the vendor’s solicitor. If in preparing the contract the solicitor writes the terms outside the spirit of the agreement, in order to advantage their client, this will be perceived as extreme bad faith by the purchaser.
The second point of conflict occurs where the purchaser returns after a legal review of the contract demanding substantial amendments over frivolous items. A seller may interpret this tempest in a teapot mentality as a reflection of the purchaser’s attitude at work. As most transactions involve management transition periods, a vendor may subsequently question their willingness to work along side such a difficult person. If a vendor chooses not to proceed on that basis, it is ultimately the purchaser who is punished for overly protective legal advice.
It is therefore important that prior to a contract being prepared that both parties sign a heads of agreement stating the key terms of the transaction and capturing the spirit of the deal. It is also important to discuss the level of detail which is expected from the contract and the extent to which each side is happy to let the gaps be filled in by a handshake. Signing an imperfect contract with a high degree of mutual confidence and respect is often preferable to developing a superior contract at the cost of trust.
4. Salary Expectations
Equity partners in a business are remunerated by a combination of salary and dividends. When an equity partner is bought out as part of a merger or sale it may be on the condition that they remain in a salaried position. In principle parties may agree to the arrangement but have drastically different notions around the size of that salary.
If for instance a partner has been drawing an exceptionally low salary and high dividend, they might assume that they would be able to get a higher level of salary as wages are normalized. The purchaser of their equity however may interpret that they were happy to stay on at their previous salary given they are getting a large cash pay out for their equity. It is therefore necessary to drill down and quantify the exact salary expectation of exiting equity partners to avoid assumptively insulting them with a low offer.
5. Referral Agreements
When considering a potential merger or acquisition a party may be willing to offer additional consideration where they perceive a high synergy benefit as a result of the transaction.
For instance, holistic financial services firms may occasionally value a pure accounting business slightly above market when making an acquisition as they will be able to generate additional mortgage broking and financial planning revenue, the latter of which sells at a much higher multiple.
The principals of the accounting firm in this scenario, when asked if they currently provide financial planning services, could rightly say that they do not offer this service. However, there may be an informal referral relationship with a third party in place. If no referral fees are exchanged, this arrangement is also invisible on the profit and loss statements of the business.
Here, illuminating loose referral arrangements is vital for the purchaser as they affect the upside of the deal. Even in the case of an innocent misunderstanding on the part of the vendor, a discovery of such an arrangement at a late stage of negotiations will usually be perceived by the purchaser as deception. It is therefore highly important to clarify that where a vendor purports not to offer a certain service that this also includes no loose referral arrangements with other parties that do.
Conclusion
Parties frequently fail to reach completed agreements not because they are unreasonable, but because they have made inadvertent errors in the negotiation process which have destroyed their mutual trust.
Landmines are small and subtle, but have big consequences. When engaging in a negotiation it is important to make the extra effort to sweep the battlefield for these issues as they are indiscriminate in whom they damage.
