It’s a good idea to enhance your due diligence before buying or selling a business because disputes in mergers and acquisitions (M&A) are rising and are likely to get worse, a report from Berkeley Research Group (BRG) says.
Inflation and the recession threat are big drivers of post-closing disputes today, almost 85% of 181 M&A deal experts surveyed say.
“Performance of recent acquisitions may fall short of expectations, [producing] an upswing in M&A disputes over the coming year,” said BRG Director Kevin Hagon in the report.
The Ukraine War, lingering COVID-19 impacts, the rise and fall of crypto markets and increased activity by private equity, which despite tighter credit conditions is sitting on lots of dry powder, are also big dispute drivers.
Private equity is in the mix because in its rush to pick up struggling companies or otherwise grab opportunistic deals, it tends to have a higher tolerance for conflict – a “sign now, fix later” mentality among some buyers today, said Marina Boterashvili, an international litigation and arbitration senior associate at Quinn Emanuel in London.
Even the environmental, social and governance (ESG) movement, which can create conflict when two merging companies don’t view these values the same way, can cause lawsuits.
“Disputes [are] emerging as ESG performance and outcomes fail to match up with projects,” said BRG Managing Director Neal Brody.
The ESG problem is especially big in the energy sector because carbon-based assets are becoming something not all companies want to deal with.
“The financial burden of stranded assets such as coal-fired power plants as well as … sagging commodity prices [could give rise to energy-sector disputes],” BRG Managing Director Andrew Webb said.
Significantly more than in the past, deal specialists on both the buy and sell side are advising in-house clients to look into mergers more, and better position themselves, before signing deals to protect themselves and, if disputes arise, be better positioned to handle them.
That means among other things being tactical on pricing.
“Prices are more volatile,” said Matthew Weiniger, a Linklaters partner in London. “So when you sign the deal today to close in three months’ time, there’s a greater chance that your economic assumptions will be completely wrong at closing.”
Given that volatility, one of the questions you want to answer before you get too far along is when to run a valuation. It’s harder to plan if you wait until after closing, but by waiting you can come up with a more solid number.
“As market conditions become more challenging, that question will become very acute,” said Nicholas Lingard, a Freshfields Bruckhaus Deringer partner in Singapore. “The valuation differentials could be really stark between a year ago and now.”
In addition to changes in valuation, there are other deal aspects coming under scrutiny mid-transaction. These include liability caps, representation and warranty insurance and material adverse change (MAC) and material adverse effect (MAE) clauses.
Among other things, parties want to see limitations placed on liability caps and they’re seeing more breaches of rep and warranty insurance.
In addition to enhanced due diligence, deal specialists are advising clients to make sure they’re retaining rights to information, approach contract clauses flexibly and undergo pre-litigation counseling.
“We’ve seen disputes arising from significant mismatches in management styles, investors’ outlooks for the business, their exit strategy and so on,” said Boterashvili, the Quinn Emanuel senior associate. “It really brings to light the importance of proper due diligence, in terms of both the business you are investing in and whom you are doing it with.”