M&A: Mind the Gap L


Lawyer Perspective


Martin Mankabady


Corporate Insurance partner at Mayer Brown.


mmankabady@ mayerbrown.com +44 20 3130 3830


Warren Buffett once said: “Risk comes from not knowing what you’re doing”. Even if you know what you’re doing, there can still be risk, of course, but, at least, in theory that risk should be more manageable. Mergers and acquisitions (M&A) activity is an area of risk particularly if it is not managed properly.


In the more risk averse world in which we now find ourselves, it is perhaps no wonder that M&A activity levels have been down.


However, the flip side of risk is opportunity – and M&A does present real opportunities for businesses. Indeed, there seems to have been a recent increase in M&A activity. There is a sense now that businesses, which have been focused to date on balance sheet management and stripping out costs from their businesses, are looking for ways to grow or better deploy scarce capital, and M&A is one way of doing just that.


Martin Mankabady is a partner in Mayer Brown’s corporate practice, and head of the corporate insurance group in London. He focuses on mergers and acquisitions (both private and public), joint ventures, and corporate finance. Martin also advises on general company law, commercial, and regulatory matters, and has advised on a number of complex, high profile transactions over the years, often with a cross- border element.


Current M&A activity


It is fair to say that M&A activity in the UK and elsewhere has been patchy over the past few years. There are a number of reasons for this.


For a start, confidence in the global and local economies generally remains quite low. There is also uncertainty over the future direction of regulation in certain parts of the world which breeds a lack of confidence. Confidence is an important ingredient in the deal-making mix.


There is also a price gap between sellers and buyers. As far as buyers are concerned, sellers are still expecting too much for their businesses. As far as sellers are concerned, buyers are undervaluing their businesses. This gap might have narrowed recently, but it is still there.


In addition, sellers are concerned to ensure buyer deliverability - that is, that a buyer will be good for its money and can generally deliver on the deal. The lack of readily available bank funding has not helped alleviate this concern. Nor has


the tendency of buyers to include a number of conditions to completion, such as conditions relating to there being no material adverse change in the target business between signing of a deal and its completion. The risk for a seller is that if any of these conditions is not met, then the buyer has the right to walk away from the deal.


For their part, buyers are concerned at the covenant strength of sellers. If a successful warranty or indemnity claim is brought, will a seller be good for the claim? Buyers are investing more time and effort in due diligence, and are concerned about what skeletons may lurk in the target business’ cupboard. Buyers are also concerned to ensure that material issues are, where possible, resolved before completion. As a consequence, execution risk (that is, the risk that a deal will not complete) has increased.


Solutions


So, how can the gap between sellers and buyers be bridged? There are a number of solutions, many of which will involve careful negotiation and will depend in part on the relevant parties’ respective bargaining strength.


For instance, to minimise concerns over covenant strength, a parent guarantee could be offered, assuming the parent has the requisite covenant strength. If a claim is subsequently made, this may require the parent to make a provision in its accounts which may not be ideal. An alternative is to lodge monies in an escrow account, but this has the disadvantage of tying up money potentially for some time which cannot then be put to work elsewhere.


There has also been an increase in the use of earn- out provisions, with part of the purchase price being


26 Author Viewpoint


Risk and Insurance in Private Equity and M&A 2012/13


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