The M&A Mini-Series: Accounting’s Role in the Deal Structure Phase

Buyers and sellers shouldn’t think they’re out of the woods once the due diligence phase has been completed.

The deal structure analysis phase has its own unique minefields.

Success often depends on an inclusive team beyond just “dealmakers,” precision on every negotiating point and strong communications.

In my last newsletter – the first scenario of my four-part “M&A Mini-Series” – I discussed the due diligence phase. Specifically, I discussed the unique issues and lessons learned when the target’s financial results have never been subjected to an audit because it is either the subsidiary or business unit of a larger company or a very closely held private company. In this newsletter, I’ll move on to the deal structure analysis phase and discuss a recurring theme that can present hurdles for buyers, targets, the respective auditors and lawyers, and consultants. Deal structure analysis is the phase where the team puts together the definitive agreement. It involves intricate issues such as working capital adjustments, capital reserves, earn outs, etc. – all of which have complex accounting implications. The recurring aspect that I want to discuss is the frequent disappearance of the accounting delegation once the due diligence phase is completed. When the action moves to structuring the transaction, the lawyers and other dealmakers often tend to craft the deal among themselves without seeking the continuing input of the accounting team. This always surprises me because these dealmakers are the same folks who went the extra mile to make sure their due diligence team included the best from the internal accounting function along with top-tier accounting consultants. Having been both a member of many accounting due diligence teams and the independent consultant called in by buyers or sellers or stockholders after disputes had erupted, here’s my perspective on why an accounting contingent is vital to the deal structure analysis phase. (Full disclosure: As you all know, we’re a full-service finance and accounting advisory firm.) As the negotiating team considers the various alternatives of the deal structure – merger, acquisition, asset purchase, stock purchase, earn out, etc. – each side has competing interests. The accounting folks look at every issue through an impartial lens with the sole aim of identifying future accounting problems, risks and opportunities. Will it work or won’t it? The material issues they look for include ability to transfer liability, contractual requirements, stockholder approval, tax consequences, among others. When the accounting team is excluded, it can open buyers and sellers alike to unforeseen outcomes that can land the parties in unfamiliar and even hostile territory. Here are just a few of the types of issues the accounting team can identify upfront to help both sides understand the implications of the deal they’re considering – not to mention saving money in the long run.

• Whether the timing of the deal will affect the acquiring company’s financial statements both current and going forward.
• Whether the retention or release of key senior employees – and their compensation – will affect results.
• For a deal heavily dependent on stock issuance, whether all SEC and other regulatory filings can be completed accurately and on time.
• For an earn out deal, whether the terms to calculate what the target company must “earn” are sufficiently precise, clear and objective.

I think there are three important lessons learned from engagements in which we’ve participated: First, mergers and acquisitions are incredibly dense, complex, complicated documents. Even the most experienced “dream team” can’t foresee every ramification of a deal. The best teams anticipate that there’s going to be a dispute at some point, and they plan for it in the terms of the agreement. Put another way, they think positively but plan realistically. Second, in the specific case of earn outs where potentially hundreds of millions of dollars are on the line (or tens of millions for smaller companies that will nonetheless have the same impact), both parties need to be absolutely crystal clear on how results will be determined before they leave the table. Once the signatures are on the line, they need to ensure that they’re tracking carefully and communicating regularly. If necessary, the finance function should hire an objective professional to maintain the books and communicate with both sides throughout the period leading up to the payout date. Making or missing the agreed-to target should be known to both parties well in advance of the payout date. Third, and to repeat, it’s essential to keep accounting involved before, during and after both the due diligence and deal structure phases. A strong accounting team can ensure the right processes are in place to meet both contractual obligations and all regulatory requirements. Following these suggestions can help ensure a smooth transition from due diligence efforts to structuring a smart, fair deal. If you would like to discuss anything in this or any of my newsletters, please contact me. We have a proven track record of helping companies make investment decisions with confidence. I’d be delighted to talk with you.

To discuss this important topic further or if you’re looking for general accounting advice and counsel, contact marc@blytheglobal.com