Most Wasteful Costs During M&A

What are the most wasteful costs during an M&A transaction, and where should you definitely invest your money?

Mergers and acquisitions are rare during the life of most companies. If and when the time comes, the focus is often on completing the deal, with little attention paid to the related costs. However, these costs can wind up being substantial, and represent anywhere from 1% to 10% of the total acquisition cost.

If you’re new to the M&A game, here are some tips on how to be smart with your money during the transaction process, and what areas you should definitely invest in.

Wasteful expenses during M&A

Broadly speaking, the most wasteful expenses during the M&A process can be broken down into two groups; pre-acquisition and post-acquisition.

Pre-acquisition costs that can generate a lot of waste:

  • Legal fees
  • Financing fees
  • Advisor fees paid to investment banks and consultancies

While these things are certainly important, carefully managing their costs is important too, both when agreeing to an initial contract and in terms of managing the ongoing process. If possible, getting service providers to agree to a fee cap can be advantageous. Shopping around can also be worthwhile to make sure you’re getting the best price. Some providers see dollar signs when they hear M&A, so make sure you go with someone you feel comfortable with and can trust.

Post-acquisition costs that can generate a lot of waste:

  • Internal operating costs (HR, IT, finance, and overall redundant staffing)
  • Retention payments to ensure key staff are retained
  • Working capital adjustments

Internal operating costs and retention costs can be managed by having a clear integration plan in place by the time the sale takes place. Many companies will speak of expected cost savings, but not begin the integration process, which can take months or even years, until after the acquisition takes place. This often frustrates shareholders who expect to see synergies sooner than that.

Clear planning should also be done to ensure that key employees are identified and proactively communicated with regarding their position in the new company. Losing key employees because they didn’t like the uncertainty, or making retention payments to employees who are later let go, are things that regularly take place during M&A.

It’s also crucial for both parties to clearly understand the implications of changes in working capital, and how this can factor into the ultimate selling price. Typically, with both a share purchase and an asset purchase, a set value is attributed to the working capital being acquired, with any difference between the agreement amount and the actual amount transferred being adjusted to the purchase price. The seller may therefore be unpleasantly surprised to learn that a $500K change in working capital between the agreement date and the transfer date came out of the selling price they receive. Set expectations early.

Tips for reducing costs

As a seller, there are many things you can do in the lead up to an M&A transaction to prepare your business for sale.

Ensuring you are as prepared as possible will reduce the overall costs of the transaction, as the longer it goes on, the longer costs will be piling up.

Making sure that your business has audited (not reviewed) financial statements is a key way to reduce due diligence costs. Many deals can be prolonged and eventually fail due to the extra financial due diligence needed when a company does not have audited financial statements. Undisclosed financial surprises are not something any buyer wants to come across.

Proactively identify and document any risk or potential fires in the company, and address these items upfront with a potential acquirer. Coming clean and showing how you have planned to mitigate the risks appears far better than if they are discovered during the due diligence process. Your lack of disclosure will raise red flags.

Avoid large scale system changes or process improvements in the lead up to a merger or acquisition. An M&A transaction usually involves extensive system integration and process improvement initiatives, so the costs will likely end up being duplicated post-merger.

Where is your money best spent?

There are two key areas that should never be neglected or compromised when it comes to an M&A transaction; performing extensive due diligence and retaining key people.

Due diligence will typically involve internal reviews and analysis, but also require consulting with legal and financial experts. While these costs certainly need to be managed (as mentioned above), they do need to be incurred to ensure legal liabilities and risks are all clearly identified and understood.

Retaining key people on both the buy-side and sell-side is crucial to the success of the combined entity. Without the right people in the right roles the new company will struggle. Even if retention bonuses are needed, key individuals should be identified and held on to.

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Edward Stephen

Ted Stephen is the Director of Demand Generation at Firmex.