Last week we looked at the role of a contract manager in a Merger & Acquisition deal from 50,000 feet. Now we’ll look more specifically at contract review and, when necessary, supplier negotiations in the due diligence phase.
Before sitting down to write this post, I asked friends and family to tell me how long they thought companies conduct due diligence before executing a Merger or Acquisition.
Not surprisingly, most thought that due diligence takes as long as it needs to until the acquiring entity is satisfied with the knowledge of what they’re acquiring.
The perception is, the bigger the deal, the longer the due diligence
But the reality is that Mergers & Acquisitions either happen quickly or often not at all. We only hear about the successful ones in the news.
And the bigger the deal, the smaller the window for due diligence.
That sounds counter-intuitive. You’d think a company that’s about to spend millions, sometimes billions of dollars would take the time to understand what they were getting.
3 FACTORS THAT DEFINE THE SPEED OF DUE DILIGENCE
There are three critical factors that determine how much time you’ll have to conduct due diligence.
#1 – EMPLOYEES
Loose lips sink ships. If the acquisition includes employees, it’s only a matter of time before they find out. And if the valuation is based on key personnel staying on post-acquisition, you don’t want them finding out and then having months to start looking for work elsewhere.
Worse still, if due diligence drags on and a deal’s not done, the seller risks losing staff for nothing.
For these reasons, it’s in the interest of both parties to quickly figure out if there’s a deal to be made.
#2 – PUBLIC PERCEPTION
There was a stunning infographic published in 2010 which showed the M&A activity within the US banking industry from 1990 to 2009.
During this period, 37 major banks were consolidated into 4: Citigroup, JPMorgan Chase, Bank of America and Wells Fargo.
That’s a tremendous accumulation of wealth and financial control in less than 20 years. Not something the banks would want their customers stewing about for a very long time. Especially if their’s was one of the banks that was getting gobbled up by the big boys.
#3 – VALUATION
There are different reasons why two companies may decide to merge, or one decides to buy the other. Sometimes a big company realizes it can gain significant marketshare by buying up other slightly smaller companies to then become one ridiculously big company (hence the bank mergers).
Other times, a company may want to buy a competitor in order to kill the competition. This happens often in the tech space.
Or the acquisition just makes sense at that time.
But regardless of why, there’s always a price. And the longer due diligence goes on, the more volatile the price gets.
HOW CONTRACTUAL RISK AFFECTS VALUATIONS
There are many factors that affect acquisition cost. Annual revenue, profitability, geography and technology are all things that go into a valuation.
But there’s another one that’s often under estimated: the fear of the unknown.
The buyer wants to know what contractual risks they’re taking on. As they discover more risk, the valuation decreases. Which is another reason why the seller wants to keep due diligence as short (and sometimes difficult) as possible.
For example, if the seller has a contract with a critical supplier, but that contract doesn’t allow for assignment in the event of an acquisition, the risk to the buyer is they may have to repurchase those goods or services post-acquisition.
That cost, or some estimation of it, then gets subtracted from the price the buyer’s willing to pay.
Many potential buyers will ask the seller to provide them with all of their contracts to review as part of due diligence. The problem is that most companies don’t have a good handle on where their contracts are, so it takes time to gather them.
Once the seller has all of the contracts (or at least some subset of them), it’s up to the buyer to go through them to understand what potential risks they might be taking on.
Unfortunately, a short due diligence window makes it difficult to go through every contract. And acquirers often make the mistake of not giving supplier agreements the same priority as HR and customer contracts during due diligence.
The incorrect assumption is that suppliers aren’t going to walk away from recurring revenue, so we think we can just deal with them once the M&A is complete.
But anyone who’s lived through an M&A knows that’s simply not true.
Smaller, non-critical suppliers will usually submit to the new company’s demand. But larger companies, especially those that know their goods or services are critical to the business (regardless of who now owns it) will leverage their position to generate net new revenue.
Sometimes it’s inevitable, but there is another approach that’s often overlooked.
CASE STUDY: NEGOTIATING WITH SUPPLIERS IN THE DUE DILIGENCE PHASE
A few years ago we were asked to assist with due diligence for a company that was looking to make an acquisition which had a large technology component.
The buyer was a large data processor that wanted to buy one of it’s competitors and consolidate the technology in it’s data center.
After a bit of legwork, we were able to collect and review most of the seller’s technology agreements. Many of the contracts had favourable assignment language. But there were a handful of large, mission-critical suppliers that either had no assignment language or had sold a site license that couldn’t be moved without the suppliers consent.
After discussing with our client, we asked the seller’s executive to reach out to these supplier’s with an NDA and a request to meet.
Once under an NDA, we told these suppliers that their current customer may be acquired and the technology consolidated in the buyers data center, who we represented.
Our client obviously wanted to continue business with the supplier but wasn’t interested in repurchasing the same software to run in its data center. So we wanted to discuss what options might be available in the event of the deal going through.
After that, it was a negotiation like any other.
Some suppliers easily conceded, especially after we informed them that our client had competing software running in their data center which could simply replace them post-acquisition. Others played hardball.
Regardless of what position the suppliers took, we were able to quantify the risk and prepare a contingency plan for the suppliers who might want to take advantage of the situation.