When handling M&A assignments for over 20 years, I have, along the way, encountered various sellers, buyers, and hundreds of transaction targets. Most of the transaction processes have been pleasant and smooth, but in some instances, the atmosphere has approached that of a contentious legal battle. While disputes rarely arise after successful transaction, when they do, they invariably belong to the latter category. In this article, I describe, based on my own experiences, the factors that contribute to the success of a transaction process.
Transparency and clear communication
One crucial factor for the success of a transaction process, and many other projects, is clear communication. Transaction often begins with the signing of a letter of intent (LOI) or an offer submitted by the buyer, even after relatively brief preliminary discussions. The LOI is a concise document, usually drafted on the buyer’s document template, and contains the elements the buyer wishes to include. These elements typically pertain to defining the target of the deal and the purchase price. From the seller’s perspective, the focus at this stage often revolves around the purchase price and its determination. If these conditions are acceptable, more in-depth discussions on the matter may not necessarily take place.
From the perspective of the transaction process, the significance of the LOI is much greater than often realized. Although the LOI is generally not binding, the parties are mentally committed to its terms. Deviating from the terms of the LOI is always challenging during transaction negotiations and requires a concrete basis, such as a negative finding during due diligence. Therefore, from the outset of the process, it is advisable to consider, from the seller’s perspective as well, what the key conditions are that must be easily met in the deal, in addition to the most important consideration, the purchase price. Otherwise, there is a risk that these issues will only surface as the negotiations progress, leading to unnecessary friction when the buyer’s and seller’s differing assumptions collide.
In addition to clear communication, an effective way to mitigate risks related to various assumptions is to act transparently. This does not mean that the buyer or seller should disclose all underlying motives or goals without filtering them. Instead, from the beginning of the process, both parties should identify the key aspects that are crucial for the other party in the execution of the deal and ensure that their intentions regarding these aspects are communicated clearly and transparently. Examples of such aspects include the roles of the sellers in the buyer’s organization after the acquisition, the terms of their employment, and the buyer’s plans for taking over and integrating the target into its operations. If these issues are left undiscussed during the LOI stage or are not addressed in detail, they will inevitably come to the fore once the commercial aspects have been resolved. If it then turns out, for example, that the buyer no longer sees the continued employment of all sellers as necessary or that the offered job role represents a significant downgrade from the sellers’ current positions, or that the buyer intends to implement a significant change in the target after the acquisition, it can lead to a significant disappointment for the buyer, even if the buyer proceeds according to the terms agreed in the LOI.
Flexibility and fairness
In most cases, the object of the transaction is the target company’s equity or business operations. Even if the deal involves movable property, the target of a business transaction significantly differs from any typical movable property that can be concretely defined. To a certain extent, business assets can be defined through the balance sheet by listing the items included in it. However, in a business acquisition, the balance sheet assets rarely play a significant role in the overall transaction. The buyer’s reasons for the acquisition can be either financial or strategic. The earlier stage the target is or the more technology or products it has developed on its own, the more likely it is that there is a strategic reason for the acquisition related to the company’s technology or expanding the buyer’s product portfolio or its operations into a new market. The more strategic the buyer’s reasons and the less they are based on the target company’s owned balance sheet assets, the more the transaction process relies on the assumptions made by the buyer.
The buyer’s key assumptions are usually documented in the LOI at the outset of the process. However, many of them remain abstract in the early stages of the deal due to the abstract nature of the target company. The buyer’s decision to enter the transaction process is typically based on its assessment of potential acquisition targets and discussions conducted during the initial exploration phase with potential sellers. At this stage, the level of information provided by the sellers is usually limited for risk management reasons, especially if the buyer is a potential competitor. During the due diligence process, conducted in parallel with negotiations, the buyer seeks to confirm the accuracy of its assumptions. This is when the buyer and its advisors gain a more detailed insight into the target of the transaction. It is not uncommon for the buyer to have to revisit its assumptions or even consider whether the seller intentionally provided incorrect or incomplete information about the target. Often, this is not the case, but rather, sellers presented information in a way they assumed the buyer would want to hear. Additionally, sellers often do not analyse their company’s operations with the same level of detail and risk appetite as an external due diligence provider, so sometimes the findings can be surprising for the sellers as well.
If the buyer becomes uncomfortable during the process due to the erosion or modification of its assumptions made during the LOI stage or due to findings during due diligence, both parties should continue transparent and clear communication while being sufficiently flexible and fair. A buyer who originally entered the deal for strategic reasons may get stuck in the due diligence phase over a technical observation, such as an accounting error or an issue in a contract made by the target company, which may not necessarily affect the original decision to acquire. On the other hand, sellers may perceive the buyer’s criticisms based on the due diligence findings or the weakening of the conditions outlined in the LOI or new conditions that increase the sellers’ responsibilities as unfair, which can quickly turn the negotiations negative.
In the best transaction negotiations, such situations are addressed promptly and decisively. To find a solution, both parties must be reasonable and willing to compromise. A rational buyer rarely makes an acquisition offer with the assumption that the target company is entirely flawless. The same principle applies to any transaction involving the purchase of used movable property. On the other hand, sellers sometimes go too far in the LOI stage to secure the most critical aspect at that stage, which is often the purchase price, and make promises that are not always entirely realistic. When issues arise during the due diligence process that are either surprises for both parties or that the sellers simply did not remember or understand in the earlier stages of the process, it is essential for both parties in the deal to consider a solution from the other party’s perspective as well. In the worst case, absolute inflexibility can lead to the suspension of negotiations or damage the relationship between the parties, making continued cooperation after the deal difficult.
During the transaction process, the understanding of the target company and the people associated with it becomes increasingly refined. This understanding is not only compared against the assumptions made at the outset of the process but is also projected into the future. Often, the completion of a transaction is just an interim step, continuing as a collaborative effort between the buyer and the seller towards a mutually agreed-upon objective. This objective may include the exit of the buyer company or the achievement of additional purchase price targets. Sellers may also become part of the buyer’s ownership base through a reinvestment made in connection with the transaction.
As the understanding of the target grows and the visibility to the shared desired future state for the post-acquisition period improves, the commitment of both parties to the common objective grows. Buyers are often concerned during the deal-making phase about the commitment of sellers to a controlled transfer of the target to the buyer’s possession, while at the same time, sellers are concerned about the buyer’s plans for both the sellers and the future of the target company. In the best transaction processes, the closing of the deal is merely an intermediate stage where sellers transfer the legal ownership of the target to the buyer and jointly advance the business towards the agreed-upon next objectives.
Respecting the other party
Despite the best intentions, not all transaction processes are great. There are many reasons for a process to become a bad one. Sometimes, these issues arise from individual challenges, while in other instances, they result from poor communication, changing circumstances, or even fundamentally erroneous assumptions. There are also processes where significant flaws are discovered in the target during due diligence, making the completion of the transaction impossible. Occasionally, well-intentioned advisors steer the process in the wrong direction by adhering too firmly to their own perception of the only correct solution to a presented problem, even when there might have been alternative solutions through some degree of flexibility and fairness.
I dare to assert that most transaction processes can be successful when both parties adhere to certain fundamental principles from the outset. The requirement for a successful process is not that both parties agree on all matters. If solutions are sought with clear communication during negotiations and flexibility and fairness are exercised at the right junctures while respecting the viewpoints of the other party, the likelihood of ending up in a great process is significant.