Barry Kelly of KPMG Deal Advisory shares his advice on minimising misunderstandings and avoiding disputes when negotiating a deal. The outlook for mergers and acquisitions in the Irish market continues to be very positive, according to recent research from KPMG. However disagreements over the ultimate amount to be paid for an acquisition can prove time-consuming and expensive - so what steps can be taken to avoid costly disputes following the conclusion of a deal?
The recent KPMG 2016 M&A Outlook survey indicates a strong appetite for deal making amongst Irish businesses, with those surveyed by the firm expecting deal activity to exceed that of 2015. As deal execution speed accelerates and competition for assets increases it's prudent to consider what can go wrong once a deal has been signed.
Under normal circumstances, a potential purchaser looks at an acquisition target, goes through due diligence and, if a buy decision is made, negotiates and enters into an acquisition agreement, pays the money and that's it. However the pricing of most deals includes some variability to be resolved after the event through the mechanism of "Completion accounts". It is here that potential ambiguity in the sale agreement can turn a great deal into an ordinary one, or a poor one into a potential disaster.
With the best will in the world, things may not go to plan. According to Barry Kelly of KPMG Deal Advisory: "Different people can take opposing views of what words in an agreement mean. Something that may appear crystal clear and unambiguous to one party may be anything but clear to the other. This can result in a material change to the price you thought was being paid or in a very costly dispute which may end up in arbitration or even in court."
Kelly highlights how the key is identifying and closing down as many areas of potential disagreement before signing. A simple example of such a misunderstanding might be the sale of a hotel which has significant unredeemed gift vouchers on its books. Kelly notes: "If the parties can agree an acceptable approach, for example, that vouchers which date back further than, say, two years are expired, the potential for a future dispute on the issue is greatly diminished."
In some cases, there can be very significant amounts at stake relative to the price, particularly if the business involved has low margins but significant stocks, receivables and trade payables (e.g. a retail business). In arriving at the purchase price each of these have to be examined and values put on them. According to Kelly: "A lack of clarity in relation to what is agreed upon working capital, for example, the treatment of items such as tax, rebates or pensions, could diminish the value which the purchaser thought they were getting."
Dispute avoidance is clearly the best policy in this regard. "Completion accounts are used as a mechanism to adjust for uncertainty that exists at the point the agreement is signed, such as around working capital or cash or debt balances." However, Kelly makes the point that they can also be used to re-open negotiations on price or seek a price hike through the back door.
He notes an alternative mechanism, favoured by sellers, known as a "locked box" where the price is fixed at signing and there is no completion accounts process and no price adjustments. "The parties agree a purchase price based on a recent historical balance sheet on the assumption that all value and cash flows generated by the target from that date will be trapped in the business and delivered to the purchaser on completion," says Kelly.
"The purchaser gains the economic benefit from the effective date of the sale but doesn't actually take control or pay the purchase price until the completion date. It's vital to ensure that the price agreed at signing reflects the purchaser's view of any price adjustments which may be required for items such as working capital and debt."
Whilst the locked box mechanism may sound attractive and almost fool-proof, Kelly cautions care must be taken to build in adequate contractual protections to prevent value leakage between the locked box date of the sale and completion, noting: "There must be a mechanism to compensate for any movement of value or cash out of, or indeed into, the locked box."
Of course, every company and every deal is different and completion mechanisms need to reflect the specifics of the deal. This can sometimes lead to complications and the adoption of hybrid mechanisms which comprise elements of both completion accounts and a locked box. These are not common but can arise from time to time.
In Barry Kelly's view there is no certain way of avoiding disputes. Misunderstandings can arise and if left unresolved can result in conflict. "The best option is to have the argument about these matters during the sale process and prior to agreement on a sale price." Not surprisingly, he believes that this is where sound professional advice comes in, noting: "Good professional advisors will identify the potential points of disagreement early on and endeavour to achieve either a mutual understanding on the items concerned or agreement on how to resolve any differences of opinion later."
In the event that such differences arise it is always best to attempt to resolve them without engaging in litigation. In the first instance it may be possible for the principals or advisers involved in the deal to arrive at a solution between them. After that the services of an independent accountant are typically called upon to arbitrate on the case.
Regardless of how a potential dispute may conclude, Kelly says: "While it can take weeks or months and involve pain on both side, most disputes will typically be resolved between the parties, with only a small number determined by Independent Accountants, like KPMG. The objective is to minimise insofar as is possible the prospect of a dispute going to court. Litigation is such an expensive process that it can destroy value in a deal for both sides and outcomes are invariably uncertain."
This article appeared on BizPlus.ie on 27 April 2016 and is reproduced here with their kind permission.