Buyers and sellers contemplating entering into a deal must understand why regulatory compliance is non-negotiable in M&A. Mergers are extensive, complex procedures, and there are several legal laws and mandates that govern how the deals proceed.
Before negotiating a potential deal, both entities must do their due diligence to understand the laws pertaining to their jurisdiction. Regardless of the business vertical where you operate, location, and scope of the acquiring and merging company, compliance is critical.
You’ll research and comply with not just legal hurdles but any other issues that can result in the deal failing. Retaining the services of an expert M&A advisor is always recommended to ensure that the transaction proceeds as planned.
Statistics indicate that 70% to 90% of M&A deals are unsuccessful despite dealmakers spending close to $2T on executing them. Experts cite several reasons for this failure. You’ll consider issues resulting from integration, sharing information and technology, and effective risk management.
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Why Regulatory Compliance is Non-Negotiable in M&A
M&A transactions result in the acquiring company assuming not only the targeted company’s assets and resources, but also its liabilities. Any unexpected liabilities can result in unprofitable deals. Worse, exposure to criminal and administrative risks could lead to losses and a damaged reputation.
This is why, before, during, and after the M&A deal, buyers must conduct due diligence for several reasons. For starters, they’ll want to reassess the targeted company’s valuation and take the essential steps to protect the acquiring company.
They may also need to work on minimizing any potential liabilities that can arise after the deal is closed. Planning for the risks, renegotiating the deal, or even reconsidering the transaction is possible at this time.
During the M&A compliance, you’ll identify any potential red flags that can influence the value of the seller’s company. Examine compliance in legal areas like human rights, workplace health and safety, data protection, cybersecurity, privacy, environment protection, and labor.
Also, look for risks around anti-corruption and bribery, anti-trust, conflicts of interest, and government regulations. If you’re negotiating an export-driven business, the key areas of interest should be money laundering, sanctions, export controls, and trade bans.
M&A compliance is not just about due diligence in legal matters. Aside from identifying the above risks, experts also ascertain how adept the company’s management is in recognizing the risks. They also focus on what the seller is doing to minimize the transactional risks and prevent liabilities.
Proactively addressing the M&A compliance risks is critical to ensure that the deal receives approval from regulating authorities. You’ll also avoid any penalties and criminal prosecution for not complying with the regulations.
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M&A Deals Must Comply with SEC and DOJ Guidelines
Companies entering into M&A deals must follow The Securities and Exchange Commission (SEC) and the Criminal Division of the Department of Justice guidelines. Here are some of the rules to focus on.
Liability for Misconduct & Criminal Behavior
The authorities require due diligence from the acquirer to identify the misconduct risks they are taking on. That’s because the acquiring company becomes liable for any criminal activity or civil misconduct the seller’s company may have done in the past. This is why regulatory compliance is non-negotiable in M&A.
Although getting around the liability is not possible, the buyer can take steps to avoid penalties. And any enforcement action the law may have to take against the seller company. The buyer is also liable for tracking and resolving the misconduct risks and integrating the acquired company into its internal controls.
Any compliance programs that the acquiring company has should also extend to the company it has purchased. A good example is compliance with anti-corruption laws for export-driven companies working with other countries that have these laws.
Complying with anti-money laundering laws is also critical. Potential buyers must start by checking SDN (Specially Designated Nationals and Blocked Persons) lists for entities falling under US federal sanctions. Financial organizations must check LEI (Legal Entity Identifier) reviews.
The targeted company may not be directly involved in the supply chains and transactions. However, working with corrupt vendors or end-use customers can also make them liable for penalties.
Examining Culture & Financials
The law recommends that the acquirer connect with the top management personnel and get them to provide essential information. Any reluctance on their part to divulge intelligence for assessing the risks could indicate possible red flags.
Hiring forensic accounting personnel is critical to examine the targeted company’s financials. Since these professionals work under a legal obligation to protect client privilege, an independent counselor should retain their services.
Reviewing Agreements and Contracts with Third Parties
The targeted company will likely have entered into agreements and contracts with third parties during the course of its operations. It is up to the acquirer to examine these documents during due diligence.
They are liable to review any commissions and payments the company may have made and identify any irregularities. While efficient integration is crucial for a successful merger, the buyer should also be ready with a compliance integration program. And make sure the targeted company complies.
Protecting Customer Data
As part of the due diligence, sellers must provide a large number of documents to the potential purchasers. However, many of these documents may include personal and sensitive information. The owners of this information may have only authorized the seller to process and use.
Any statements of consent the third parties may have signed could only be between the employer and employee or seller and client. These agreements don’t include contracts with the acquirer.
Non-disclosure agreements (NDA) signed during the negotiations may only extend to the buyer and seller companies. But not to the third parties whose information is also divulged and affected. These entities may include employees, customers, and vendors.
To get around this problem, the law requires the participants of the M&A deal to set up a virtual data room. This process is not exactly easy to execute. However, they should try to make sure that the PII or Personally Identifiable Information is hard to decipher.
Yet another solution is for both the buyer and seller to sign an agreement under Article 6(1)f of the General Data Processing Regulation. Under this rule, both entities describe why revealing the PII is important for the M&A transaction to take place.
The agreement will also specify that the M&A sale cannot take place without the data. Further, most importantly, the parties agree on the steps they will take to secure the information. And possibly delete the data after the due diligence process is complete.
If the merged company intends to continue using the PII, it must have a technological infrastructure or framework in place. The management must prepare steps to deal with data breaches and violations. That’s one of the reasons why regulatory compliance is non-negotiable in M&A.
Disclosing Intellectual Property and Trade Secrets
The principle of competition law dictates that the seller need not reveal any strategic information that could leak to competitors. This information may include pricing structure, customer base, upcoming product designs, trade secrets, and non-patented intangible assets.
In short, any information that can result in the seller company losing its edge over the competition is kept confidential. That is until the M&A transaction is concluded and finalized.
However, this law can present a problem because the acquirer will need to obtain some of the details. They will need the data to evaluate the targeted company as a viable purchase before making offers.
To resolve this situation, the seller can provide a limited amount of data to specific personnel. Like, for instance, the consultants assisting the companies in negotiating the deal. Once the information is evaluated, consultants can advise on the viability of the purchase without revealing secrets to the buyer.
Typically, acquiring companies are also competitors. And there’s every possibility that the M&A deal does not materialize. This is why regulatory compliance is non-negotiable in M&A.
The law also applies to protecting patented Intellectual Property (IP). Both entities must work out how to value and transfer the assets and manage any other intangible assets. These may include copyrights, trademarks, logos, brand names, and any other assets that hold value.
Checking Licensing Requirements and Permits
Registered businesses must acquire licenses and permits to conduct operations. The licenses also dictate the taxation laws that pertain to them and the safety regulations to comply with. Depending on the type of business, owners may need permits from the local fire department and health and safety department.
Companies dealing in pharmaceuticals may need to get sign-offs from the federal, state, county, and city levels. Sales tax licenses, sign permits, Employer Identification Numbers (EIN), and other mandatory compliances should also be up to date.
Buyers considering a company for acquisition should make sure that all permits are renewed on time. And that it operates within mandatory guidelines.
Regardless of whether you’re entering into an M&A deal or acquiring funding for a startup, knowing how to do your due diligence is crucial for its success. Check out this video where I have explained how to do that.
Background Checks on the Management & Key Stakeholders
Conducting background checks on the management and key shareholders is quickly becoming an essential part of M&A compliance. Acquirers are keen on learning more about the backgrounds of the personnel in decision-making positions.
The KYC information might indicate that they have any pending litigation or legal proceedings against them. In that case, any licenses and permits the company holds may not be valid. Shareholders in the acquiring company may also not be keen on partnering with the company.
Background checks are also crucial when potential investors assess pitch decks for funding a venture. Keep in mind that in fundraising, storytelling is everything. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
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How to Initiate the Due Diligence Process
Before initiating due diligence, you must understand why regulatory compliance is non-negotiable in M&A. Here’s a quick list of the procedures you’ll likely follow:
- Begin by researching the entities involved, starting with the targeted company and the subsidiaries, if any.
- Next, identify the business vertical in which they operate, their geophysical location, and their ability to run operations. Also, explore their potential to expand their company to offshore locations and build an export-oriented venture.
- The next step on your checklist is to ensure that the company is reputable and compliant with state and local regulations. Inquire about their annual reporting, tax filing processes, and licensing to do business–both within and outside the country.
- Identify any potential issues that can cause hurdles in the M&A transaction and work out how to resolve them. Also, create estimations of the time frame within which the deal can take place.
- Companies often set up Special Purpose Vehicles (SPV) to disperse their financial risks. Or, they may enter into SPE transactions. As part of the due diligence, you’ll research these aspects and how they can influence the M&A deal. Remember to factor them in when working out the details of the merger.
- Inquire into the Uniform Civil Code-1 filings the targeted company and acquirer have. Checking the documents will reveal the assets set aside as collateral that creditors can claim in case of loan defaults. The targeted company may have loans and pays interest on them. Or earns interest on the loans it has given out. Its financials and valuation will reflect the assets and liabilities accordingly.
Expect Delays in the Estimated Timelines
Mergers and acquisitions can be complex processes that take time to accomplish. Although you’ll work out a timeline for the deal to be finalized, prepare for unforeseen delays and the possibility of backlogs in the federal offices. Errors in the documentation leading to files getting rejected can also happen.
Mergers or acquisitions of companies require significant attention to detail and due diligence. That’s how you’ll ensure that the merged company continues to function and is successful in the long term.
You’ll want to ensure that the objectives of the merger have been achieved. The entire deal should progress with strict compliance with legal requirements and other regulations. You’ll cover the potential risks and create failsafe measures for managing them.
Start by understanding why regulatory compliance is non-negotiable in M&A. If needed, retain the services of an in-house compliance officer who can direct the entire transaction.
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