Considering the incredibly high percentage rates of failed M&As, dealmakers should know the best practices for exiting an unsuccessful merger. As a rule, only 10% to 30% of M&A deals culminate successfully. When the failure risk is 70% to 90%, having failsafe measures in place is advisable.
Several internal and external factors contribute to shelved transactions, which is why dealmakers and executives should take robust measures. Extensive due diligence, deploying AI tools to research the targeted company, and aggressive negotiating strategies are great first steps.
But, the most crucial facet now emerging is the need for well-planned exit strategies to preserve value. Your objective should be mitigating the possible fallouts of the failed merger–for both parties at the negotiation table.
Read ahead to understand the best practices for exiting an unsuccessful merger.
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Unexpected Situations in the Macroeconomic Environment Contribute to Failures
Mergers and acquisitions worldwide have been taking a hit steadily in the last few years. During the third quarter of 2022, M&A deals worth $738.1 billion took place across the US. However, this figure has clearly dropped to $717.4 billion during the September quarter of 2023.
Experts have identified different reasons for this phenomenon, such as uncertainty because of global unrest and geopolitical tensions. The Ukrainian war and the latest attacks on Israel, along with stock market volatility, have resulted in rising inflation rates.
Strategic federal monetary policies are working to reverse skyrocketing inflation rates, but that hasn’t worked well for the M&A sector. Slow growth in the economic landscape, affordable debt, and high risks of disruptions are promoting higher-than-ever asset sales.
A typical merger can take anywhere from six months to several years to complete. Several things can go wrong in this interval that can alter the business landscape. Both sellers and buyers may not consider the deal viable enough to follow through.
This is why they should set up rigorous rules for canceling deals that don’t result in burning bridges. Or, more importantly, affecting shareholder value. The main fallout of an unsuccessful merger is losses worth billions of dollars, which can be lowered.
The value of canceled deals in 2022 was the highest since 2018 and stood at $215 billion.
Seller companies face the risk of closing down completely, not to mention other issues like lost revenues. Negative publicity that can impact the brand’s reputation, loss of its customer base, and mass layoffs impact stability. A failed merger can prove to be a complete catastrophe for the seller.
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Elon Musk’s Attempt to Opt Out of the Twitter Deal is One Such Example
Elon Musk’s announcement to buy the social media company, Twitter, did not attract as much interest as his backtracking. The $44B agreement ended up in court as the two parties attempted to resolve the confusion surrounding the deal.
Elon Musk claimed that Twitter misrepresented the volume of traffic that bots generated. On its part, Twitter claimed that Tesla’s owner had attempted to sabotage the company because stock markets plunged. Twitter’s legal team appealed to the courts to expedite the trial to eliminate the uncertainty.
The social media giant was concerned that Elon Musk would continue to push for a way to exit the deal. His argument was that Twitter was not completely forthcoming about the number of fake accounts on its platform.
Although the acquisition did proceed as planned, and Elon Musk is the new CEO, Twitter has gone through extensive rebranding. Experts estimate that Twitter will lose 3.6 million users in 2023 across the US, which is a decline of 6.3% from 2022.
Whether the loss in value is because of the conflict is not clear. But, the parties could have avoided the litigation and other costs with in-depth due diligence before the M&A transaction became public.
This is why dealmakers should be ready to back out of the deal even in the later negotiation stages. That’s one of the best practices for exiting an unsuccessful merger.
Draw Up an Agreement for a Negotiation Deadline
M&A advisors on both sides should set up a timeline and deadline for the negotiations to complete. This timeline ensures that both parties align their goals and engage in detailed discussions. While monetary resources are a significant investment, so is time.
Once the deadline is passed, any party can step away from the table. That is, if they aren’t convinced of the merits of the deal. The agreement can also include clauses that will prevent negotiations from breaking down completely.
Allow for the possibility of revisiting the proposal at a more opportune time. Or, when the parties can offer more favorable terms and conditions to clinch the transaction. Having expert M&A advisors or consultants at the table is a huge advantage here.
These entities can maintain an objective view and neutrality and diffuse any tensions and tempers. Especially when the failed merger risks the seller company’s value, reputation, share prices, and more.
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Conduct Meticulous Due Diligence
Conducting meticulous due diligence can help dealmakers avoid situations where they must walk away from the deal. Moreover, they should watch out for the sunk cost fallacy.
The sunk cost is the expense an entity has already incurred and cannot recover. The due diligence process typically involves investing significant resources. You’ll hire individual teams to evaluate the various aspects of the transaction.
Financials, Intellectual Property (IP) and Intellectual Property Rights (IPR), synergies, and the potential scalability post-merger are only some of the areas. In the current business ecosystem, the stress is also on environmental, social and governance (ESG) risks that buyers must assess.
Having invested time, money, and effort in digging for potential deal breakers, executives proceed with the deal. Even if they have identified issues that indicate the transaction is not viable. Essentially avoiding these pitfalls during the due diligence can eliminate the need for exiting a failed merger.
Attempts to outbid competitors deflects from the original goal of acquiring value. When missed deals could also result in loss of market value, buyers tend to overpay to acquire the company. This gross mistake could result in the merger failing completely.
Material Adverse Clauses in the Merger Agreement
Since the timeline for finalizing an M&A transaction is so long, dealmakers can add material adverse clauses in the merger agreement. This clause covers the risks that buyers and sellers may face in case one of the parties walks away from the deal.
Once the deal is announced in public, the parties must sign the merger agreement, which is a binding contract. This contract defines the conditions under which the buyer can terminate the sale. That is, if they think that the target company is facing material adverse changes.
The changes can include any of the conditions that impact the entire business vertical, like rising operating and inventory costs. Unexpected situations like the Ukrainian war, COVID pandemic, and inflation can also affect the company’s stability and merger’s viability.
Also account for supply chain disruptions, non-availability of affordable financing, and unfavorable economic conditions that can be deal killers.
The seller may be unwilling to include material adverse clauses or wishes to limit the conditions for its inclusion. Acquirers should consider that as a red flag and may want to terminate the merger without moving forward with the negotiations.
The “no-shop” clause is another addition to the merger agreement. This clause prevents the seller from reaching out to competing buyers for better deals while negotiations are ongoing.
In this way, buyers can prevent the seller from canceling the merger to consider other offers. These options can potentially offer them a higher price or more beneficial terms and conditions.
Compensations for Deals Falling Through
The agreement may also include the break-up fee, a predetermined amount that either party may have to pay the other. This amount depends on the extent of the risk each entity carries. From the buyer’s perspective, they must raise the necessary funding to pay for the purchase.
If the acquirer is a private equity buyer and cannot secure the funding, that’s a risk for the seller. The reverse termination fee is another clause that sellers can use to protect their interests. This charge is the amount of money the acquirer must pay to the targeted company. That is, if they fail to complete the deal.
Clauses and payments like these can mitigate the fallouts from failed mergers like litigation and bad publicity. This makes them some of the best practices for exiting an unsuccessful merger.
Preplanning – Best Practices for Exiting an Unsuccessful Merger
Dealmakers should preplan for the possibility that the deal could fall through. With this objective, buyers should be upfront with the target company if they aren’t confident about the purchase. A heads-up will allow the seller to mitigate their expenses and have a failsafe plan in place.
When founders anticipate an exit that doesn’t pan out, they must move quickly to ensure that the company is stable. Accordingly, they may have to evaluate the operating runway they have available. They must also add up the remaining cash reserves, capital, and other resources.
From the acquirer’s perspective, they must estimate their costs for integrating the merged company. If they need to invest in new processes, systems, equipment, or even work premises, the recovery costs could be too high.
If the sellers have shared sensitive information with the prospective buyers during the due diligence, they’ll take steps to secure it. Any data, trade secrets, information about Intellectual Property and other proprietary assets should also be protected.
Both buyers and sellers are accountable to investors and other stakeholders. A failed M&A deal can lead to lack of confidence and investors may want to pull out their capital. Shareholders may want to sell their equity quickly leading to share prices dropping significantly.
Reassuring them that their interests are secure and taken care of can mitigate the fallouts and ensure stability for the dealmakers.
Whether in acquisitions or fundraising, the core talent a company has is one of the key areas of focus. Managing and retaining the talent skill sets is crucial for the long-term success of any organization. Check out this video where I have explained what investors or acquirers look for in the founding team.
The Human Resources Aspect
An essential part of the due diligence is sharing information about the human resources and core talent both companies have. Considering that the possibility of talent poaching is very real in the corporate world, buyers and sellers should be wary.
You can prevent this risk by including non-solicit clauses in the merger agreement. Yet another way to minimize the risk of employee attrition and layoffs is to rework salary packages and compensations.
Top-tier executives, board members, and other employees may anticipate raises or monetary benefits after the merger. You may have to deal with their expectations and discuss new terms and contracts. At least for the interim period until the company is stable again.
Detailed pre-planning can make the ultimate difference in dealmakers ending the negotiations on an amicable note. Or walking out of the conference room into a courtroom. The stage at which talks break down can also influence the outcomes.
Failed Mergers Needn’t Be the End of the Road
Among the best practices for exiting an unsuccessful merger is to keep communication channels open for future negotiations. A single failed merger does not signal the end of the road. Dealmakers can revisit the proposal at a later date.
This is why it is essential to walk away from the table on an amicable note. In case the possibility of a deal arises in the future. Dealmakers could identify and rectify the key issues that led to the merger’s failure and come back for fresh negotiations.
Improved economic conditions, new federal laws and policies, lower interest rates, and various other factors could set a new stage. Be open to the prospect of reconsidering the M&A deal.
Walking Away From Negotiations is Preferable
Unsuccessful mergers do involve writing off the expenses for due diligence and other resources both parties may have invested. However, walking away until the deal is viable for both parties is always preferable.
Companies face serious issues with integrating synergies, managing human resources, cultures, and ensuring value from the deal. If the conditions are not right, companies face far more significant losses if they must go for a demerger.
This is why you must adopt the best practices for exiting an unsuccessful merger and minimize the fallouts. Retaining the services of an expert M&A advisor for assistance can help you get there.
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