A survival guide to M&A without warranties

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Some quick background: according to the market practice, the seller of a company or an asset is expected to give the buyer a set of representations and warranties regarding various aspects of the target, including accounting, tax legal and operational issues (“R&Ws”). If any of these representations and warranties reveals to be not truthful, the buyer is entitled to an indemnity from the seller, subject to qualifications and limitations.

Sooner or later you will meet a seller refusing to grant any R&Ws. The sale will be on an “as is” basis. That could happen for many reasons. The seller, or the subject managing the sale, is a public entity, a court or a bankruptcy receiver. Or there is an auction process in place and there is a truly unique asset for sale. Or the seller just ignores, or pretends to ignore, the market practice, which may happen in non-sophisticated jurisdictions or when buying a family-run company.

Be prepared. Here an approach I use to navigate through uncharted waters.

1 The return of the due diligence. While due diligence has become a commodity, where no warranties are involved do not tighten your pockets. Make sure that the due diligence team members your advisors are sending are not fresh out of university. Lower the value thresholds of the documents to be reviewed. Be sure that the smallest subsidiary of the target group is searched. Expand the scope of the due diligence process to involve technical experts to assess the regulatory compliance, the conditions of real estate properties, the presence of environmental issues in production plants, the manufacturing processes and so on. Go beyond the paper.

2 Close encounters of some kind. Although it does not sound cost-efficient, I realized that it is worth spending as much time as possible at the seller’s premises and with the company managers. De facto issues cannot be detected though documental reviews. This is as true for the buyer as it is for its consultants, including lawyers and accountants. And do not forget the IT guys (find out why here). If a picture is worth more than a thousand words, a personal experience is worth more than a thousand due diligence reports.

3 Never say Rep again. Are R&Ws as reassuring as we think? Enforcing R&Ws often involves disputes and no security to get the money back, unless a substantial portion of the price is held by a third party (a so-called escrow agent – not to be confused with an escort agent). In any case, it will not be quick. Therefore, if you cannot obtain R&Ws by the seller, get them from somebody else. Part of the R&Ws’ range can be covered by company house certificates, mortgage reports from notaries, accident reports from insurance agents and litigation reports from external consultants of the target company, including trademark attorneys and lawyers. Banks can release statements confirming the balance of facilities as well as the cash available. Clients and suppliers can give assurances about the absence of disputes. Employees can be asked to issue statements about the absence of claims.

4 For a few Euros more. Mitigating the risk by playing with the price structure is essential, but if you are taking part to a bid you also want to be competitive. Therefore, instead of just lowering the price, the buyer can offer a deferred or variable price depending on the future performance of the target company, typically in terms of Ebitda margin. By working on the Ebitda definition, a smart buyer can capture material profit and loss deviations from the reference financial statements, although in absence of R&Ws. Also broadening the price adjustment spectrum may be instrumental to intercepting deviations to the reference net debt.

5 The great escape. When R&Ws are not involved, having the ability of getting out of the contract if something goes wrong between signing and closing is a great tool. A material adverse effect (“MAE”) clause is what you need. The issue here is to define what material really means. Value thresholds

6 The usual suspects. Make friends (or hostages, depending on their viewpoint). Involving those who know the target company well in your future plans or in those of your broader organization will put them in a cooperative mood and you will get to know more than any set of R&Ws could tell. Employment and consulting arrangements are key to lock-in sellers, directors, top managers and key employees.

7 True lies. Psychologic warfare sometimes works. Induce the seller to make a complete disclosure by emphasizing the consequences of intentional deception under the applicable law. This tactic should be deployed both in the contractual documentation and in face to face meetings.

Copyright Giorgio Mariani 2016 – All rights reserved.

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