Good Housekeeping: Preparing for an M&A

15 April 2024 ,  Luhann PrinslooSian Angus 326
When a company is considering a Merger or Acquisition transaction (M&A), it is vital that the correct preparation is done for the transaction using what we call good ‘housekeeping’ practices. In this article we take a look at these housekeeping practices and why they are important in the run-up to an M&A.

The first, and arguably most important step that an acquiring company should take when it is considering entering into an M&A with a target company, is to conduct due diligence in respect of the potential target company. In the context of M&A transactions, ‘due diligence’ can be defined as ‘the examination of a potential target for a merger, acquisition, privatisation or similar corporate transaction, normally undertaken by a buyer’.

From the acquiring company’s perspective, conducting a thorough due diligence will enable the company, as the purchaser, to negotiate a more favourable deal, either in respect of the purchase price or the terms and conditions of the sale. Conversely, if there are material circumstances in the target company that may give rise to potential liabilities and risks for the acquiring company after the sale has been concluded, the acquiring company may decide not to proceed with the transaction at all.

It is also possible for the target company, being the seller, to negotiate a higher purchase price with the acquiring company after a thorough due diligence has been conducted. This is due to the fact that the probability of unknown liabilities or risks arising from the transaction that the acquiring company may be confronted with is far less likely if comprehensive due diligence has been conducted, compared to limited due diligence.

Therefore, there are certain key questions that can be answered by means of due diligence, namely:

1. whether to conclude the sale transaction at all;
2. what the purchase price in respect of the sale will be; and
3. how the transaction should be structured to mitigate identified risks or issues.
 
It may be argued that there are two critical elements to ensure the success of an M&A transaction, namely due diligence, on the one hand, and the proper integration of the merged company, on the other. Therefore, the purpose of conducting a proper due diligence assessment is not limited only to identifying potential risks for the acquiring company but, rather, it also provides a chance for the target company to identify opportunities in order to realise the future prospects of the consolidated company, identifying collaborations between the merged companies, including post-merger planning.

Three primary types of due diligence should be conducted, namely financial, legal and commercial due diligence:
 
Financial due diligence
Conducting a financial due diligence entails the validation of the historical financial information of the target company, including reviewing the management and systems implemented by the target company in order to record and maintain its financial information. This will allow the acquiring company to ascertain the target company’s financial performance, by considering its past, present and future financial performance and, thus allowing the acquiring company to determine if the transaction will be feasible and ultimately a profitable investment by the purchaser.
 
Legal due diligence
Legal due diligence consists of an in-depth analysis of the primary legal documentation and information pertaining to the target company. This primarily consists of a review of the aforementioned documentation to ascertain whether there are any potential legal issues that may entail risks in respect of the transaction or the functioning of the target firm and that may potentially adversely affect the transaction. This involves a comprehensive assessment of, among others, the corporate structure and governance of the target company, agreements, employment and labour-related matters, intellectual property and regulatory compliance requirements.

A review of the corporate structure and governance of the target company should also be conducted, which includes reviewing the qualifications, experience and expertise of the company’s management team, decision-making processes and corporate governance policies implemented by the target company in order to ensure adherence to good industry standards and best management practices.

Existing contracts and agreements concluded by the target company should be scrutinised to establish the risks and benefits associated with such contracts and agreements. This will also enable the acquiring company to have a better understanding of the nature of the business carried on by the target firm and potential liabilities emanating from the contracts or agreements and which may be transferred to the acquiring firm upon conclusion of the transaction.

Where an M&A transaction takes place, it is normally accompanied by changes to the workforce of the acquiring and target companies. It is important to assess the impact of the transaction on the employees of each of the companies involved in the transaction. Due consideration should be given to the Basic Conditions of Employment Act, 75 of 1997, the Labour Relations Act, 66 of 1995, the Employment Equity Act, 55 of 1998 and the Broad-Based Black Economic Empowerment Act, 53 of 2003.

M&A may be subject to various laws and regulations, in particular the Companies Act, 71 of 2008 and the Competition Act, 89 of 1998. Furthermore, it may also be necessary for the parties to obtain approval from regulatory bodies, such as the Takeover Regulation Panel and the Competition Commission. A comprehensive review of all applicable regulatory approvals should be conducted to ensure compliance with applicable laws and regulations and that all necessary documentation is submitted to the relevant authorities in order to enable the parties to proceed to conclude a successful transaction.

Transaction structuring entails an assessment of the legal, financial and tax consequences associated with an M&A transaction and includes various factors, such as purchase price and payment, financing, asset purchase and share purchase, tax efficiency and implications and obligations following upon the conclusion of the transaction.
 
Before the conclusion of the transaction, the parties should agree to a purchase price, including payment thereof. The payment terms applicable to the transaction should be recorded in the agreement concluded between the parties.

It is possible for the parties to come to an agreement that the acquiring firm should obtain financing in order to enable it to acquire the target firm. This may also be incorporated in the written agreements concluded and to be signed by the parties as a suspensive condition.

A transaction may be structured as either a sale of business or a sale of shares and it is important that the parties agree on the type of sale before entering into a transaction with each other. A sale of business entails an acquisition of the assets of the target company’s business, which includes its goodwill, agreements, equipment, and inventory, among other things. A sale of shares, on the other hand, entails an acquisition of the target company’s ownership, including its assets, liabilities, and existing contractual obligations.
 
It is also vitally important for the parties to consider the most tax-efficient manner in which the transaction should be structured in order to mitigate tax consequences arising from the transaction for both parties. It may be advisable for the parties to obtain proper tax advice on this aspect before proceeding with the transaction. 

Commercial due diligence

Commercial due diligence aims to have a clear understanding of the market in which the target company operates with the purpose of predicting the level of future market growth and the target company’s competitive position within the market. Conducting a commercial due diligence can be particularly useful when the acquiring company is looking to expand into a new market by means of the merger, however, it may not be equally as useful if the target company already operates within the existing market of the acquiring company.

From the target firm’s perspective, conducting a comprehensive due diligence will assist to:

  • ensure the correctness of the agreement to be concluded between the target firm and the acquiring firm;
  • identify and remove potential complications that may arise prior to concluding the transaction, in order to realise a higher purchase price;
  • limit the risk of any potential claims that may arise after the transaction has been concluded;
  • verify the representations and guarantees made by the target firm;
  • provide legal opinions; and
  • make the target firm more attractive through the provision of key information to the acquiring firm, thereby saving the acquiring firm time and money.
Conducting a comprehensive due diligence and ensuring that a transaction is structured properly will allow the parties to consider the potential risks that may be associated with the transaction and make informed decisions prior to the conclusion thereof. This will ensure that the transaction aligns with the intention of the parties, as well as limiting risks and liabilities that may result from the implementation of the transaction. Due diligence is, therefore, a process that should not be neglected as it can either ensure the success or failure of an M&A transaction.

For guidance or assistance with your transaction due diligence and the implementation of your M&A transaction, feel free to make contact with our M&A Team who can help establish the correct approach for your transaction. 

Visit our M&A Team page


Disclaimer: This article is the personal opinion/view of the author(s) and is not necessarily that of the firm. The content is provided for information only and should not be seen as an exact or complete exposition of the law. Accordingly, no reliance should be placed on the content for any reason whatsoever and no action should be taken on the basis thereof unless its application and accuracy have been confirmed by a legal advisor. The firm and author(s) cannot be held liable for any prejudice or damage resulting from action taken on the basis of this content without further written confirmation by the author(s).
Related Sectors: Mergers & Acquisitions
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