5 Common Risks Involved in Mergers and Acquisitions

The total global value of corporate mergers and acquisitions (M&A) reached $5.9 trillion in 2021. For 2022, the figure is expected to reach $4.7 trillion, making it the second-best year on record for the M&A market after 2021.

Robust M&A opportunities exist for companies looking to stimulate growth, increase market share, and influence supply chains. Despite these potential benefits, M&A deals are also fraught with serious risks.

Below are five risks that can jeopardize the outcome of an M&A deal or prevent a company from capturing the expected benefits.

1. Poor Due Diligence

What it Means

Due diligence is essential for all mergers & acquisitions. It allows the acquiring company to discover important facts about the seller, such as:

• ​Contracts
• ​Financial stability
• ​Insurance
• ​Customer agreements
• ​Distribution agreements
• ​Compensation agreements
• ​Employment contracts
• ​Liabilities, such as debts

These details may affect the buyer’s decision to merge with or acquire the company. Such insights also allow the acquirer to adjust its expectations, inform negotiations, and reduce the risk of legal or financial problems. With proper due diligence, the buyer can avoid entering risky and potentially catastrophic business deals.

Risks

Inadequate due diligence can cause serious problems, such as poor valuation, unexpected litigation, or tax issues. Ultimately, the buyer may make a poor decision that could damage its financial position or reputation.

Risk Mitigation Strategies

Proper due diligence is crucial for any M&A deal. The buyer must start the process early with an experienced team that has business, legal, and financial expertise, as well as industry knowledge. That team must create a master due diligence request list so the acquirer can ask the right questions during the process.

2. Overpaying for the Target Company

What it Means

In M&A transactions, buyers are frequently under pressure to close the deal. In their rush, they may overpay for the target company rather than negotiating a fair price that could create market value and provide a satisfactory investment return. Buyers may also use overly optimistic assumptions or follow poor valuation practices, resulting in overpayment.

Risks

Overpayment increases the cost and risk for the buyer, even if the deal is well-conceived and well-implemented. It also increases the probability that the buyer may be surprised by unforeseen circumstances that compound the pain of overpayment.

Risk Mitigation Strategies

The buyer must understand the issues that often lead to overpayment, such as:

• ​Intermediaries focusing on providing the seller with a negotiating edge
• ​Concern that a competitor might buy the target first
• ​Adjusted EBITDA made to look especially positive
• ​Stock premiums in anticipation of acquisition

Acquirers must produce a comprehensive valuation report, collecting crucial data about the target, including stock premiums, tax returns, organizational structure, and shareholder agreements to guide negotiations.

3. Overestimating Possible Synergies

What it Means

One goal of M&A activity is to leverage the synergies of the two companies to boost growth and competitiveness. Synergy can be intangible (e.g., becoming a key player in the market) or tangible (e.g., increasing cost efficiencies).

Risks

Tangible synergy is easier to measure, but paying for intangible synergies that are not rooted in economic reality can lead to overpayment. Buyers often overestimate synergies; according to McKinsey, this optimism affects at least 25% of mergers and results in a 5 to 10 percent valuation error. Buyers may also underestimate how long it will take to achieve synergies, resulting in unrealistic expectations.

Risk Mitigation Strategies

Buyers must remain conservative when estimating synergies, reduce top-line synergy estimates (especially around revenues and access to customers), and consider possible post-deal problems such as customer loss and difficulties reconciling teams.

4. Integration Challenges

What it Means

Integrating processes, systems, and workforces after an M&A is one of the most complex aspects of the deal. A robust post-merger integration (PMI) process is vital to reduce complexity and maximize synergies.

Risks

A poor PMI process can reduce employee engagement, increase turnover, affect customer engagement, and erode sales and profitability. The buyer may miss growth and cost targets as the two business units struggle with integration. Communication challenges and problems merging corporate cultures may also hinder success.

Risk Mitigation Strategies

Companies that efficiently achieve integration post-merger can deliver 6 to 12 percent higher total returns to shareholders compared with those that fail to achieve integration. It’s important to implement an integration plan and process as early as possible. The acquiring company should:

• ​Establish best practices to streamline new processes and workflows
• ​Create a roadmap for cost and growth synergies
• ​Define the target organization’s structure
• ​Map system and process interdependencies
• ​Identify critical employees for retention and create a team to stabilize the business and culture post-integration

5. Unexpected Problems Related to Costs, Communications, or Security

What it Means

Despite due diligence and a PMI plan, surprises can happen when integrating two companies. Consolidating teams takes time, and organizations may experience increased costs in the short term before realizing expected savings.

Risks

Legal fees, investment banking fees, advisor fees, and other costs can overwhelm a buyer. The cost of due diligence and post-merger integration can also be substantial. Poor communication reduces transparency and causes integration problems, leading to cultural issues and disengagement. Large volumes of data collected during M&A are attractive to cyber attackers, increasing the risk of data breaches.

Risk Mitigation Strategies

Planning can help avoid surprises around costs, communications, and security. Buyers should adopt a flat rate pricing model with due diligence specialists and use M&A project management platforms. An M&A communication plan can prevent confusion and cultural issues. Technology solutions, such as virtual data rooms (VDR), provide secure online repositories for confidential deal information.

Best Practices for Successfully Navigating Mergers and Acquisitions

In addition to risk mitigation strategies, organizations should follow best practices to navigate an M&A deal successfully:

• ​Implement a change management program to address employee, cultural, intellectual property, and process issues
• ​Capture synergies likely to yield the highest returns quickly
• ​Align stakeholders on the overarching M&A goal
• ​Adopt agile practices to maintain focus on synergy capture
• ​Strengthen security infrastructure with strong encryption and multi-factor authentication
• ​Analyze past market disruptions to glean insights for future M&A challenges and integration risk