Why Mergers and Acquisitions Fail (And How to Avoid the Most Common Mistakes)

As they continue on their mission to demystify every aspect of selling a business, Nick and Justin cover the numerous ways an M&A deal can go wrong and explain why the majority of deals which fail, do so in the due diligence phase of the process.

Take a look at this in-depth discussion in the video or read through the transcript below…

Video sub-topic timestamps:

00:00 – Introduction
01:12 – Why the majority of M&A deals fail at the due diligence phase
02:29 – How prior preparation can increase the chances of a successful M&A transaction
03:41 – Failed M&A deal: A real-world example
04:48 – Shareholder disputes
05:27 – Poor or incomplete financial reporting
07:40 – External factors which can negatively impact an M&A deal
08:30 – Managing personnel

Video Transcription

Nick Davies:
Morning, Justin.

Justin Levine:
Morning, Nick.

Nick Davies:
How are we?

Justin Levine:
Good. Good. Thanks.

Nick Davies:
Excellent. Welcome back. So we’re talking today, continuation of our M&A series, about various aspects of M&A. A key question, I think, that lots of people have is, what can derail a deal? What can stop a deal dead in its tracks? What can make the parties want to abort and walk away? And what can people do to guard against that?

Nick Davies:
So I hand over to you straight away. What’s your take on that? And what’s your experience?

Justin Levine:
Yes. Well, I think the first one is nobody wants to see a deal fail because, the problem is, by the time you’ve signed heads of terms, then, as a seller, you’re incurring cost. You’ll have a legal team in place. You’ll have an accounting team in place, dealing with accounting and tax due diligence. And if stuff happens in that two or three month period where due diligence is happening, you’ve agreed a deal, you are emotionally committed to the deal, you’re almost counting the pounds in the bank at the end of the deal. If it fails, then it’s problematic for everybody.

Why the majority of M&A deals fail at the due diligence phase

Justin Levine:
So I would say, a bit reductionist if you like, I apply the 80-20 rule. 80% of the things that can derail a deal happen in the due diligence. And the due diligence, of course, is that process, which the buyer is inspecting the business in minute detail, asking lots and lots of questions: accounting, tax, legal. And it’s typically that a “skeleton is discovered,” I’m using it in inverted commas, that the seller is unaware of an issue. Or maybe aware of an issue, but doesn’t think it’s particularly important.

Justin Levine:
Unaware or aware makes no difference. The buyer discovers that issue. And typically, it’s something fundamental. It can be a tax issue, whereby taxes haven’t been paid properly, taxes haven’t been accounted for properly. It could be an IP issue, intellectual property, that the seller thinks they own the intellectual property, but in fact, actually on very close scrutiny, it turns out that there might be question mark over it. It could be an environmental issue, discharging stuff which shouldn’t be going into the public waste system. And so on and so on. But something that is material, that the buyer looks at and says, “Hang on a second. It’s shifting the risk. And the risk is becoming too high for me as a buyer to absorb.”

How prior preparation can increase the chances of a successful M&A transaction

Justin Levine:
And of course, my argument to all of this is preparation upstream is the bit to avoid; that bit. So if you say, how can you avoid that deal failing because of that big skeleton in the closet, the answer, the solution to that conundrum, is doing pre-due diligence. It means spending money in advance of the deal, and…

Nick Davies:
Housekeeping.

Justin Levine:
Housekeeping. Housekeeping.

Nick Davies:
Getting your house in order.

Justin Levine:
It is. And most clients won’t want to do that because it’s expensive. It is simply expensive, because if you’ve got to commission an accounting team, and a tax team, and a legal team to inspect your business without a deal in play, and you’re saying, “Just get me ready”…

Nick Davies:
It’s cheaper than losing a deal, though? It’s cheaper than getting into a deal and having that deal go aborted probably. And what’s your downside? Your downside is that you’ve got your house in order and your business is in a better shape, you’re more organised. So there’s a value to that. I appreciate that it comes at a cost, but it does put value back into the business.

Justin Levine:
I think it does. And I think that the biggest, if you like, obstacle that I personally face leading a business where we advise clients on selling their businesses, it’s actually almost convincing a seller that that is a worthwhile investment. And the reason I say that is because very often, it is not the seller who’ll have lived with issues.

Failed M&A deal: a real-world example

Justin Levine:
And I can give you an example without breaking any confidences. One can have a business, for example, a notional business, let’s create one, a limited company, turning over let’s say five million pounds per year. And all of the directors invoice their costs via service companies. So they basically take their income by invoicing via their own legal entities, limited companies.

Justin Levine:
And they’ve done that for sort of 10, 15 years. So it’s day-to-day business, they’ve got quite happy with the risk they’re taking. They don’t perceive any great risk. The buyer can do the due diligence and find, in this particular example, that there is literally millions of pounds worth of potential tax at risk because it, in effect, is that they broken IR35, or potentially broken IR35.

Nick Davies:
Yeah. There’s an issue there.

Justin Levine:
There’s an issue there. And I think the point being is that this notional example, so I’ve obscured some details to keep it very confidential, but that’s an example of where the seller doesn’t perceive there’s a risk, and therefore might not have invested to have had a look at the problem upfront. The buyer investigates it with a very competent accounting business and said, “Yeah, the risk is quite high here. So we’re going to pull out of a potential deal.”

Shareholder disputes in M&A deals

Justin Levine:
So 80% of the issues that I see that can derail a deal are in that due diligence phase. There is 20% of other stuff, and the other stuff’s a little bit more intangible, if you like. But it has… through 10 years of experience or more, I’ve seen this stuff happen. And examples of it… Shareholder disputes, is that a business, a seller, with multiple shareholders going into a sale process, at some point in the process, the shareholders of the seller start to disagree about something important. And that can potentially derail the process.

Poor or incomplete financial reporting

Justin Levine:
The other aspect that I see, and I think this is one that I see quite commonly, and that is that the financial team or the accounting team within the seller is not able to produce the level and quantity and accuracy of financial information that the buyer will want to see through the due diligence. And I think it’s important.

Justin Levine:
If I just unpick that slowly, is when a deal is agreed, heads of terms is set between buyer and seller, is the buyer is looking at the seller’s business very carefully, all the way through to closing. And for the seller, that’s unusual because the seller says, “Hang on a second. Surely, they pay attention once they bought it.” And the answer is no. Once the heads are actually signed, the buyer wants to see reliable management information.

Nick Davies:
The magnifying glass comes out at that point, and they put the business in that spotlight and look very closely.

Justin Levine:
You’ve got it. And they’re looking, they’re doing the due diligence on the business, and, very important, underline the “and,” and they are looking at the performance of the business all the way to closing. And I think if the seller’s business does not have the capability to produce very accurate management information in a timely way, it can put huge pressures on a deal. And I’ve seen it happen where the accounting team have struggled to produce timely information because they only have done light management reporting in the normal running of the business, and the buyer gets increasingly disconcerted about what is happening within the business they’re buying.

Nick Davies:
It’s unsettling.

Justin Levine:
It’s unsettling. It’s unsettling. So typically, I always counsel that that period, once a deal is going to be in play really throw resource. And if the resource needs to come in from outside, if you need to appoint an external accounting firm, tax firm, to support you in the sales process, even if it’s costing more money, it’s money well spent.

Nick Davies:
That’s really interesting, Justin. Listening to what you’ve got to say there, a lot of those are factors which sellers can control. And I suppose in terms of the factors that can derail a deal, you can do your housekeeping, you can control that. In terms of your financial support, you can control that by getting the right resource.

External factors which can negatively impact an M&A deal

Nick Davies:
Some deals will fail for reasons that can’t be controlled. Market conditions, pandemics. I wouldn’t want to be trying to sell a pub chain or hotel chain in the last 18 months [at the time of shooting this video – SEPT 21], there’re some difficulties there. But people should focus on what they can control, and getting all of that housekeeping done and getting the business in tip-top shape so that the due diligence is easier, it doesn’t highlight key issues. And that has other benefits, as well as keeping the deal railed and on the straight and narrow, it can reduce risk for the sellers in terms of warranties and indemnities. That’s a subject of another video. But if you are regularising historic problems, sorting them out, that’s going to put a buyer at ease. It’s going to make the buyer more comfortable, and it’s time and money well spent.

Managing personnel

Justin Levine:
One of the questions that comes up that clients often ask me is about incentivising or even making the management team aware of a sales process. It’s an interesting question, isn’t it? Because on one side, if you’re selling a business, you’re going to want to keep a level of confidentiality within your business so it doesn’t leak out, you don’t disrupt people, don’t stress people unnecessarily. Why explain to your employees that you’re selling a business when it may not sell, for example. But then, if you have a key manager leave the business in the time where you’ve agreed a deal, that can literally stop a business sale, especially if that is a key person within the organisation.

Nick Davies:
Absolutely right. If that person is integral to the running of the business, even under the buyer’s ownership, then a buyer will be very unsettled if that individual leaves. And you are right, it’s a challenging question. And it’s a timing question. At what point do you bring the relevant management team into your confidence, into the knowledge that the company’s being sold? You need to do it at a point where you know the deal is certain or near to certain. And some people do think about incentivising those people and getting them focused on the target, which is completion.

Nick Davies:
But there’s also a lot of work to be done in terms of complying with due diligence requests. It’s very hard for sales to deal with all of that on their own. There’s a great wealth of information that needs to be provided: contracts, employment information, data protection, health and safety. And actually having a team that you can delegate some of that to and say, “Please go away and find A, B, and C,” that will help enormously and help a seller manage their stress, manage the process, and manage the time demands, which are significant.

Justin Levine:
Yes, absolutely. So I think we’ve covered off those key elements, and it’s all about preparation.

Nick Davies:
I think so.

Justin Levine:
If you’re going to sell a business and you are going to get £10 million, £20 million consideration in whatever form, whether it be 100% cash or otherwise, spending some time upfront preparing…

Nick Davies:
Yeah. It’s a good investment.

Justin Levine:
…it’s just a drop in the ocean in terms of expenditure.

Nick Davies:
Agreed. Thanks Justin.

Justin Levine:
Thanks Nick.

_ _ _ _ _ _ _ _ _ _ _ _

More from Series Two of M&A Deconstructed

• Sale and Purchase Agreements (SPAs) in Mergers and Acquisitions
• A Guide to M&A Warranties, Representations and Indemnities
• Understanding Earnouts, Deferred Payments and Vendor Loans in Mergers and Acquisitions

Take a look at Series One of M&A Deconstructed

As part of this in-depth series, other topics discussed include:

• What is EBITDA?
• What are Heads of Terms?
• Completion Accounts vs Locked Box Mechanism
• What is Due Diligence in Mergers and Acquisitions?
• The difference between a Share Sale and an Asset Sale?

Connect with the M&A experts

Justin Levine, Managing Director, The NonExec Limited M&A Boutique 
Justin leads a boutique exit advisory firm specialising in manufacturing, technology, IT, digital, healthcare, wholesale and distribution markets. With the support of a 15-strong virtual team of analysts and researchers, he helps private business owners with growth and exit strategies. Connect with Justin >

Nick Davies, Partner and Specialist M&A Solicitor, Steele Raymond LLP
Nick acts for a wide range of business clients across various sectors, advising on complex corporate transactions including company sales, purchases and mergers. Nick also advises on on mergers, de-mergers and re-organisation. Connect with Nick >

Make an Enquiry

If you have any questions regarding your business, a business exit, a merger or any other corporate legal query, please contact Nick Davies on 01202 294566 or email [email protected]