M&A transaction risks and the best method to mitigate them

In today’s world, M&A are an integral part of the corporate finance world. Every day, many deals are made around the world that brings companies together to create larger companies. Usually, the combination of several businesses is behind the increase in the market value of the new company, and in some cases, the acquisition of synergistic benefits. This article will consider the risks of these deals. 

The essence of M&A transaction process

The current stage of economic development shows that one of the key factors for the company’s success is building an effective corporate governance system. Moreover, in developed economies, corporate governance is viewed as a tool to reduce investment risks in a volatile environment, and, therefore, as a key factor in sustainable development. Thus, in order to maintain a global competitive advantage, increase the pace and scale of production, and improve the quality of products and services provided, new methods and tools of corporate management are required.

The process of mergers and acquisitions is multi-stage and difficult to implement. There are four main stages in conducting transactions:

  • justification and development of a strategy;
  • company selection – goals and its initial assessment, 
  • price determination and choice of a source of financing;
  • conducting of a deal.

What are the risks of M&A?

The lack of proper methods of risk assessment when making these transactions hinders the use of this important anti-crisis tool. Analysis of risk as an economic category shows that along with such risk functions as regulatory, protective, compensatory, socio-economic, it also has an innovative function. The latter is to stimulate the search for ways of unconventional solutions to the problems facing the business entity. At the same time, most enterprises achieve success, become competitive due to innovative activities associated with risk. Risk assessment of such transactions is one of the key functions of data room service providers

In the theory of M&A, the main source of risk is an incorrect assessment of opportunities and the loss of potential benefits, which leads to a decrease in the effectiveness of transactions.

Risk in corporate mergers and acquisition is considered as a set of input variables, such as:

  • the probability of a deal breakdown;
  • exceeding the deadlines for closing a deal;
  • excess of transaction costs in excess of those stipulated by the contract;
  • Error in assessing the value of assets.

How to evaluate the risks of M&A?

The assessment process can be divided into the following stages:

  • Initial selection. Selection of similar transactions over the past 1.5 – 2 years by such parameters as the industry of the companies involved in the transaction, their size, source of financing for the transaction;
  • Analysis of transactions in which the companies performed similarly to the participants in the proposed transaction under consideration. This includes balance sheets and other forms of accounting that are similar in structure, similar quality of management, etc;
  • Analysis of potential benefits and effectiveness of transactions. In the further evaluation process, it is advisable to use companies – analogs with a similar structure of sources of synergistic benefits as in the proposed transaction.
  •  Calculation of estimated multipliers and coefficients.