Acquiring a Company: Here Is What Can Go Wrong

By Kresimir Peharda, Partner

Business owners often ask what could go wrong when evaluating an acquisition of a private company.  While anecdotal evidence is helpful a study is even better.  The following is based on SRS Acquiom’s 2015 M&A Claims Study.  Even though the study is weighted very heavily in favor of mergers v. asset purchases or stock acquisitions, there is still a great deal of useful information.

What are the leading claims/areas of dispute?

The top 3 claims areas were:

  1. Breach of a representation or warranty
  2. Purchase price adjustment
  3. Fees/costs

 

Within the representation and warranty bucket, the following topics emerged as most common sources of disputes:

  1. Tax
  2. Intellectual property
  3. Undisclosed liability
  4. Employee related

 

How common are purchase price adjustments?

Purchase price adjustments (PPAs) were very common as 77% of the deals analyzed had some form of adjustment.  In 48% of the cases the PPA adjustment went in favor of the buyer as opposed to 17 % for the seller.  The average PPA claim size was 1.3% of the transaction value.

What should I expect if the escrow period expires?

In situations where the escrow period has expired, 60% of these deals had at least one escrow claim.  The most common claims were:

  1. Negative purchase price adjustment
  2. Tax
  3. Fees/costs
  4. Intellectual property

 

What are the leading claims for escrowed funds?

The leading areas of dispute as a percentage of funds were:

  1. Fraud
  2. Breach of fiduciary duty
  3. Customer contract
  4. Intellectual property

 

How long did it take to resolve the leading claims between the parties?

On average it took 7 months to resolve claims in the deals analyzed.  The following chart demonstrates the leading dispute areas and months required to resolve:

Claim type                                                                                                           Months to resolution

Fraud 3
Breach of fiduciary duty 13
Customer contract 12
Intellectual property 8

 

What is the prevailing practice for indemnification baskets?

The study reveals that 58% of deals have first dollar baskets as opposed to 37% of the deals with deductible baskets.  In first dollar baskets the indemnifying party is responsible for each and every dollar once a threshold is reached.  In the deductible version, the indemnifying party is only responsible for damages above a certain threshold amount.

Takeaways

Based on the information in the study, buyers would be well advised to invest more heavily in the due diligence process with respect to the highlighted areas.   Of note is the fact that disputes in the areas of breach of fiduciary duty and customer contracts take on average a year or more to resolve.  The time and money spent on the resolution and lost productivity from pursuing these claims makes it clear why these areas need to be taken very seriously.