In this series of articles we share our learnings and insights from over 125 M&A, fundraising and restructuring transactions that the Aurum team has done over the past 2 decades of professional experience. We explore the factors that help speed up the transaction as well as watchouts that derail transactions in which the fundamental value & valuation were not the main cause of the transaction not going through.
Aurum Insights on Reps and Warranties
The quality of Reps & Warranties and Indemnities, and the state of related data is critical to concluding M&A transactions. Incomplete and work-in-progress reps & warranties data, even with honest intentions raise doubts & concerns, which are the primary reasons for buyers walking away from deals. Likewise, poor preparation on reps & warranties make sellers uncomfortable in equity swap deals.
The better prepared the parties are on their respective reps, warranties, indemnities and disclosures, better the chances of a quicker conclusion of a transaction.
Better the quality of reps & warranties, lesser the chances of just the valuation numbers being a deal-breaker if the valuation mismatch is within a reasonable range. On the other hand, we have seen deals with poor quality of reps & warranties fall through even when the valuation expectations were within reasonable limits of variance.
Most sellers, with all the honest intentions, are not prepared with all the information that they should include in reps & warranties. It takes time and effort and focus, and CANNOT be the sole responsibility of the finance and legal teams who may or may not have a full view of the business processes. Reps and warranties has to be the CEOs responsibility, and should include aspects of risk and dependencies from across ALL departments and processes within the organization.
Definition of reps & warranties: In simple words, reps & warranties refers to ALL the information that a buyer and seller need to give each other so that they both can take a decision with a full understanding of all the facts and realities as they exist in the current state.
Reps & warranties should include ALL possible points that the other party may need to know, and assess the impact of, for making a decision on whether they want to proceed with the transaction, and if yes, the terms of the transaction.
Of course it will include some of the more obvious areas like legal cases, pending tax liabilities, etc. But often what gets missed out is often what is not in the realm of the finance and legal teams. E.g. That a member of the management team is leaving in 6-months time or that a major customer is building an in-house team for the business that they currently give to you is information that is critical. But since reps & warranties are usually prepared by the legal team and finance team working in tandem, other business aspects that they are not aware of usually get missed out.
The seller’s reps & warranties usually include points that will help he buyer value the company for the transaction. Unless it is an all-cash deal, he buyer too has to provide reps & warranties, and they will usually cover the consideration that the buyer is providing for the transaction. E.g. if the buyer is giving stock in the company as consideration for a part or full stake in the selling company, the buyer will give reps & warranties that establish the seller is legally free to offer the shares to the seller.
Why are reps & warranties important? Reps & warranties, and the accompanying and related information as well as the conversation related to those points help both parties assess the risks, liabilities as well as the opportunities and benefits associated with the transaction.
Reps & warranties have a legal implication – both on the inclusion and the omission side. I.e. The information providing party is liable if the information and reps & warranties provided are found to have inaccuracies and misrepresentations. Also, points and issues that the party was aware of but were not reported can also be the basis of claim & litigation against the information provider.
Aurum advice to sell-side CXOs based on our experience & insights:
- Get an understanding and awareness of ALL factors that can be either a risk or an opportunity for the company. Reps & warranties are perceived only as disclosures to provide information for the buying party to assess the risks. However, reps & warranties can and should also be used as a strategic tool to strengthen the value proposition and the value of the company to the buyer.
- Start collecting information for reps & warranties BEFORE embarking on negotiations for a M&A transaction. During negotiations you should have your mind-space and time free to think through negotiation tactics and not on gathering information. Also, being well-prepared gives a confident, comforting view of you and your company to the buyer. It reflects openness to share and disclose. And this, in our experience, helps significantly in speeding up the decisions AND also encouraging the buyer to overlook minor issues that could otherwise have been aspects that would delay concluding a deal.
- While the interest to engage in conversation for M&A may be triggered by a variety of factors, whether to conclude the transaction or not is usually dependent on the information and discussions provided by reps & warranties. M&A is a transaction where value is traded for value. The value of the selling company is compensated for by the buyer in the form of cash or stock or other consideration that may represent the value that the buyer and seller agree on. Reps and warranties also form the basis of valuation and terms of engagement.
- As a seller, your goal should be a quick decision from the buyer – even if it is ‘not interested’. That’s because it is costlier as well as painful to go through prolonged discussions & negotiations that do not conclude in a transaction. Being prepared with comprehensive, all-encompassing reps and warranties help sellers push for early decisions. Under-prepared sellers usually find themselves on the defensive.
- Reps & warranties also allow a seller the opportunity to enhance the value of the company based on
Sanjay Bansal – Founder & Managing Patner – Aurum Equity. Click here to view profile.