Volatility, disruption and fraud: the making of a modern M&A dispute A RESEARCH PAPER BY BRG Berkeley Research Group About BRG Post transaction and Berkeley Research Group is a leading global shareholder disputes strategic advisory and expert consulting services firm that provides independent advice, Our experts have helped resolve hundreds data analytics, authoritative studies, expert of post transaction and shareholder testimony, investigations, and regulatory disputes. We have a deep and up-to-date and dispute consulting to Fortune 500 understanding of transactions and the corporations, financial institutions, accounting and financial aspects of closing government agencies, major law firms and mechanisms. This knowledge is necessary regulatory bodies around the world. to identify key issues in disputes and to link them into the quantification of damages or Our experts combine intellectual rigour investigations of fraud. with practical experience and an in-depth understanding of industries and markets. In essence, most private M&A disputes Their expertise spans economics and relate to disagreement over “value” finance, data analytics and statistics, and transferred from seller to buyer at closing. public policy in many of the major sectors The target may be worth less than what of our economy, including healthcare, the buyer paid for (for example because banking, information technology, energy, it becomes clear that the target’s future construction, and real estate. earnings will be lower than expected, or liabilities were concealed). This could be Named by Forbes as one of America’s either by accident or design. Best Management Consulting Firms in 2016, BRG is headquartered in Emeryville, Cross-border M&A and LBO transactions California, with offices across the United that end up in disputes are often resolved States and in Asia, Australia, Canada, Latin through international arbitration. BRG America, the Middle East, and the United experts often work on the quantification of Kingdom. damages and forensic accounting matters in arbitrations, including matters related to Litigation and arbitration closing accounts, breach of warranty, fraud, services and earn-out disputes. We work as advisors or expert witnesses. Where appropriate, we Our litigation and arbitration experts work closely with other experts, for example provide independent and objective analyses, in construction, investigations, or forensic litigation support, and expert testimony technology. on damages issues in prominent litigation cases in court proceedings, arbitrations, and mediations, and before governmental agencies. Our commercial litigation and damages services are primarily focused on allegations and issues relating to disputes in antitrust, intellectual property, securities, healthcare and pharmaceuticals, financial reporting, labour and employment, contract, business interruption, and mergers and acquisitions. Copyright ©2016 by Berkeley Research Group, LLC. Except as may be Disclaimer: The opinions expressed in this publication are those of the expressly provided elsewhere in this publication, permission is hereby granted individual authors and do not represent the opinions of BRG or its other to produce and distribute copies of individual works from this publication employees and affiliates. The information provided in the publication is not for non-profit educational purposes, provided that the author, source, and intended to and does not render legal, accounting, tax, or other professional copyright notice are included on each copy. This permission is in addition to advice or services, and no client relationship is established with BRG by rights of reproduction granted under Sections 107, 108, and other provisions making any information available in this publication, or from you transmitting of the U.S. Copyright Act and its amendments. an email or other message to us. None of the information contained herein should be used as a substitute for consultation with competent advisors. After the transaction is signed, $ but before it is closed, the largest customer of the target decides to take its business elsewhere Political uncertainty causes the buyer’s home currency to crash. Earn-out payments become more expensive ? Purchaser accountants become A whistleblower calls the purchaser suspicious about the level of the shortly socialafter closing security and fraud mentions target’s provisions 18 months after the deal closes, the owner manager of the target A forensic analysis of the target’s sues over his earn-out What could possibly go wrong? accounts uncovers fabricated invoices 100,000 of the target’s customer accounts get hacked European countryyields nearmove the sharply target elects ultra right wing leader. Bond Purchaser discovers that the target has been theespionage victim of industrial Long-term contracts initially valued at millions of euros discovered to be worth a fraction of that amount $ A few weeks after closing, the target’s management requests additional cash to cover unexpected operating losses CHANCE Volatility. Disruption. Foreword At BRG we have seen more than our fair share of disputes arising from mergers Fraud. Dispute. and acquisitions. These disputes are time consuming, costly and best avoided. This paper focuses on post M&A disputes, how they come about and some of the ways dealmakers can avoid them. If we had to give just one bit of advice about how to avoid a dispute it would be this: make sure everyone on your team works together and communicates effectively. This may seem banal, but we have seen hundreds of disputes that took place because a lawyer forgot to share a clause in a document with an accountant, or because a risk expert didn’t look over an accountant’s assumptions. This risk of avoidable error is multiplied in cross border disputes where local practices differ. For example, in Europe most deals now close using a mechanism called a “locked box”, a practice that is very rare in the US. Conversely, representations and warranties insurance has long been a common feature of US deals, but has only recently caught on in continental Europe. As a result, this paper includes the perspectives and views of many different BRG experts from across our global practice. We hope you find it interesting and would welcome your feedback. Author: Heiko Ziehms Edited by James Lumley Thank you for the helpful comments from: Anna Baird, Matthew Caselli, Ron Evans, Ben Johnson, Amy Kingdon, Eric Miller, James Rusden, Alice Sheridan and the experts interviewed for this paper. 5 Elements of a Overconfidence Interest rate environment Human frailty and fallibility is a constant. and the valuation of dispute There have always been, and will always liabilities be, sellers who get “deal fever” and ignore Debt, both on and off balance sheet, plays due diligence red flags, only to regret it Disruption and volatility an important role in M&A disputes and later. Overconfidence in decision-making is fraud cases. Real interest rates have been One frequent element of an M&A dispute a major contributor to post deal disputes. exceptionally low for a significant period is disruption – the unexpected creeping In our experience, buyers systematically of time, and even negative in some large into a deal. overestimate their knowledge and ability to economies. Low interest rates are causing make a transaction a success. Curve-ball events often lead to breaches of long-term liabilities on company balance sheets to increase. They are creating representations and warranties or alleged Buyers who overestimate how well they record pension deficits which in turn material adverse effects. Surprised buyers understand the target and its markets weigh on deals. And extremely low interest tend to look for reasons for their surprise, are likely to make technical errors. They rates also affect long held practices in and, because humans make mistakes, are also likely to underestimate the valuation, both when valuing a transaction lawyers and accountants who get paid to challenges they may face when integrating or quantifying damages. uncover inconsistencies and errors, tend to their acquisition. This is why many deals We focus on this in the section on debt find them. fail, disappointment may well set in after PAGE 16 to 18 closing, and dispute could be the result. Unsurprised buyers tend not to question We highlight the perspective of a the deal they have just done, and so behavioural economist on PAGE 9 sleeping dogs are allowed to lie. It is safe to Completion assume that many breaches of warranties mechanisms and even frauds go unnoticed. Ambiguity Even level headed sellers are likely to take All of the factors listed above have led to Unexpected events can impact final prices an optimistic viewpoint when preparing disputes that BRG experts have worked on. in unexpected ways, and the world in which their accounts pre M&A. This is to be But where are these mistakes made and we are living at the moment appears to be expected as accounting, after all, allows a where is the smoking gun? one where the unexpected is increasingly great deal of scope for judgment. Disputes becoming a factor. The markets, as we often arise where judgment goes beyond For dealmakers, the deal’s blueprint is the all know, were wrong-footed by the UK optimism into bias and outside of SPA. In M&A disputes the SPA is most electorate’s decision to leave the European acceptable ranges of estimates. often – though by no means always – the Union. The market volatility that followed battleground.