6 minute read 26 Jan 2021
One person standing at the foot of a massive sea stack iceland

Seven vital Mergers and Acquisitions issues and how to address them

Authors
Suwin Lee

EMEIA EY Private Leader; Transaction Tax Partner, Ernst & Young LLP

Trusted business advisor specializing in Tax restructuring. Passionate about helping private businesses thrive and achieve their ambition.

Kerry McKeown

EY EMEIA and UK&I Post-Deal Services Leader; Partner, Tax, Ernst & Young LLP

Experienced Tax partner at Ernst & Young LLP. Knowledgeable in private equity ownership. A father, husband and bad golfer.

6 minute read 26 Jan 2021

EY Private Perspectives: The close of the transaction is just the beginning when it comes to generating value from a new acquisition.

In brief
  • This installment of the EY Private Perspective series highlights tax as a crucial component of “Day One readiness.”
  • Remediate risks and ensure compliance with post-deal clauses.
  • Look after key people and find ways to rethink intellectual property, legal entities and operating model effectiveness.

It’s Day One after completing a major M&A deal and you’ve got the metaphorical keys to your newly acquired business. So, what happens now? If you’re anything like the organizations that EY typically works with, you’ll want to start driving value from your acquisition straightaway, to deliver on the investment thesis. Often, that’s easier said than done, since the post-deal environment poses some significant challenges to buyers. Let’s look at these challenges and what you can do to address them:

1. Tax

Tax is a crucial component of what we like to call “Day One readiness”. It’s vitally important to know which tax filings are required, the frequency of those filings, and what mechanics will make each of those filings happen – across all of the different taxes for each jurisdiction relating to your investment. Ideally you will have done your homework in all these areas before the deal is completed. This allows tax to generate value for the rest of the business from the word go and prevents unforeseen tax bills arising further down the line.

With the deal done, the next step is to review the deal costs, along with withholding tax filings and management incentives. There may be tax bills due immediately. You can also start to explore Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)-enhancing items, such as optimizing the group’s position around sales taxes or research and development credits, as well as cash tax opportunities such as capital allowances. 

2. Risk mitigation

Once the deal is completed, it’s time to start remediating any tax or legal risks highlighted by the due diligence process, such as poor documentation in relation to transfer pricing, or failure to withhold taxes on interest payments. If you don’t do anything about these risks, you could find they increase over the period you own the asset, meaning you might have to accept a price reduction on exit. 

Sometimes the process of risk mitigation may present you with an opportunity to get to a better answer to create value. For example, let’s say that at the time of due diligence, a national tax authority had raised an enquiry in relation to your asset – an enquiry that is still ongoing. You may find that by meeting the tax authority, you come out with a better result compared with the exposure you anticipated during due diligence because you took a prudent approach to the potential worst-case outcome.

3. Compliance with post-deal clauses

It is common for sale and purchase agreements to contain post-deal clauses, which may remain in force for several years. Often these clauses will provide you with protection – for example, in the event that your newly acquired asset becomes the subject of a lawsuit. But there can also be clauses relating to group tax relief. So, if your asset has been carved out from a bigger group, these clauses may relate to the treatment of losses as they are shared between ownership periods. It is important to be aware of what these tax clauses contain and to bear them in mind when filing tax returns.

4. Intellectual property

Following the deal, you have an opportunity to rethink your intellectual property (IP) strategy, both with regard to legal protection and tax optimization. To do this, you will need to identify what IP you have – within both the existing organizational structure and in the newly acquired business – and where it is located. Consider whether the acquisition could enable you to group all your IP in one location and find new ways to develop IP for the combined group.

5. Legal entity simplification

When you pursue a deal, it is possible the target may include legal entities that you won’t necessarily want to retain in the future. Post deal, you may therefore look to remove any obsolete or superfluous entities, either to achieve cost savings or to more effectively manage your risks so you achieve a smoother exit when the time comes. It can be a good idea to seek professional advice to ensure that you don’t inadvertently take action that leads to issues later down the line.

6. People

A ‘brain drain’ has the potential to seriously undermine the success of a deal. Dealmakers have historically used equity incentives as a way to motivate and retain the key executives within an acquired business. Yet it is also important to bring along the team who work just outside of senior management, as well as other key members of the workforce with particular skills and expertise. Here the priority is to develop an incentive package that motivates them, and aligns them to your strategic goals for the business, without excessively diluting the equity pool. The best incentives may not necessarily be cash, but could take the form of flexible benefits or a long-term incentive plan.

Another consideration is making sure you have the right people and back office set-up. By automating certain repetitive and low-value activities, or outsourcing them to external advisers, you will free up your in-house staff to focus on value creation.

7. Integration

One of the biggest challenges – if not the biggest challenge – in most post-deal situations is integrating the acquisition into the existing business structure in a way that meets cost expectations. Operating model effectiveness is an important consideration here. Look at how you can optimize your supply chain and business structure so that you are operating effectively while remaining compliant with all relevant rules and regulations.

There might be an opportunity to make efficiencies by centralizing certain functions, such as finance or procurement. In some territories, you can even lock in the benefit of that type of reorganization by securing rulings that confirm your transfer pricing is correct. Operating model effectiveness projects tend to generate the most value for an organization when they are aligned with wider commercial initiatives to drive efficiency.

Secret to success

The closing of a deal is not the end of the transaction. Rather, it is a new beginning. A successful deal is not just one that completes – it is one that completes and results in the target being successfully integrated with the acquiring business. What’s more, the cost of an acquisition – while seemingly expensive at the time – tends to be minimal in the context of the lifecycle of the portfolio. 

Particularly at times when good-quality assets are expensive – due to high levels of competition in the market – the real value of an acquisition is not about the pricing of the deal itself, but about post-deal value creation. The more successful you are at creating post-deal value, the better your portfolio will be, and the higher the return you should achieve on exit. 

Summary

There are many important issues to consider once a major M&A transaction has completed. What’s more, these issues can potentially become major challenges unless they are effectively addressed. The main issues relate to tax filings, risks highlighted by due diligence, compliance with post-deal clauses, intellectual property, legal entities, key personnel and integrating the acquisition into the existing business structure. 

About this article

Authors
Suwin Lee

EMEIA EY Private Leader; Transaction Tax Partner, Ernst & Young LLP

Trusted business advisor specializing in Tax restructuring. Passionate about helping private businesses thrive and achieve their ambition.

Kerry McKeown

EY EMEIA and UK&I Post-Deal Services Leader; Partner, Tax, Ernst & Young LLP

Experienced Tax partner at Ernst & Young LLP. Knowledgeable in private equity ownership. A father, husband and bad golfer.