Updated Sep 11, 2024
Most people would say that to do business is always a risk; as such, it is up to the people running the business to minimize or to even eliminate these risks.
Mergers and acquisitions have many advantages, which is why these are still relevant in Canada’s market. However, parties to these transactions may wonder what the risks of mergers and acquisitions are.
Knowing these risks will help parties strategize on how to move forward with the merger or acquisition — or even whether to push through with it at all.
What are mergers and acquisitions?
Mergers and acquisitions (M&As) are business transactions where two separate and distinct companies become one, either through:
- the combination of the two companies
- the purchase of one company by the other
While these two may seem similar, they still have their own differences. Mergers are when two companies integrate to continue as a single entity. Acquisitions, on the other hand, happen when a company is taken over by another through the purchase of all its shares or its properties.
In acquisitions or takeovers, the company being bought is called the target company, while the other is called the purchasing, acquiring, or buying company.
In mergers, the two companies merging are just called the combining companies, and the result is simply called the new company.
Read more: Why you need a lawyer to buy a business in Canada?
Know more about the key differences between mergers and acquisitions, and their objectives which are related to these differences, with this video:
Be guided on the application of specific Canadian laws to your planned merger or acquisition. Reach out to the best mergers and acquisitions lawyers in Canada as ranked by Lexpert for guidance.
What are the risks of mergers and acquisitions?
Parties must minimize the risks of mergers and acquisitions to ensure the success of the process and even that of the resulting company. These risks may result in failed M&As, triggering legal problems for and against both parties.
Here are some of the top risks of mergers and acquisitions:
- Overlooked laws on M&A
- Overestimated synergies
- Unexpected costs
- Overpriced M&A
- Integration shortfalls
We’ll discuss each of these risks, some practical examples of how these may happen, and suggest some ways to address them.
1. Overlooked laws on M&A
M&As in Canada are governed by federal laws such as the Canadian competition and antitrust law and other statutes. Whether the M&A transaction involves multi-billion companies or smaller businesses, the law and its application are the same. Some of the important Canadian laws on M&A that influence its process are:
- Competition Act
- Investment Canada Act
- Canada Business Corporations Act
This is in addition to the countless regulations that regulatory bodies have issued. For these reasons, it’s vital that M&A lawyers are involved at the very start of the process.
Related to this risk of mergers and acquisitions is the litigation risks in M&As. Court actions can come from different flanks:
- parties may sue each other for a failed merger
- regulatory bodies may challenge the transaction
- employees may sue the old or new company for labor issues
The risk of disregarding the law before pursuing an M&A will have devastating results. For instance, penalties for violating the Competition Act can include administrative penalties and civil liabilities. Worse, the Competition Bureau may challenge the merger with the Competition Tribunal. In turn, the Tribunal may direct that the merger not proceed or that the merger be dissolved.
How to address the risk of overlooked M&A laws
The best solution to this is to engage a lawyer who is an expert in Canadian laws involving M&As at the very early stages of the M&A transaction. It can be as early as when the idea of entering into a merger or an acquisition is first discussed.
On the part of the purchasing company, talking to a lawyer before reaching out to possible target companies can be done. Target companies, on the other hand, may immediately seek the help of M&A lawyers right when a purchasing company transacts with them.
2. Overestimated synergies
The point of M&As is to create a new company from two different entities, even though they’re similar in some ways. These two entities usually think that because they are going through this tough process, it must result in something bigger profit-wise, compared to when these two entities operate on their own.
However, an unharmonious process is one of the risks of mergers and acquisitions, which may even have a domino effect on the other aspects. This is usually the result of an overestimated synergy. Here, companies tend to set up unrealistic expectations and bank too much on their perceived results. Instead of reaping the benefits of a much-anticipated M&A, parties in the end lose much more.
How to address the risk of overestimated synergies
Identifying ways where the two companies can collaborate, and the areas of mutual interest, can help in improving their synergies. Another is to measure the compatibility of both companies without rose-tinted glasses by recognizing areas of conflicts and addressing them ahead of time.
3. Unexpected costs
Another risk of M&As is the surge of unexpected costs along the way. These costs may show up before the contract signing and until the integration phase.
Some examples of these unexpected costs are:
- employee training
- rebranding costs
- new systems and processes
- costs for legal compliance
- legal and other professional fees
The risks of M&As related to costs may also arise in the contract price itself. When there’s overvaluation of the other company (as will be discussed below), it may trigger unnecessary costs just to ease this problem. And this is aside from the excess cost due to the overvaluation itself.
How to address the risk of unexpected costs in M&As
Here’s where companies can exaggerate the M&A cost. Parties can set up a financial safety net that will answer any unexpected costs in the future.
Another way to address this risk is to do simulations, list all possible costs, and set aside funds to cover them.
In addition, faithful compliance with M&A laws should prevent hefty fines and other unforeseen financial liabilities from the government and regulatory bodies.
Valsoft's general counsel, David Felicissimo, on handling complex mergers and acquisitions in-house. Felicissimo says their job is 'to protect the mothership'.https://t.co/xwesWTQknQ
— Lexpert (@Lexpert) April 19, 2024
4. Overpriced M&A
Understandably, having a larger amount involved in the M&A process seems like a guaranteed success. A target company may want to price itself a little higher, and the acquiring or buying company will sometimes give in just to close the transaction. Oftentimes, it’s the purchasing company that misinterprets the target company’s value or the market, which results in an overpriced M&A.
This may not be a problem at first instance, especially for a purchaser or acquirer who has a lot of money to spare. But having a failed M&A, just because this risk of overvaluation is disregarded, will eventually affect the parent company, the resulting company, or both.
How to address the risk of overpriced M&As
It’s important to set realistic, achievable projections. This is usually done during the due diligence process, where every decision is backed up by data. While there’s always this internal pressure to close the transaction in a hurry, parties may do so without sacrificing the quality of the overall M&A process.
5. Integration shortfalls
Even if companies reach past the signing of all the necessary contracts, there are still risks of mergers and acquisitions that these companies must be aware of. Integration failures are one of these risks of M&A after closing the transaction. While integration may last for months or even years, there are many shortfalls that may arise during this stage, such as:
- employees jumping ship because of unresolved HR issues
- clashes between cultures involving employees of the different companies
- confusion of newly implemented systems among retained and new employees
All of these will affect the endpoint of it all: the customers. A confused and disorderly company, because of an unstable workforce, can reflect on the products or services offered by the new company.
How to address the risk of M&A integration shortfalls
The effort and resources that parties have devoted to the financial aspects of the M&A must be equal when looking at human resources. Aside from uplifting employees during these uncertain times, there must be an integration plan in place to ensure a smooth transition. It can also be reviewed by the employees, department heads and company executives.
Employees integration
Because changes will surely be implemented, one of the risks of mergers and acquisitions is disturbing the already established culture among employees.
M&As may result in layoffs, such as when there’s redundancy between positions, or when there’s excess employees after the integration. These issues, when not handled correctly, may pose a problem for the new company.
It may frustrate employees, increase stress levels, or develop uncertainty as to their future in the new company. These will impact the efficiency of employees, consequently affecting the overall performance of the company.
This video explains further the issues and risks of M&As for employees and HR managers:
If you’re considering a merger or acquisition, consult a lawyer in your area. Companies in Toronto or Ottawa can contact any of the Lexpert-Ranked best mergers and acquisitions lawyers in Ontario for advice.
How can the risks of mergers and acquisitions be mitigated?
All these key risks of M&As can be addressed by parties through preparation. In addition to what were already discussed above, here are additional ways to prepare parties to the M&A in mitigating these risks:
Build a comprehensive strategic plan
These risks of mergers and acquisitions, such as unexpected costs and integration problems, are mitigated when there’s a comprehensive strategic plan in place. Being particular in every detail on the process of the M&A, plus a constant review of the Canadian laws on M&A, are useful when the time comes to the M&A planning and its implementation.
Aside from outlining everything in the contract, a plan on how to move forward during the integration process will be helpful. For instance, the plan may also include:
- the specific persons involved in a particular process
- the costs allotted for the integration process
- the remedies when the process fails or does not meet expectations
Put everything in writing
Risks of mergers and acquisitions that may arise because of the relationship between the two companies involved are solved by one important document: the M&A contract.
When drafted in specific detail, this contract (or a series thereof) will answer any problem that may arise during integration. It will also clear up any dispute between the parties, but only if all agreements are on the record through these contracts.
Focus on due diligence
Exercising the highest degree of tenacity when conducting due diligence is one of the important problem-solvers, and even troubleshooting tools, for M&A risk management. The due diligence team must be composed of the most trusted people in the company. It must include M&A lawyers, HR executives, and the company accountants. They must also be familiar with the history of the transaction — from the company’s strategic planning until integration.
Choosing the right due diligence team is one of the ways to mitigate most risks of M&As, such as:
- knowing whether the right target company was chosen
- transacting with the other party to plan the rollout of the M&A
- planning how to do a smooth integration
There are also certain areas that the due diligence team may look at in the other company to address some key risks of M&As:
- cultural assessment
- market and industry analyses
- legal and regulatory compliance
If you’re looking for an M&A success story as a case study, visit our Canadian Law Awards page for the M&A Deal of the Year.
Discover the important things and to do’s that must be included in your mergers and acquisitions due diligence checklist in this article.
Risks of mergers and acquisitions: preparation is the key
While risks will always be present, there are many ways to minimize them or prevent them from happening. Addressing these risks of mergers and acquisitions involves not only one side of the equation, but both parties talking it out to make sure the M&A’s success.
An important factor for this is getting help from the right professionals, such as M&A lawyers, who know how to handle these risks swiftly and efficiently.
Looking for a law firm that knows more about the risks of mergers and acquisitions and what strategies you can take to address them? Check out our directory of the best mergers and acquisitions law firms in Canada.