Given that the private equity sector has tripled in size during the last decade, and PE-backed deal volume continues to rise, the intersection between M&A and PE investment is notably shifting. New variables in dealmaking processes, regulatory oversight and financial valuation are creating a number of risks and additional steps PE investors need to be aware of.
For example, economic and political factors are also impacting markets, requiring a greater level of due diligence across every phase of the M&A lifecycle. With PE currently holding roughly two-thirds of the share of overall M&A volume, and the large majority of PE firms anticipating a return to normal for M&A activity in 2024 (54% believe that will happen within the first half of the year), there are numerous issues PE firms should prepare for when dealmaking in the current and impending environments.
Further, PE-backed M&A transactions are likely to be impacted by the increasing regulatory scrutiny over the potential anti-competitive implications of new mergers. PE companies may encounter more resistance when obtaining antitrust clearances in the U.S., including for deals that are otherwise unproblematic in substance. Recent steps by the U.K. Competition & Markets Authority, as well as Australia’s Competition and Consumer Commission, suggest a higher level of scrutiny over PE firm acquisitions of minority shareholdings in competing companies.
Below are insights from FTI Consulting’s experts on the top PE M&A issues to watch in the coming months and year ahead.
A Reset of Pre-Deal Expectations – Julian Gorniok, Business Transformation
“As a result of increased interest rates and capital costs, the projected return on investment required for new deals is now higher, with more pressure placed on value creation and the amount of stretch required to make these deals work. For PE firms, this means that not only do they need to identify the right company and management team, but there also needs to be more analysis of the pre-deal strategy with emphasis on value creation and transformation or intervention.
“M&A experts can help with this process by laying out the investment case hypothesis, key value drivers for enhanced revenue, margin, cash flow and multiple, and key potential external scenarios, to determine critical assumptions and risks to test and review throughout the deal lifecycle.”
Increased Focus on Cybersecurity and Environmental, Social and Governance-Related Due Diligence Assessment – David Dunn and Nicola Cobb, Forensic & Litigation Consulting
“Due diligence assessments for cybersecurity, privacy and ESG have long been an integral component of deal reviews. They are however, increasingly given greater weight in valuations because of the significant financial, reputational and legal risks they carry.
“For example, the average data breach currently is estimated to cost USD$4.45 million, but in practice, these breaches cost much more as they frequently lead to follow-on investigations, private enforcement actions, reputational fall out and can result in abandoned deals or post M&A disputes.
“Cybersecurity experts focus on understanding risk management, strengths and weaknesses regarding existing protections, the threat landscape and strategy integration. Not only do prior incidents and existing vulnerabilities need to be identified, but sufficient information needs to be obtained to determine if mitigating measures can be adopted and how best to effectively implement ahead or after the deal’s closed.
“From an ESG perspective, the associated risks of a data breach are complex and multifaceted. There’s increasing scrutiny from shareholders for deals failing to meet specified sustainability and social equity targets. From a regulatory and compliance perspective, the regulatory enforcement obligations are rapidly evolving and vary across jurisdictions. In turn, this exposes investors to new risks carrying additional compliance spend which can impact the potential deal value given investors are looking to minimize risk and avoid future ESG-associated challenges. The valuation of a business is now looked at through a variety of lenses, not least the impact of regulation and the consequences of anticipated increases in supply chain transparency requirements and costs associated with certain natural resources.
“In light of the above risks, it is critical to perform robust cybersecurity and ESG-related due diligence assessments given transacting parties often find themselves at greater risk of a data breach once a deal is formally announced or subsequent integration is underway.”
Regulatory Scrutiny – Ashley Brickles, Technology
“Global competition enforcement agencies continue to increase their scrutiny of PE-backed deals, as most recently indicated by the Federal Trade Commission’s proposed amendments to Hart-Scott Rodino Act. Often this focus results in more onerous regulatory clearance reviews, resulting in significantly higher legal spend and time required to prepare initial filings and defensibly respond to information requests.
“Engaging data experts earlier on in the deal-making process can help ensure transacting parties comply with new data preservation requirements, identify relevant data sources and support outside counsel timely respond to large, complex information requests to avoid a ‘stop the clock’ scenario.”
Communications Due Diligence - Alex Le May, Strategic Communications
“Long gone are the days when it was simply about winning over investors in a peer-to-peer transaction and deals in the private market would sail through. Today, a wide range of stakeholders will have their say — government is increasingly looking through the lens of national interest, employees may be vocal and customers have been known to wade into the debate, all before investors have their say whether a transaction makes sense on paper. For these reasons, communications is playing a critical role in diligence, landing the transaction according to the broader interest on day one, and engaging throughout the process. Failure to do so may still see the transaction get over the line (after a potential media storm), but whether the talent is still in the building can be another question altogether.”
Managing Transactions from Signing to Closing – Gorniok
“For both buyers and sellers, ensuring sufficient business readiness for day one deal close, such that on day one, the business being bought/sold, is able to continue uninterrupted operation of key customer and supplier facing functions, internal, and financial operations, once separated from the seller.
“This will require parties to prepare clear day one separation and take control plans for the business, with sufficient clarity on program governance, functional scope and deliverables, day one blueprint, key milestones, customer considerations, people and culture factors, and potential transitional services.”
Deal-Related Disputes – Kami Zargar, Economic & Financial Consulting
“Deal-related disputes, including price adjustments (e.g., completion accounts) and deferred consideration (e.g., earn-out) disputes to breach of warranty and fraud claims, have intensified in the wake of unprecedently high deal valuations, the end of the low-interest rate environment, external shocks to supply chain issues, the energy and banking crises, and the war in Ukraine. This has led to many cases where acquisition targets have fallen short of the expected returns, spurring a new wave of post-deal litigation and arbitration disputes.
“In these cases, accounting and valuations experts are often needed to help resolve disagreements over the final purchases price of a target, investigate potential misstatements, provide specialist advice in breach of warranty claims and proactively mitigate the need for future litigation by providing guidance on financial provisions and accounting warranties to help reduce the scope for post-close disagreements.”
The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.