Managing Mergers and Acquisitions Risks
It is a trend today for mergers and acquisitions to have more condensed timelines than they used to, which can lead to less time for performing a due diligence review. A rushed mergers and acquisitions due diligence process increases the number of risks that could slide under the buyer’s radar when reviewing a seller’s past and current liabilities.
The reason hidden mergers and acquisitions liabilities are such an issue is that the buyer’s insurance typically doesn’t cover them. Usually, when a company is acquired, its liability coverages are terminated or turned into run-off coverage, which expires after a set period of time, depending how the policy language is written. If these potential liabilities aren’t considered in mergers and acquisitions when the purchase price is decided and the contract drawn up, the buyer could find itself questioning the transaction down the road—when it is too late to take any corrective action.
Taking on Liability From Mergers and Acquisitions
During a merger or acquisition, the buyer takes on the liabilities of the acquired company. The extent to which liabilities are taken during mergers and acquisitions is determined by the type of sale. If the sale is an asset sale, the seller retains possession of the legal entity and its liabilities. Only the seller’s individual assets and their accompanying liabilities are transferred to the buyer. Assets could include items like equipment, trade secrets, inventory or licences. Buyers typically prefer these types of purchases, as they reduce the likelihood of future contract disputes, product warranty issues or product liability claims arising from mergers and acquisitions.
In a stock sale, the buyer purchases the selling shareholders’ stock directly, and therefore obtains ownership of the seller’s complete legal entity and all of its accompanying liabilities. Stock sales present more risk for buyers, who need to prepare for the possibility of future lawsuits, environmental concerns, employee issues or OH&S violations. These liabilities can be reduced to some extent through policies like Representations and Warranties Insurance and indemnifications. Still, performing thorough due diligence in a stock sale is crucial.