Compliance for mergers and acquisitions

Whether you like it or not, mergers and acqusitions are going to be an increasing factor in the legal landscape over the next year or so. For a number of compliance teams, they will be faced with the issues and challenges of a merger or acquisitions of another firm.

Merger activity is cyclical and driven by the economic situation and in 2019 and Q1 of 2020 there was plenty of activity that slowed down in 2020. We are now seeing a recovery and the expectation is that in the second half of 2021 we expect to see increasing activity. With a large number of similar firms we can expect to see a level of consolidation.

Scope of mergers

Why are companies bought?

• Build capability
• Manage IT costs
• Improve competitive position

Not all areas of law are equally attractive for merger activity. For example, we see conveyancing and corporate commercial activity are particularly hot areas of interest.

As well as trade sales, there is also increasing interest from PE firms as they see high margins in the industry of 30-35% and a stock market boon will drive M&A activity.

Often buyers are opportunistic and pursue an available deal with all the danger that the desire to make the deal happen blinds the team to the downsides. A minority of firms take a strategic approach and will happily turn down opportunities that do not fit their objectives. Firms that take a strategic approach will have an advantage by repeating the buying process they will be more effective in integrating purchases.

We can expect to see distress sales for example personal injury firms who are struggling to adapt to the sector reforms.

Due diligence

Any merger will be subject to due diligence and this will require the seller to provide significant information to give confidence to the buyer that the purchase price is set at an appropriate level. The issue we face is that there are a number of conflicts:

• Can information be provided and not breach client confidentiality?
• Can the information be kept securely so it cannot be used for other uses?
• Time needed for robust due diligence vs desire for rapid execution of the deal
• Getting active consent for the disclosure of any confidential client information

Due diligence will require a full disclosure of often sensitive information and if the merger does not go ahead, the insights gained cannot be 'unforgotten' so how should we approach?

We discussed considering how to use redaction of personal data, the use of a data room to control access and how client retainers can help with the disclosure of information to potential purchasers.

Both compliance teams will need to think about what questions will need to be answered to help the purchaser have a clear view on how the risks to be managed by the team of the new combined entity. Thinking of the issues that will radically change the risk profile of the firm is key to ensure that the due diligence is robust.

Think about what you are buying and make sure that you have confidence that you will actually end up with the firm you thought you were buying. Staff will be a core part of the firm as a going concern, so are you sure that the key staff will stay? How will you integrate their infrastructure? Can you manage the WIP?

Don't let the excitement of the deal mean you don't consider the risks.

PII insurance impact

A key issue for firms to consider is how to ensure continuity of PII cover for the new entity. Whatever you do, waiting until just before renewal to tell the current insurer details of the new entity is not a viable strategy. Engaging early on, even before the deal is agreed, is key to maintain a good relationship with your insurer. Remember the doctrine of no surprises.

The new entity may have a very different risk profile especially when you look at historical work and having a good understanding of the mix of business will be essential to mange the conversation on PII.

Covering the run off claims is a key factor to consider and often taking run off insurance is the best solution even though it requires and upfront fee. Many insurers will not want the liability for the past book and it may require personal guarantees and a forensic audit if you decide to carrying the liability to the new firm. Runoff insurance derisks the new organisation and avoids awkward conversations between partners from the different sides.

Remember that the insurer may want to look not just at this merger but historic mergers as well. What due diligence was carried out for these previous mergers? What documentation is still held? How thorough were these? Just think about finding out 2 years later that the PI firm you thought you bought has significant historical conveyancing claims. Especially if you did not take run off insurance.

Regulatory concerns

Due diligence may identify issues and the team should be aware of this.

• Should the firm report the issue, e.g. to the SRA?
• Is the COLP actively engaged in the due diligence and looking for potential issues?
• Does the team need external advice for any points identified?

Funding

Where will the cash come from to fund the purchase? It is easy to get wrong and end up over stretching the firm. You may consider looking at forming an ABS or taking external investment but this will raise issues of its own.

The purchase process

The usual approach is to start with agreed deal terms, develop a heads of terms and finally draft the contract. The initial stages are key to make sure that the deal structure is agreed and covers all the terms.

The issue for many is that the compliance team get involved towards the end of the process when it is more difficult to solve issues that may get raised. Compliance can add a lot of value to the process but will the senior team see this? If not, how do you build your reputation?

An issue for a compliance team can be one of perception as they often end up giving bad news which can be difficult for the team to manage. Any issues can have political ramifications as they are likely to have an impact on profit share. Don't forget that egos can have both positive and negative effects.

It is worth looking at running simulations to see what is the worst case. Having a clear view on what could be the worst case is key to understanding if the proposed deal is a good one. Don't let a change in circumstances make what you think is a profitable deal a toxic nightmare.

Post merger

What is the plan? Who will lead? Is everyone bought in to deliver?

Are you clear on where the firm will get value from the deal? Will your plan deliver it?

Remember, many mergers fail to deliver the expected volume.