Whether the world is truly emerging from what has been one of the biggest economic upheavals since the 1930s remains to be seen. What is clear, however, is that companies cannot remain standing still. There was an inevitable scramble by businesses to batten down the hatches as the financial and economic storm hit. But now, management teams are refining strategies and seeking ways of ensuring their companies can capitalise on any future improvements in the economy, even if the current signs of recovery turn out to be short-lived.

Mergers and acquisitions (M&A) will play a key role in these strategies. Activity has been restrained over the past 18 months, with values and volumes in 2009’s nadir down to levels not seen for five years. Buyers have remained cautious because of a lack of visibility on future performance that has made it difficult to assess prospects for their own business and that of any target – and all but the most distressed sellers have held back, unwilling to part with their assets at knockdown prices.

Yet there are signs that M&A is moving further up the agenda in many corporate boardrooms. Activity has already begun to grow, with the number and value of transactions rising since the fourth quarter of 2009.

But many corporate buyers will find the M&A landscape has changed markedly: there is far less competition for targets than there has been for several years. Although private equity activity has increased over recent months, many of the deals that are now being completed have been on the table for some time. Mid-market European specialist Bridgepoint, for example, had been mulling over the sale of retail business Pets at Home before the crisis hit, but had to abandon any sale plans after the credit markets dried up. The deal has now been completed, and at a fantastic 14.2x multiple, but this sale, and many recent ones, are examples of a pent-up desire to sell rather than consistently full pipelines of new deals.

Poised for action

Debt has become more available than in the past 12 months, but the markets remain fragile and most private equity houses report an uphill struggle in lining up financing. The February 2010 sale of Spotless, the French maker of laundry and cleaning products, went to BC Partners, for example, mainly because it was the only firm of the three vying for the business that had managed to secure debt finance. In other cases, private equity buyers have had to approach several banks for a relatively low amount of debt. Advent International needed seven lenders to obtain £110m of leverage for its £190m acquisition of benefits outsourcing consultancy Xafinity, which suggests that financing billion-plus deals will be a problem for many. This means any corporates with an acquisitions war chest will have a distinct advantage over private equity bidders if they are able to move nimbly.

But much of the activity over the coming 24 months will be driven by regulatory issues, particularly in the UK. Many of the banks that received government support during the crisis have already started divesting businesses to improve their balance-sheet positions, and there will be much more to follow from financial institutions over the coming years as they are forced to comply with the demands of regulators and competition authorities.

Other sectors that we expect to become active include healthcare, in particular the big pharmaceutical manufacturers, as many companies grapple with the issue of dwindling pipelines for new drugs. The energy sector is also likely to see a surge in activity as world demand picks up and the need to develop renewable alternatives to fossil fuels intensifies. Information technology is also likely to be an area of busy deal activity.

Despite the hostile economic climate, most companies are not acquiring simply for synergies – cost-cutting is likely to be more of a by-product of M&A activity than the primary driver. Instead, businesses are taking a more strategic approach, focusing on particular markets in which they can maintain a strong position or become leaders. Fill-in acquisitions may fit the bill in some circumstances, but many companies will be looking at targets that will catapult them into the big league by expanding their geographic or horizontal market reach.

Those on the acquisition trail will also find that there are more businesses up for sale than in the past ı8 months. While distressed sales dominated the market last year, there is now a greater perception of stability than previously, making valuations less of a stumbling block. Business owners, whether private or corporate, have waited out the storm and are now much more open to the idea of selling, albeit at a lower price than they could have achieved three years ago.

A new role for legal advisers

Against this backdrop of increasingly strategic M&A, in-house legal departments are facing some of the largest-scale changes they will ever have witnessed. Many general counsel have seen their departments shrink over the past 18 months as companies sought to cut costs to get through the economic downturn. On top of all that, however, they are increasingly called upon to operate along commercial lines, putting in business plans to manage budgets, much like other parts of the organisation.

Clearly, this trend towards cost control has an impact on the way in which general counsel manage the M&A process. With smaller in-house teams and budgets, they will be under pressure to find new ways of producing a greater output with fewer resources. At the same time, the legal processes involved in M&A work have become more labour-intensive as well as more important to the success of a deal. In this new, more cautious environment, acquirers will want to be certain they are buying the right business. Due diligence will need to be more rigorous and comprehensive than ever before.

For sellers, this means providing tightly packaged, powerful and comprehensive vendor due diligence packs or ‘datarooms’ to ensure the administrative to-ing and fro-ing between buyer and seller is minimised. Bidders pulling out due to a lack of information or because the information has not been presented clearly enough will be highly damaging to the prospect of selling a business. Similarly, there is also a drive to minimise the costs associated with low-level transaction work.

Buyers will be looking for more information not just on areas such as accounts receivable and other financial matters, but also on intangibles that are harder to quantify. The regulatory framework in which a business will be operating both now and in the future will be key to making the right acquisitions. Similarly, buyers will be taking a hard look at a target’s intellectual property (IP) portfolio to ensure it holds the assets it purports to hold, particularly as many corporates will be looking to acquire capability and knowledge through their acquisitions. This, combined with contract review and redaction, makes the administrative burden on in-house legal departments significant.

Looking to the future

With M&A picking up and an increased emphasis on background due diligence, in-house legal teams will find their workload picking up considerably in the coming months. But, as pressures on cost continue, they will have to find innovative and creative ways of doing more with less. Like the rest of the business, legal departments need to come out of the economic downturn more efficient, effective and competitive if they are to exploit opportunities in an emerging M&A marketplace.

The challenge for general counsel, however, is to find a way for their teams to carve out a role at the forefront of the M&A process, rather than scurrying behind in an attempt to complete formalities or fix issues before it’s too late. Uncertain times or not, legal departments should be involved from the beginning. Only then can they ensure the appropriate level of due diligence. Careful planning will also have a beneficial impact on fees – and help a company to manage its risk. For depleted in-house legal departments that means more work, rather than less. Even after they smash through the block to get involved early, they will still need to find a way to achieve more results in a shorter time and for less budget. That’s why general counsel need to ask themselves now: ‘Are your teams set up to deal with new challenges in the new world?’ and ‘Have we developed the right commercial approach to get the right deals done?’ Those that are struggling for an answer need to start rethinking their approaches.


Rhys Phillip is head of M&A at Ernst & Young LLP. He is based in London


FINDING SUPPORT
The upturn in M&A activity puts increased pressure on in-house legal departments, which need to react quickly to potential deals. CPA Global’s Lynelle Swanepoel outlines the benefits of outsourcing transaction support services

M&A is back on every general counsel’s radar thanks to an upswing in financing and improved balance sheets at corporate level. But, as positive as the increase in deal activity is, legal departments remain constrained by tight budgets and limited resources. Legal services outsourcing (LSO) provides department heads with the means to reduce the cost of M&A transactions as well as the resources to act quickly when potential deals hit their desks.

Breaking down the process
Although each case is different, the legal fees involved in any M&A transaction can be broken down potentially into five key areas: the pre-contract phase, due diligence, agreement drafting and negotiation, completion and exchange, and post-completion activity. Of these, the due diligence and agreement phases take up the vast majority of the legal team’s time and resources; however, across each phase of the deal, there are many routine but time-consuming tasks.

Background research on the target company, virtual data room set-up and management, document review and redaction of confidential or commercially sensitive information, IP due diligence, portfolio analysis and valuation, and contract review/due diligence and management: these are just some of the supporting elements that can be outsourced to third-party providers in order to free up internal resources to concentrate on higher-value work. Lower-level legal work can often be overlooked in the heat of a deal, but legal departments know – particularly in this new landscape – how crucial it is to be well prepared and thorough during the entire M&A process. LSO can provide the high-quality support that is needed to complete a deal smoothly and in a timely manner.


Lynelle Swanepoel is global practice head, Transaction Support, at CPA Global. She can be contacted at LSwanepoel@cpaglobal.com


This article first appeared in Legal Strategy Review, issue 6