When and How to Share Data in an M&A Transaction|
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If you’re in the finance sector, you’re likely familiar with Eugene Fama’s Efficient Market Hypothesis (EMH), an investment theory whereby share price reflects all available information. The more transparent the information, the more closely the transaction price reflects fair value. In this ideal world, neither party holds an advantage over the other, and consistent excess return, or alpha, generation is impossible.
Further, EMH theorizes that in public markets, alpha can only be generated with inside information — that which is not known by all market participants. For M&A deals in which the target is a privately-held company, achieving transparency can be particularly challenging. It requires sharing data in such a way that maintains the target’s confidential information without negatively affecting deal value. In other words, all parties should strive to overcome the inherent asymmetry of information access on each side of the transaction. Various strategies can be deployed to incentivize the reduction of asymmetry, such as the use of shareholder earnouts and retention bonuses for key target leadership. But those do not address the logistics of information sharing in the context of earnest negotiation.
Six Stages of M&A Activity and Information Sharing
Assuming a target company is being represented by a team of investment bankers and legal and accounting advisors, a typical process will unfold in six stages:
- Interested Parties Contacted: The investment bankers will reach out to various strategic and financial market participants to gauge initial interest.
- Confidential Information Memorandum: Market participants who execute a non-disclosure agreement will receive a confidential information memorandum (CIM), which contains a discussion of the company, its operations, industry and market context, and high-level financial information.
- Indication of Interest: Based on the data provided, market participants will submit indications of interest (IOI), which will be reviewed by the company and its advisors.
- Management Meetings: Based on the IOIs received, a select group of market participants will be invited to attend detailed one or two-day management meetings.
- Letters of Intent: Following the management meetings, interested parties will submit detailed letters of intent (LOI) which will layout deal terms and closing requirements.
- Partner Selected: Based on a host of factors including LOI value (both cash and non-cash), payment terms and strategic fit, a partner will be selected.
Knowing that information asymmetry favors the target company and its advisors, how much confidential information should the company share, when and how?
The answers often depend on the number and types of bidders:
- Do the interested parties include strategic buyers with whom the target company competes?
- Have regulatory requirements such as anti-trust or Hart-Scott-Rodino hurdles been cleared?
- Finally, even if it is legally permissible to share certain information, does it make business sense? Even with an NDA in place, a company may not want to hand a competitor its customer contracts and pricing details.
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Apples to Apples: Ensuring Consistent Data
After a target company and its advisors have determined the types and amount of information to be shared and when it’s important to ensure the information being shared is consistent and reconciled among various potential sources of information. These include audited and unaudited information, such as trial balance and adjusted earnings schedules, the Confidential Information Memorandum itself, board presentations, and daily/weekly/monthly/quarterly KPI decks.
While it’s not uncommon for innocuous inconsistencies to occur among multiple internal information sources, they should be reconciled before information sharing begins. Inconsistency can lead to uncertainty, which is the last thing anyone wants in an M&A deal.
Uncertainty can delay closing while potential buyers struggle to understand a business being presented with conflicting data. Uncertainty can also lead to lower bids, as market participants react to what they perceive as inaccurate financial information. The same holds true for non-financial operational information such as key ratios and KPIs that may be outlined in quarterly management decks or board presentations. One way to address such conflicting data items is through the use of a sell-side due diligence report. While popular in Europe for many years, these reports are now starting to become more and more common in the U.S. and can help potential buyers move from an audit to management’s proposed adjusted, as shown in the CIM, with a detailed explanation as to why each adjustment was made.
Clean and Super-Clean Teams Mitigate Risk
Information sharing becomes more complicated when a target operates in multiple legal jurisdictions and is involved in a merger’s approval. Or, if authorities ask for certain dispositions as a stipulation for the transaction’s approval. In these scenarios, clean teams — even “super clean” teams — can mitigate risk and ensure a smooth transaction.
Clean teams are composed of individuals who, by virtue of their respective roles in the deal, are granted access to different types and amounts of data — much like a security clearance. In a recent buy-side deal I worked on, just a few members of a buy-side team were allowed to see non-public data, such as divisional revenue and profit and holistic operational metrics. Meanwhile, as members of the buy-side advisory team, our “super clean” team was granted access to revenue by customer, underlying contracts, and operational metrics by location and product line.
Further complicating matters, our client had to sell off a large division in order to close the deal. As part of the super clean team, we were able to see and understand all the underlying data, which allowed for a smooth closing and integration process. Even with regulatory complications, the super clean team ensured the transaction’s closing could move forward quickly once all remedies were satisfied.
Three Keys to Private M&A Information Parity
In summary, the three keys to achieving success in the context of a private M&A deal are:
- Establish a plan for staged, time-appropriate information sharing.
- Ensure consistent internal data that presents a clear and accurate picture and eliminates uncertainty on the part of prospective buyers.
- Create protocols that protect both the confidentiality of the seller and the information needs of the buyer.
When all of these objectives are met, even the most complex private M&A deals can unfold as Eugene Fama intended, with maximum transparency and fairness.