Your M&A deal imploded: now what?

Elon Musk’s announcement of acquiring Twitter in a $44 billion deal last April drew attention, but it was his decision to walk away from the deal that sent shockwaves through the mergers and acquisitions universe. Amid confusion and disagreement over Musk’s legal commitment to the purchase, the two parties will now go to trial to decide the fate of the transaction, revealing just how confusing the consequences of a failed merger can be.

But Musk’s takeover bid wasn’t the only large-scale deal to fail in recent weeks.

In June, retailer Kohl’s announced that it had ended negotiations to sell the company to Franchise Group, owner of The Vitamin Shoppe, pointing to a weakened retail environment. Just days later, SPAC USGH Acquisition Corp, an affiliate of the Union Square Hospitality Group, and Panera decided to end their merger discussions, citing “deteriorating capital market conditions,” while Walgreens dropped its efforts to sell the company. British network Boots, also citing “unexpected and dramatic changes in financial markets”.

From the struggle to access adequate funding to a worrying economic outlook, mergers and acquisitions activity appears to have hit a bumpy stretch of road. You look at these big deals, you look at what’s going on and there’s a lot of complicated factors that are intertwined – it’s not just funding. And many of these factors impact the middle market.

Whether merger discussions were in their early stages, or the ink was dry on contracts, buyers and sellers within the middle-market business community must prepare and protect themselves if they find themselves at an impasse.

Understanding why businesses fail

The recent string of high-profile business meltdowns may not be surprising considering current market conditions. Ongoing COVID-related disruptions, supply chain restrictions, the war in Ukraine, inflation and a shaky economic outlook as contributors to a less-than-ideal M&A environment. For some larger conglomerates, securing funding in a challenging capital market environment can be a deciding factor.

In the middle market, however, businesses tend to be less sensitive to capital market conditions thanks to the funding available from private equity firms and portfolio companies with strong balance sheets.

Still, the challenging retail environment that stymied the sale of Kohl’s is also taking a toll on middle-market dealers as inflation pressures consumers to prioritize spending on gas and groceries. This made it more difficult to determine the value of an asset.

In the case of Walgreens’ failed sale of Boots, for example, bidders were unable to offer adequate value in the current market and this illustrates not only the tougher financing market, but also that there is a disconnect between the sell-side and purchase side over value. The market will need to calm down a bit before this disconnect closes.

This valuation disconnect could prove to be the biggest obstacle to closing deals in the mid-market, especially after a period of record activity and high prices. A tricky issue is that many private companies have raised money in the last 12 to 24 months with a much higher valuation on the sell side. It will take a little longer for people to lower their expectations of value or price.

The consequences of a failed transaction range from an amicable end of discussion to legal proceedings, depending on how far the deal progressed before it went bust. Middle market traders, on both the buy and sell sides, must plan for the possibility that a deal could fail.

For buyers, being upfront with the target company about plans to step away from business discussions will help the company mitigate expenses and plan ahead. Buyers should also examine whether one of the parties is required to pay a separation fee or other expenses based on the contracts they have signed.

In the meantime, sellers must understand how much the company has left to operate after a deal fails. You might not have expected to continue operating for the next two years, but now you turn to it quickly and say, ‘Okay, what kind of track do I need? How are my cash reserves?’, it is vital that sellers remind buyers of their data privacy and security obligations if a deal moves into the due diligence phase, when a buyer has likely secured confidential information about the target.

In addition to the logistics of closing a deal, buyers and sellers must prioritize the human capital component of their business. There may be executives and employees who expected a raise or other monetary benefit upon the completion of a deal, and managing those expectations will be important to retaining those professionals. If negotiations were in mature stages, sell-side professionals are likely to know buy-side professionals, so sellers should be on the lookout for potential employee poaching and buyers should sign a non-solicitation clause.

Avoid Burning Bridges

In the event of a failed merger, there can be significant disappointment and disruption. Understanding whether your company has enough capital to continue operating, keeping investors confident, and ensuring employees are well-informed can all help ease the bumpy road of a failing business.

However, negotiators must be careful not to burn any bridges. Maintaining relationships between buyers and sellers will be important to closing a deal if the opportunity arises again in the future.

For buyers, keeping in touch with the target audience, trying to maintain a good relationship, is always a good idea, because things can change. The same goes for sellers: some companies can fix problems that have held a merger from moving forward and then return to the market.

There is likely “a little bit of reckoning” ahead for companies that relied on a deal to survive. But for those able to weather the current storm, there may be other opportunities to strike a new deal. It is important to take a long-term view. Historically, interest rates are not the highest ever. They are still manageable for people. Business must be done. It’s good to try not to burn bridges.