Effective risk management is playing an increasingly prominent role in the M&A process.
Organisations with strong balance sheets are in a good position to take advantage of acquisition opportunities in the current climate, but the stakes are high and robust risk assessment is crucial to avoiding costly errors.
Appropriate due diligence has always been vital in M&A, but increasingly-systematic risk procedures are playing an early and central role in corporate processes.
Specific company, industry and execution risks can have an adverse effect on enterprise values, making it vital for companies considering an M&A process to assess potential targets through a much more tightly-focused risk lens.
Exposure to particular risk areas can result in a complete change in a transaction’s dynamics and can lead, in some cases, to companies walking away from potential deals.
With demands on quality and value getting higher and leveraged debt finance being harder to secure, the focus on risk has never been greater.
Activity levels have picked up in the energy sector in the last 12 months, and a greater focus is being placed on scrutinising the forward order book in order to assess their sustainability.
If trading is underpinned by a committed and growing order book, this goes a long way to supporting higher valuation multiples and easing the cost of funding.
Another area of early focus, particularly for targets with overseas footprints, is the evaluation of local customer feedback and specialist assessment of local country risks.
External factors are a vital consideration for any purchaser as, while they may not directly impact current trading results, economic and political risks have a significant impact on valuations.
A particular challenge for oil and gas companies is in assessing economic, political and fiscal uncertainties in less stable or emerging countries such as Brazil, Venezuela, and certain Middle East or Caspian jurisdictions. We don’t have to look too far in the UK to see that, even in relatively stable political systems, unexpected fiscal changes can be enacted at short notice.
The process of obtaining appropriate indemnities and warranties is one of the main protections for buyers.
However the actual indemnities themselves are really a backstop as they can prove very time consuming and difficult to exercise post-transaction, often resulting in long drawn-out legal cases.
The real benefit is in the risk identification and disclosures that are obtained through the legal process.
Time spent in this last phase of the deal is vital to ensure that diligence findings are appropriately reflected in the contract and price negotiations.
Companies are tailoring their due diligence and M&A processes to focus on the specific risks which have the most impact on value.
Effective risk management in these areas helps companies to better prioritise activities, allocate resources and ultimately enhance the returns to be made on acquisitions.
Shaun Reynolds is an assistant director of corporate finance at Deloitte.