Kira has its finger on the pulse of global M&A trends through daily interactions with the legal marketplace. In August 2021 we pulled together a group of M&A partners and leaders from the UK for a roundtable discussion. These roundtables give participants a chance to share experiences and approaches to the changing dynamics of M&A transactions, and they have been particularly useful in surfacing the many challenges and opportunities that the global pandemic has posed for the industry.
The theme of this roundtable was identifying the lasting impacts of the pandemic. Not just what has changed, but what has changed that won’t be returning to its earlier form.
We asked our participants to identify new types of risks they are encountering in deals, discuss what that could mean for the future of due diligence, and consider how technology is playing a bigger role in this new era of deal making.
The discussion led to insights about three main market trends, and many interesting implications of those trends for M&A practitioners, their firms, and the clients they serve.
Warranty & Indemnity Insurance is More Important Than Ever
The use of Warranty & Indemnity (W&I) insurance to mitigate risk in deals is on the upswing, according to many of our roundtable participants. Some noted that there is a W&I component to every deal, and that sellers in particular are insisting on W&I as part of most deals.
This wholesale adoption of W&I as a risk mitigation strategy is creating issues for the pace of deals; some noted that insurers are increasingly busy, and the negotiations around that insurance sometimes hold up transactions.
Implications for due diligence processes
This has significant implications for due diligence processes. W&I insurance affects the scope of due diligence and the materiality discussion. Insurers are looking more closely at what is in the data room, and more importantly, looking for what is missing and they will need to be reassured that everything has been reviewed**.** Responding to those demands, lawyers need to build in more time for diligence when W&I is applied, because they may have to do more diligence and answer more questions about it.
Another shift that roundtable participants noted is that more sellers are using vendor due diligence to “package up” due diligence in advance, to help speed up those timelines and prepare for the W&I analysis.
The increased use of W&I insurance has shifted the discussions that law partners are having with their clients about materiality. In many cases, they are reducing materiality thresholds in order to review more to meet W&I insurance requirements.
Many firms are turning to technology in order to review more documents in less time. With the current capabilities of contract review technologies such as Kira, many firms are offering a total diligence approach, which allows firms to economically offer a comprehensive review that extends well beyond materiality concerns.
Deal Timelines Are Getting Even Shorter
Deals are being executed faster, because of an increasing urgency in the market to move during windows of opportunity. Some roundtable participants observed cases where deals are rushed and mismatches in understanding between the parties (such as earn-out provisions) can arise. That press for speed is adding to transaction risks and can sometimes lead to buyer’s remorse.
Implications for due diligence processes
Several participants felt that the shorter time frames might be pushing people to take bigger diligence risks and cut corners.
With shorter timelines, some participants believe that populating the data room in an organised manner has become more difficult and the quality of the data rooms is therefore poorer.
There was also concern about the quality of vendor due diligence reports - some mentioned they are missing key information due to the speed at which they are being put together by vendors. Additionally, emerging areas of risk analysis such as Environmental, Social, and Governance diligence are suffering in this environment, because the urgency of getting deals done has limited the development of standards for addressing those factors in due diligence.
Where speed is key, accuracy and comprehensiveness are at risk. Firms have a responsibility to help their clients avoid buyer’s remorse down the line. Today’s technologies can help clients maintain the pace that the current environment requires, while leaving fewer stones unturned.
- Speed: the efficiency gains of using an assisted review platform helps keep the review process on track.
- Comprehensiveness: AI-based review decreases the chances of missing something and putting clients at risk. When deciding how much you can review in a short period of time, a total diligence approach allows a much more comprehensive review in a shorter time frame.
- Organization: AI-assisted technology can be used to classify documents, cleaning up the organisation of documents and getting lawyers quickly up to speed with a game plan.
Valuations Are More Complex and Uncertain
Another source of uncertainty that has been exacerbated by the pandemic is valuations. By now, COVID has been backed into many valuations, but the uncertainty remains. Even if there is a general bounce-back in fighting the pandemic, COVID considerations and risks are likely to remain as a factor reflected in the price of an asset.
But the effects are still very uneven by industry, putting traditional valuation techniques to the test. For example, one participant noted that EBITDA has become less relevant as a valuation standard in new industries like clean tech. Now, valuations are based on hope and a “we need to do this” attitude. Valuations are often impacted by a mismatch between the parties where there is a big player vs. small business, and smaller targets have less sophistication. So it seems that traditional rule books are being torn up, and the traditional valuation measures are no longer as relevant.
The dynamic situation has injected other uncertainties as well. Among those mentioned were the fact that in many deals, valuations are not fixed but rather might be revisited and revised many times during the course of a transaction. Social media trends can have a big impact on valuations, and publicity can have a devastating impact on valuations in a short period of time - the example of star athlete Ronaldo impacting Coca-Cola’s valuation with a small online gesture was mentioned. These kinds of risks are much more unpredictable than can be accounted for by traditional valuation analysis.
Implications for due diligence processes
Many of these uncertainties go beyond the scope of the risks that traditional due diligence is designed to uncover. Participants in our roundtable see an expansion of the role of interpretation and strategy in the due diligence process.
For example, some participants noted that due diligence is about what documents really say about a business - it goes beyond assessing obvious legal risks. This level of analysis requires lawyers that understand the dynamics of the business they are looking at. Particularly in new industries, valuations are much less about the contracts and existing commercial relationships, but more about negotiations around the proprietary technology and the people that are tied to the deal.
Finally, much of an organization’s real value is tied to the strategy of the target, and it’s often hard for outsiders to see those internal strategy machinations because they are not tied to any numbers in documents.
Making Decisions With the Best Data Available
When the intangibles like pandemics, social media explosions, and new, uncharted industries all conspire to inject uncertainty into the valuation process, what role can technology play to mitigate those risks and provide some greater measure of certainty? What role can legal advisors play to ensure their clients don’t encounter avoidable headaches post-completion?
A good strategy is to always have better visibility into the “known knowns.” You can’t control many of the intangibles and the unexpected events, but you can use technology to ensure that decisions are made based on the most complete set of available data. This is where a total diligence approach can really be of value. By leveraging AI-based document review on the maximum number of documents, the risks of the uncertainties can be balanced by a greater confidence that the available documents have been fully explored. The more data that’s part of the analysis, the more confidence the players can have in valuations, despite all the uncertainty.
If you’re interested in learning more about how Total Diligence differs from Traditional Diligence, view our latest infographic here, or request a demo to learn how Kira can help you better reduce risks for your clients and open up new revenue streams for your practice.