Do’s and don’ts in an acquisition
April 2015 | EXPERT BRIEFING | MERGERS & ACQUISITIONS
A successful group of firms tends to develop its business by having more companies, either within the same industry or different industries. In order to grow, there are two main strategies: setting up a new company from scratch or acquiring an established company.
Setting up a new company will require the establishment of an entire company from the introductory stage and require stages of growth. Potentially it may take at least three to five years for a firm to become a well-established and well-known company in its chosen market. When implementing this strategy, the group should invest in new factories, machinery and skilled human resources. The company will require sufficient time to prepare before entering the market. It will need to set up a business model, launch recruitment efforts, purchase facilities and obtain the necessary legal permits. There is a high chance of failure during the embryonic stages of a new company; the likelihood of failure will likely persist for the company’s first three years of operations.
On the other hand, by acquiring an established company, the group does not need to undergo the introduction and growth stages. The group may also enjoy the benefit of a well-established and well-known company in the market. However, an acquisition can involve a high level of investments compared to the establishment of a new company. Such acquisitions may also incur unnecessary additional costs if they are not managed properly, including commercial, legal, financial and tax issues.
Broken or low productivity machinery, expired inventory and unskilled human resources are examples of commercial issues which may create unnecessary additional costs. Legally speaking, a number of issues can arise including disputes related to land ownership and invalid licences. Meanwhile, financial issues can include unrecorded payable, uncollectible receivables and unreported pledges of facilities and machinery. Tax issues related to double bookkeeping, tax disputes, underpaid tax in previous fiscal years, and transfer pricing abuse of related party transactions can also arise.
In order to mitigate the risks, the group must consider the do’s and don’ts of an acquisition. Initially, the group should conduct preliminary analysis on the group strategy and the target company, appoint people to be responsible for the commercial, legal, financial and tax aspect of the firm, and appoint the relevant consultants needed to assist the group in conducting due diligence.
While conducting preliminary analysis of the group’s strategy, the group must assess whether the size, facilities, human resources, brand, disctribution channels and corporate culture of the target company are suitable for the group strategy. Many acquisitions have failed because the group did not take these issues into consideration. Due to mismanagement, a group’s costs can dramatically increase and in some cases can even drive the acquired company into bankrupty.
When appointing senior executives, the group should appoint the right people for each department. The commercial department will require management with both in-depth knowledge and considerable skill related to the target company’s sector. By appointing the right individual, the target company has a better chance of performing well in the long run.
From a legal perspective, the person charged with handling the company’s legal obligations should understand the prevailing law and regulations of the industry in which the target company operates. An understanding of the company’s legal and regulatory requirements will enable the group to confirm that the target has all necessary licences or permits. This person should also be proficient in drafting or reviewing shares purchase agreements.
The group should appoint a person who is capable of analysing the financial statements of the target company, as well as confirming that the information in the financial statements corresponds with the actual condition and that the acquisition price is fair. In order to mitigate the acquisition risk related to financial issues, the group may include a clause in the shares purchase agreement regarding the seller’s responsibilities before the acquisition date.
In terms of tax, it is necessary to appoint a department head who understands the tax laws and regulations of the target company’s industry. This person should understand whether the target company has already complied with existing tax laws and regulations, and is able to pay tax according to the applicable regulations. Furthermore, transfer pricing is a major issue in an acquisition, particularly for a target company that has significant related party transactions. Accordingly, management should be able to identify the risks associated with existing related party transactions. Much like the financial aspect, the group may include a clause in the shares purchase agreement regarding the seller’s responsibilities related to tax before the acquisition date.
To conduct the due diligence for commercial, legal, financial and tax aspects, the group may also look to appoint a consultant. The consultant will assist the group in analysing the target company, providing findings and risks, as well as suggesting ways to mitigate those risks. The consultant may also assist the group related to the duties of the person in charge of commercial, legal, financial and tax aspects.
Conversely, companies should never enter into an acquisition without first conducting necessary due diligence procedures and with only a limited knowledge of the target company’s industry and business. Many acquisitions have been completed without considering due diligence process as an important stage in an acquisition, which is a risky and negligent course of action. Fortunately, some groups have managed to acquire good companies regardless, but others have encountered problems and have been required to spend more money strengthening the acquired company. Accordingly, such activity poses higher risk in acquisitions.
Equally, some groups have conducted acquisitions of firms without knowing the target company’s industry and business. They have expected to learn the industry and business by acquiring an established company. Such assumption may also lead to a risky acquisition. A company can run very well due to the management’s direction, especially the shareholders’ vision. However, if the company is run by someone who lacks knowledge and expertise in the related business, it may jeopardise the established company in the future.
In conclusion, acquiring a running company is a way to speed up the development of a group of companies; however, the group should consider many factors in the acquisition in order to mitigate the future risk which may create unnecessary additional cost and even the going concern status of the acquired company.
Permana Adi Saputra is a partner at PB Taxand. He can be contacted on +62 21 835 6363 or by email: firstname.lastname@example.org.
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Permana Adi Saputra