I have seen first-hand how Mergers and Acquisitions (M&A) can be a transformative strategy for businesses looking to grow, diversify, or achieve synergy.
However, the process is fraught with various types of risks that can significantly impact the financial health of the entities involved.
In my role I have been there to guide businesses through these complexities, ensuring that they aren’t just looking at the potential benefits but also diligently assessing the financial risks.
In this article, I aim to delve into the critical aspects of financial risk assessment in M&A transactions and outline some of the things you should be aware of.
Types of financial risks in M&A
Liquidity risk
One of the first things we should always consider when looking at M&A is whether the acquisition will affect the company’s cash flow.
We always assess the target’s liquidity ratios and compare them with industry benchmarks.
A low liquidity ratio may indicate potential difficulties in meeting short-term obligations, which could strain your finances post-acquisition.
Credit risk
If the acquisition is financed through debt, it’s crucial to evaluate the creditworthiness of the target company before making a move.
A poor credit rating could not only increase the cost of borrowing but also limit access to future financing options.
Market risk
Market risk involves external factors such as economic downturns or changes in interest rates that could affect the investment’s value.
We conduct a sensitivity analysis to understand how these factors could impact the merged entity’s financials.
Operational risk
Operational inefficiencies in the target company can pose a significant financial risk in future.
In my experience, the best way to manage this is to scrutinise the cost structure, revenue streams, and operational processes to identify any red flags that could affect profitability.
Due diligence: The cornerstone of risk assessment
Financial due diligence
This involves thoroughly examining the target’s financial statements, tax records, and other financial obligations.
We look for inconsistencies, off-balance-sheet items, or any undisclosed liabilities that could pose a financial risk.
Legal due diligence
While not directly a financial risk, legal issues can have financial repercussions.
During M&A you should ensure compliance with regulations and check for any pending or potential lawsuits that could result in financial liabilities.
Technical due diligence
If the target company relies heavily on technology or intellectual property, a technical assessment is crucial.
Any shortcomings here could necessitate additional investment, affecting the financials of the merged entity.
Valuation and deal Structure
We should always seek to use multiple valuation models like Discounted Cash Flow (DCF), Comparable Companies Analysis (CCA), and precedent transactions to arrive at an accurate valuation.
A flawed valuation can result in overpaying for the target, thereby increasing financial risk.
Deal structure
The way the deal is structured—whether as an asset purchase or a share purchase—can have varying tax implications.
Each has its financial risks that must be carefully evaluated, which, of course, is where an expert accountant comes in to help.
Post-merger integration
After the deal is closed, the real work begins.
The integration process can bring its own set of financial risks, including the costs associated with integrating technologies, systems, and personnel.
An accountant can help you budget for these costs in advance to mitigate financial strain post-merger.
Mergers and Acquisitions are complex transactions that require meticulous planning and risk assessment.
By understanding and evaluating the various types of financial risks involved, you can make informed decisions that align with your strategic objectives while safeguarding financial stability.
You should always consult with your accounting team to conduct a comprehensive financial risk assessment before diving into an M&A transaction.
To find out how our team could assist in your next M&A venture, please get in touch.