Michael D. Moberly July 23, 2010
What do I mean by designing and executing monitoring covenant’s in merger and acquisition representations and warranties? It’s somewhat akin to the the statement routinely misattributed to Peter Drucker, i.e., if it can’t be measured, it can’t be managed.
So, similar to Druckers’ perspective, in M&A’s, if control, use, ownership, and value of about-to-be-acquired/purchased (intangible) assets of a targeted company are not monitored and found to be sustainable (pre and post transaction) then there’s a reasonable probability the desired outcomes and/or projected returns, synergies, and efficiencies, etc., will be significantly impaired, diminished, or left unrealized altogether.
It’s not that intangibles are particularly unstable in comparison to tangible or other types of assets. Rather, it’s due to the fact that the contributory value and competitive advantages intangible assets can bring to a deal have become essential to its success. But, in today’s globally competitive and highly predatorial business (transaction) environment, intangible asset value and competitive advantages can be rapidly undermined, erode, or irrevocably lost, if there are no monitoring (representation, warranty) covenants in place for oversight.
Conservatively, when 65+% of most company’s value, sources of revenue, and foundations for future wealth creation today lie in – evolve directly from intangible assets; it seems a ‘no brainer’ that in a majority of instances, the essence of an M&A, i.e., what’s really being merged or acquired, are intangible assets!
An effective way for M&A professionals then to increase the probability that the desired – projected returns will be achieved is to ensure that M&A planning and due diligence not be focused solely on a company’s balance sheet that tends to roll up intangibles into a single heading of goodwill. Rather, decisions to merge-acquire or don’t merge-acquire should include the question, how fragile and sustainable are the intangible assets under consideration? In other words, is asset value and materiality vulnerable to erosion or undermining prior to, or immediately following, deal closure which, in either instance, will adversely affect projected returns?
Again, in today’s M&A environment, a seller’s or acquisition target’s intangible assets carry a readily exploitable liquidity that outpaces and utterly disregards conventional intellectual property enforcements. This of course, elevates asset vulnerability to many different forms of internal-external compromise that serve as preludes to (asset) value erosion which can literally sabotage deals.
If either occurs prior to M&A finalization, the value of the about-to-purchased or acquired (intangible) assets can quickly hemorrhage and sometimes ‘got to zero’. At that point, M&A terms will certainly necessitate change based on a determination (assessment) of the extent of asset deterioration or whether the intangibles can rejuvenate to sustain the buyer’s original objectives.
To effectively mitigate such vulnerabilities-risks, its important for buyers and equity sources to have in place, a highly proactive ‘deal impact analysis’ process (capability), e.g., monitoring covenants. Such (negotiated) covenants are intended to permit monitoring of key intangibles so that the parties can be alerted, in a timely manner, to any acts and/or events that adversely affect changes in the assets’ value or materiality.
If impairments or discrepancies arise, the terms may be re-negotiated as warranted without necessarily losing deal momentum, timing, or resorting to costly and time consuming dispute resolution options. Most traditional forms of M&A due diligence still constitute ‘snap shots in time’. That is, they do not provide buyers-sellers with the level of on-going monitoring that’s necessary to address the easily exploitable and nanosecond liquidity (value erosion vulnerabilities) now common in transactions in which intangibles are in play.
The ‘Business IP and Intangible Asset Blog’ is researched, written, and produced by Mr. Moberly to provide insights and additional and sometimes alternative views for company management teams, boards, and employees to aid in identifying, assessing, valuing, protecting, and profiting from their intangible assets. I welcome and respect your comments and perspectives at firstname.lastname@example.org.