New Realities of Mergers and Acquisitions
Deloitte Insights podcast
Mergers and acquisitions are making headlines again, but as both companies and lending sources return to the market, they are encountering a collage of more stringent regulations and diligent investigations.
Tune into the latest episode of Insights to learn more about the new realities of mergers and acquisitions.
Sean O’Grady, Host, Deloitte Insights: Hello, and welcome to Deloitte Insights. Today, we are discussing some of the new realities surrounding mergers and acquisitions, as a result of the current economy and changes to tax laws. Here to share those thoughts on these realities are Andy Wilson, a partner in the Merger and Acquisition Services for Deloitte & Touche LLP, and we also have Jim Watson, a partner within Merger and Acquisition Services for Deloitte Tax LLP. Gentlemen, thank you both for joining us today on Insights. Andy, I would like to begin with you. Ah, how is the current state of the economy changed the M&A due-diligence process?
Andy Wilson (Andy): Sean that’s a really good question and yes, it has, following the recession and the slowdown in M&A activity, significant slowdown in 2008-2009. As deal flow started to come back, both companies and lending sources are becoming more stringent and diligent in the kind of information and the depth of investigation that they are expecting; the bar is just plain higher in terms of the diligence standard. Certainly, from a bank perspective, as we know, lending decisions are more difficult to get approved and the diligence process and the level of information and the types of information that companies are looking to are greater, but doesn’t that certainly mean that the diligence is expanding in terms of timeframe; we don’t see that as much. We do see as more structured and focused diligence on key areas and in some cases, more in-depth diligence that we might have seen when M&A activity was at a high and lending was much easier to come by.
Sean: Thank you for that Andy. Jim, I have to kick it over to you, so I would like to understand, have there been any changes to tax elements in that due-diligence process?
Jim Watson (Jim): Well, I think, you know, the current state of economy, from a tax viewpoint, that the stress period that we just went through did lead to some issues that buyers need to consider. For example, a lot of companies incurred significant losses during that time period and for tax purposes those losses can be carried forward. And so from a buyers’ standpoint, the ability to use those losses against future income can be a valuable asset. But there are limitations on being able to use those losses and that should be, like, you know, focus of diligence and should be part of the M&A due-diligence process. Also those losses can be carried back, so let’s say, from 2002-2008 a company made money and they paid taxes, but then during downturn, they lost money, that company could carry that loss back and get cash back from prior taxes. What we found, recently in our diligence process, is that companies may have taken aggressive positions to increase those losses and to increase the amount that could carry back. So, diligence efforts and the diligence process really needs to be tailored to account for that type of impact from the economy.
Sean: Jim, sticking with you, are there any new tax wasn’t need to be baked into a company’s M&A due-diligence process as a result of what we have been speaking of?
Jim: Well, I think, what has changed with the tax laws is that nothing changed. And what I mean is at this time last year it looked like the tax landscape was going to be vastly different. The capital gains rates were scheduled to increase, the dividend rate, which is currently in parity with the long-term capital gain rate, it was to increase back to the ordinary rates of 35-39%. So, that was driving a lot of deal activity last fall because you had closely held businesses that were trying to sell their businesses before those rates changed. In December of last year, those rates were extended until after 2012, so we didn’t have that increase that we thought we were going to have. So, what you have now is a lot of uncertainty in the system when a company is trying to plan for what its long-term tax impact is. We know that in 2013 there is going to be a 3.8% tax on investment income for high-income taxpayers. We think that these long-term capital gain rates and dividend rates are going to increase; they are scheduled to increase in 2013, but there is a lot of speculation that those changes are going to be subject to broader tax reform, and so you have this uncertainty because, frankly, that tax reform and those proposals for broader tax reform are still up in the air. So we don’t know that where rates are going to end up. So, more than the tax laws impacting the diligence process, I think it actually impacts more the modeling and post-acquisition planning that you need to think about. So I think it is important that companies continue to monitor these changes and potential changes in the tax law because it is going to impact how they consider integrating these companies they may be targeting.
Sean: Thank you for that Jim. My last question is going to be for the two of you. Andy, we can start with you, and it focuses on integration, so regardless of a deal occurred before or after the downturn, integration typically is a key factor in the M&A process and the success. So, do you have any best practices for integration that you would like to share with the audience, Andy?
Andy: You are right on that integration is key, and really that’s where the value usually comes or the value you can leak out in an M&A deal. Integration and the planning for integration something we stress to our clients and on the projects that we work on. One critical area that I often see, is that people try as they overreach from the standpoint of what they are going to accomplish through the integration process. And integration is difficult to knot, especially if it is too non-complementary businesses, the styles the businesses have been run, decentralized versus centralized management or processes, those types of items. But too often, we see that the buyer in planning the integration, is trying to include a lot of issues that need to be solved within their own organization. Now certainly, anytime you look at an integration as a buyer and a seller coming together, so there will be changes to both organizations, not just the seller’s organization that’s being acquired and brought in and integrated into the original legacy buyer company. However, if you don’t have the focus on the issues that need to be solved in the integration, especially in the first 100 days, too often, you know, the schemes can expand to the point, the plans can expand to the point - that the actual goal to integration and the value you may gain as well. For example, if you are trying to solve for mismatch in an IT system, trying to wrap an entire your global ERP instance and project into the integration plan for both the buying and selling company, maybe overreaching and you may dilute the effects and positives that that integration plan may have in the value. To be honest, you may get out of the merger.
Sean: Thank you for that Andy. Jim, your final thoughts on integration?
Jim: Well, I think, you know, in connection with what Andy is talking about the timing of when you start thinking about integration is also key. I think what we see, the companies that do integration the best, its companies that started thinking about it during the diligence process; it’s a big mistake to think about integration after the deal has been signed. So, what I mean is that businesses that are integrating the best are asking questions and gathering information during the diligence process to help them integrate. Things, not only about the financial and tax profile of a company, but also you are gathering formation about the personnel they have, as Andy mentioned, the systems that they have, so that you can effectively start thinking about it, so that on that so-called Day 1 you have your integration plan up and running.
Sean O’Grady: So be sure to set your sights as early as possible. Gentlemen, thank you both very much for joining us. We have been talking about new realities in mergers and acquisitions with Andy Wilson, a partner in the Merger and Acquisition Services practice for Deloitte & Touche LLP, and we have also been speaking with Jim Watson, a partner within Merger and Acquisition Services for Deloitte Tax LLP. If you would like to learn more about gentlemen or any of the topics we discussed on this program, you can find it on our Website, its deloitte.com/insightsus. For all the good folks here at Insights, I am Sean O’Grady, we will see you next time.
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