Next Level Due Diligence
Nearly every M&A transaction begins with a look at the possibilities: the strategic fit; the synergies; the drivers for the deal. Naturally enough, the next step will turn to an evaluation of risk. Traditionally, legal exposure from toxic tort and other forms of product liability has rated high on the list of issues to identify and protect against — up there with environmental liabilities and compliance exposures. Recently, however, eye-popping damage awards have raised the stakes, suggesting that acquirers may consider additional due diligence steps, particularly when acquiring new product lines in businesses with which they are less familiar.
In the past, during the due diligence phase one would expect to negotiate liability protections with respect to existing and threatened litigation. If a target company had asbestos exposure for example, that docket and the potential for additional cases would be assessed and indemnities might be negotiated or a reps & warranties insurance policy might be entered into to cover that risk. But trying to protect against legal liability that may emerge in the future has been viewed as a speculative exercise. It has been in the category of “risk factors” that a buyer simply needed to swallow or factor into the price it was willing to offer.
The Bayer – Monsanto merger may have changed things. Two weeks ago, Fortune reported that Bayer’s stock price has fallen over 44 percent since the merger closed and tied the fall to shareholder worries about exposure from glyphosate litigation. Glyphosate had been a controversial product for some time, but this had not translated into direct legal liability prior to the merger. Bayer clearly felt that the opportunities outweighed the risks.
Deals will always be evaluated in hindsight, and risk assessment is never perfect. There is a point where people are indeed just speculating. But buyers can and should avail themselves of every opportunity to understand regulatory, industry and social trends that may impact the value of their acquisition in the future. This could mean going beyond some of the standard techniques.
One aspect of this type of expanded due diligence involves hiring the right advisors. Private equity buyers have long understood the importance of hiring industry consultants when evaluating a business. Strategic buyers may have less of a need, given they bring their own internal experts, but when getting into a new line of business, they may need to think more like private equity.
Regulatory trends should also be reviewed. Products that have been vetted through a fulsome regulatory process (such as Europe’s REACH process) may be less likely to face challenges in other jurisdictions. On the flipside, if a target’s products are listed or proposed to be listed as priorities for action in states like California or Washington, this obviously should raise red flags.
Getting access to the right people during the due diligence process is key. A group that is sometimes overlooked is product managers. These are the line managers who are in the weeds of the day-to-day discussions with customers and other industry players. They spend their time worrying what might change across the landscape in which they sell. Particularly, if an acquirer is looking to bring in new product lines it is not familiar with, discussions with the relevant product managers can be revealing.
Finally, some law firms (like ours) are becoming more industry focused because of the simple fact that it lets us bring regulatory and industry knowledge that is fit-for-purpose. In the ordinary course, legal advisors tend to be at the center of the due diligence process anyway since identified risks need to be factored into the liability provisions of the contract. Having a team of lawyers who understand your industry well allows them to ask the right questions and filter the information more effectively.