Student 1:

There  are a few risks that companies face when trying to merge or acquire  (M&A) another company. The first risk is the risk of overpayment for  M&A for another company. With over payment, it will cost the final  company more money, in terms of reduced assets, more liabilities, or  diluted stock. The best way to prevent overpayment is through  calculation of business valuation (Lewis, 2021). There are many diverse  types of valuations, from discounted cash flow analysis, to EBITDA, to  liquidation value. Discounted cash flow analysis uses inflation-adjusted  cash flow analysis to predict future cash flow. The EBITDA is earnings  before interest, tax, depreciation, and amortization. By finding this  value, it shows how much the company earns, providing numerical value  for the company. By using the liquidation value, the company is valued  based on paying off all liabilities through selling assets (Patel,  2021). 

The overpayment risk can result from overestimating  synergies, the idea that a combined company works better than the  individual companies. Lewis (2021) explains being conservative when  valuating synergies, even reducing that number by two, as common  practice. This allows room for error if the synergy does not pan out as  thought. Another risk is weak due diligence from the individual  companies. This could take the form of not having third parties review  financial and legal documents on acquiring company to not enough  research on the purpose of the M&A with said company. Failure of due  diligence will cause future complications leading to potentially other  risks mentioned such as overvaluation of the company and synergy. 

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Student 2:

The  identification of the different types of risks is a primary and  critical process during the evaluation process when considering a merger  or acquisition. Typically, such risks are categorized as one of the  following types:

1) Systemic risk

2) Intermediary risk

3) Financial risk

4) Information risk

5) Integrated risk

6) Law risk

Regardless  of the risk associated, procedural steps to identify, quantify and  mitigate can help the acquiring company from entering into a disastrous  situation. The mitigation techniques are broad at the identification  stage, but become specific at the implementation stage.

Proper  risk management starts with due diligence. The management teams must  execute a high level of discovery coupled with a mutual effort of  high-level transparency. Surprises, especially late in the game will  undermine any merger or acquisition and introduce a level of mistrust  that could change or cancel the transaction.

One of the more  common techniques is the use of representation and warranty insurance.  “Reps and warranties insurance covers risks under the definitions of  “loss” and “breach.” For coverage to be triggered, there must be a loss  associated with a breach of an underlying representation and warranty.”  (MarshMcLennan, 2022)

Another technique that can used during the  process correlate both the due diligence process and the use of  insurance. The negotiation of “contractual outs” allows the either party  to cancel the transaction when a contractual obligation is unsatisfied  or misrepresented. This become very important when the value or price is  subject to change during the merger and acquisition process. When the  price or value changes, the tax liability can become a massive burden  and/or ongoing liability. Due diligence should uncover this. Insurance  can protect a party to the transaction to some level. However, in the  end if the deal becomes unfavorable or unprofitable a company will  want/need a legal path to cancel the transaction and possibly pursue  financial damages through the legal process.