FIN 679 AU Advanced Corporate Finance Paper

Respond to at least two classmates’ posts. In your response, compare and contrast the risk management techniques discussed by your classmate to those you discussed in your initial post. Additionally, compare those techniques discussed by your classmate to those typically used in the industry. Explain how your classmate’s chosen techniques stack up to the industry standards. 200 words each response.

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.