The principal risk for a buyer in M&A is paying too much. Overpayment is a drag on the buyer’s results for an extended period. Other major risks are (1) operating problems in putting the two firms together, (2) excess debt incurred to finance the deal, and (3) recession that occurs shortly after closing which then reduces the target’s value.
Four risks loom large for corporate acquirers: overpayment, operating, financial, and macroeconomic:
- Overpayment risk. The acquisition’s operations are sound, but the high purchase price eliminates the possibility of the buyer receiving a satisfactory investment return.
- Operating risk. The acquired business doesn’t perform as well as expected after the integration.
- Debt leverage risk. The acquisition is financed with debt, which strains the buyer’s ability to fund its operations and service its debt at the same time. Leverage risk applies to deals that are sizeable in relation to the buyer.
- Macroeconomic risk. The deal occurs at the peak of the business cycle, and the target’s earnings suffer during the ensuing recession.
Overpayment is the most common problem in acquisitions. A buyer senses the need to grow quickly and becomes overzealous in pursuing a deal. In its calculation of the target’s contribution, the buyer uses optimistic assumptions to justify the transaction. When the assumptions don’t pan out, the buyer’s shareholders suffer, as the ...