Hewlett Packard is suing Mike Lynch in a current case at the High Court, who is the founder of Autonomy plc, over the allegations that he fraudulently raised the value of the business before its takeover in 2011. Might the outcome of this high-profile case lead to more, expensive, post-deal litigation?
As this was postponed until September, this case has come at a time when the accountancy profession is facing far greater scrutiny over the reliability and quality of financial statements. Therefore, it is slowly becoming more important for businesses to take steps to ensure the financial data which they are basing their decisions is accurate and robust, when embarking on any deal-making process.
The importance of due diligence to buyers
This high-profile litigation is a reminder to potential buyers that they should ensure due diligence processes, regardless of its audit opinion, are thorough and dig deeper than just headline financial data. When considering the expected earnings of the business, for instance, due diligence providers apply a greater degree of professional scepticism and test the figures provided whilst stress testing the likelihood of projections being attainable. This could involve reviewing the terms of contractual agreements to assess concentration risks, the re-tendering process, length of contractual terms and whether their projected value is accurate. Further scrutiny on the customer relationship might be required in order to to assess the risk of the contract(s) coming to end sooner than expected, depending on the due diligence findings. Just reviewing reported financial data will not present the whole picture.
The importance of fair representation to sellers
Likewise, for the seller, ensuring that the financial position presented to the prospective buyer is a fair representation of the underlying business is important to guarantee representations and warranties/protections can be given with the upmost confidence. This will help to speed up negotiations and therefore minimise the need for late-stage adjustments, but it could also mitigate the risk of costly litigation should a post-transaction dispute arise.
Tensions may rise
It’s completely natural for deal negotiations to cause tensions – the buyer wants to receive the best deal possible including warranties and other protections while the seller is pursuing the optimum valuation. The parties involved might have to compromise their position in order to agree on a deal but the importance of access to accurate and reliable financial data should never be disregarded. If any party has cause for concern or believes that over-optimism may be hiding the facts, closer inspection may be needed to defend their interests.
Past the deal Negotiations
Once deal negotiations have commenced, and the ‘data room’ is open, it is imperative for all to stay aware for possible issues and take on further due diligence enquiries if needed. A buyer’s due diligence team would usually expect a seller to share financial data and other accounts in a transparent and open way, as an example. If any unwillingness is shown or barriers are imposed, this should be a ‘red flag’ warranting further deliberation.
Other possible ‘red flags’ include over-complex group structures; re-statements or a general lack of clarity in the financial data provided; late changes; the late filing of accounts. For example, the first might include a major asset being locked into the accounts without a breakdown of how its value has been determined. Understanding the reasons for delays, restatements or lack of clarity is an important part of the process. During the deal-making process though, whilst tightly drafted SPAs and accompanying warranties can give the parties involved with financial and legal protections, over relying on them can be costly. It’s much better to really understand the risks and rewards ahead of time.
Disputes after the fact could be costly
The costs of post-deal disputes shouldn’t be thought as purely financial and should also not be underestimated. Employing legal and accounting professionals to review matters after the event, to unpick what should have been known by whom and when, is normally a slow process. This, along with the distraction and uncertainty caused to the enlarged business, could undermine its value and might even mean missing out on opportunities to complete further deals.