Mergers and acquisitions are often built around market opportunities and long-term growth, but some deals that look great on paper can pose serious problems after an agreement is reached. If a commercial agreement contains unfavorable terms, unclear obligations or unexpected liabilities, it can undermine the entire acquisition. Careful due diligence is essential when reviewing a commercial contract to ensure an acquisition reaches its potential.
Why Commercial Agreements Matter in Acquisitions
Commercial agreements are an important part of acquisitions, as they help manage potential issues between parties and protect their rights and interests. The acquiring company inherits these agreements, so if contracts are poorly structured, the buyer may face unexpected financial losses and operational challenges. Research shows that 70-75% of mergers and acquisitions fail, and weak commercial agreements can be a fundamental cause.
Key Contract Risks to Identify During Due Diligence
A thorough contract review helps uncover risks that could derail a promising acquisition. Leaders and legal teams should focus on these key areas when evaluating their commercial agreements.
1. Hidden Liabilities and Legal Exposure
Commercial agreements can contain clauses that create unexpected legal or financial obligations. A detailed legal review of commercial agreements is essential to uncovering any risks, small issues and potential points of contention before they become significant problems. Identify liabilities early and address them before closing.
2. Unclear Contract Terms and Obligations
Contracts should clearly outline payment structures, deliverables, termination conditions, dispute resolution procedures and any relevant miscellaneous clauses. Ambiguous language can be a key reason why mergers and acquisitions fail, as unexpected disagreements, misunderstandings or obligations can derail them.
A well-structured agreement reduces uncertainty, follows proper protocol and ensures both parties understand their responsibilities. It is a good idea to use plain and simple language to reduce confusion. Sentences should be short and headings can help break up information so the content is scannable.
3. Customer Relationships and Change-of-Control Clauses
Customer contracts are a key aspect of an acquisition, as they reflect future revenue. However, some agreements include change-of-control clauses that allow clients to terminate or renegotiate contracts upon a change in ownership. This can be particularly damaging if a company depends on a small handful of major customers, as losing just one could harm the projected financial performance.
Buyers must identify any provisions triggered by a change in ownership and try to engage with customers, particularly large ones, as early as possible in the process to confirm they will continue the relationship post-acquisition.
The Importance of Thorough Due Diligence
It is essential to commit to thorough due diligence in mergers and acquisitions. Even a small issue can derail a promising acquisition, leading to unexpected financial losses and operational challenges. All representations must be verified and potential risks identified. Proper documentation and careful legal review also ensure that all contracts comply with the protocols required for a business transaction.
A structured, thorough approach identifies weaknesses early and avoids costly surprises after the deal is closed. Key areas to review include:
- Customer contracts
- Supplier and vendor agreements
- Distribution and licensing agreements
- Liability and indemnity provisions
- Contract terms and enforcability
- Change-of-control clauses
- Exclusivity and non-compete clauses
Reducing Risk Before Finalizing a Deal
Companies should conduct comprehensive audits of all customer, supplier and vendor contracts before closing to reduce risks. They should identify change-of-control clauses and examine customer concentration to evaluate risks that could affect future revenue.
Experienced, capable legal counsel should be appointed to review liabilities and obligations. Human-AI collaboration is having a profound impact across various sectors, but artificial intelligence shouldn’t be trusted to handle complex commercial agreements alone.
These steps will reduce risk and give buyers a clearer picture of what to expect. Billions are spent on mergers and acquisitions each year, underscoring the imperative of thorough risk reduction.
Ensure Acquisitions Reach Their Potential
Weak commercial agreements are a common factor in unsuccessful acquisitions and mergers. Financial planning and marketing positioning are important, and they tend to be the more exciting aspects of an acquisition that leaders want to focus on. However, prioritizing the nitty-gritty details, such as contract terms and legal obligations, is essential.
Buyers must carefully scrutinize a commercial agreement during the due diligence phase and conduct realistic risk assessments to ensure they know what to expect and that the deal can reach its planned potential.
