M&A Made Easy: How to Mitigate Treasury Risks
Published: December 06, 2024
Mergers and acquisitions (M&As) present a broad range of opportunities for corporates’ growth and expansion, but they also carry risks that can undermine the success of even the most well-planned transactions.
The treasury function is critical in ensuring that these risks are appropriately identified, assessed, and mitigated to preserve financial stability and maximise value creation. Gedeon Richter, a Budapest-headquartered multinational pharmaceutical company, has experienced this first-hand and in 2024 the company spent over €300m on strategic acquisitions. Building on this experience, there are a number of learnings to share about identifying and mitigating the major treasury risks associated with M&A transactions.
1) Financial Risks
One of the most significant risks in any M&A transaction is related to the financial health and liquidity of the company. For the buyer, an acquisition often involves a significant outflow of capital, which can drain cash flow, increase leverage, and can expose the company to market volatility. Treasury teams must ensure the company can meet its financial obligations without putting its day-to-day operations at risk.
Liquidity risk mitigation: Effective liquidity management is essential both pre- and post-transaction. The treasury team should conduct detailed liquidity forecasting to ensure that sufficient funds are available to cover transaction costs, integration expenses, and ongoing operational requirements. Establishing credit lines and other financing options in advance is also necessary to manage unforeseen financial pressures. Additionally, stress testing should be conducted under different scenarios to understand the potential impact on cash flows, and contingency plans should be developed to respond to cash flow disruptions.
Debt and leverage management: M&A transactions frequently require additional debt to finance the deal, which can lead to increased leverage and create risks around debt covenants and credit ratings. Treasury teams must closely monitor debt levels and adjust the capital structure to maintain targeted leverage ratios. Regular reviews of debt covenants are also critical to ensuring compliance.
Valuation risk: Another major financial risk involves the valuation of the acquisition target. Paying too much for an acquisition can lead to financial problems and potential impairment of goodwill. Treasury should work closely with third-party valuation experts to validate the purchase price and ensure that it aligns with market conditions. For cross-border transactions, currency fluctuations can pose a significant risk to valuation. Hedging strategies such as forward contracts or options can be utilised to mitigate this risk and protect the company from adverse FX movements.
2) Operational Risks
Beyond financial considerations, treasury teams must manage operational risks that can arise during the integration of the acquired company’s systems, processes, and resources. Poor integration can lead to inefficiencies, disrupted operations, and a failure to achieve synergies.
Integration planning: A detailed integration plan is critical for ensuring smooth operational transitions. This plan should include clear timelines, milestones, and the roles of relevant stakeholders across both companies. A key element of operational risk mitigation is aligning the treasury systems of both companies, such as the TMS and ERP platforms. Standardising these systems helps to avoid disruptions in financial reporting, payments, and liquidity management. Treasury should also use project management tools to monitor the integration process and address potential issues proactively.
People management: M&A deals often lead to changes in staffing and resource allocation, which can present risks for the treasury team. Retaining key personnel is essential for a successful integration, so offering incentives or career development opportunities may be necessary in order to keep critical employees engaged. During peak periods of workload, such as the integration phase, treasury may need to temporarily augment its resources with external consultants or contractors. Regular talent assessments ensure that the team’s capabilities remain aligned with the evolving needs of the integration process.
3) Market Risks
Treasury plays a crucial role in managing market risks, particularly in the context of fluctuating interest rates, currency values, and the broader economic environment.
Interest rate risk: Volatility in interest rates can affect the cost of variable-rate debt used to finance acquisitions. Treasury can mitigate this risk by using interest rate swaps, caps, or collars to lock in favourable rates and limit exposure to rising costs. Regular reviews of the company’s debt portfolio are essential for optimising the mix of fixed and variable-rate debt, minimising the impact of interest rate fluctuations.
Currency risk: In cross-border M&A transactions, currency risk becomes a significant concern. Exchange rate movements can affect both the purchase price of the acquisition and future cash flows. Treasury can manage currency risk by implementing hedging strategies such as forward contracts, options, or currency swaps. Additionally, aligning the currency of debt and revenue streams can create natural hedges that reduce exposure to currency fluctuations.
Economic environment: M&A transactions are vulnerable to broader economic conditions. A sudden downturn or recession could negatively impact the new combined entity’s profitability or cash flow. Treasury should stay informed about global economic trends and regulatory changes that could affect the transaction. Scenario planning enables the company to anticipate potential economic downturns and prepare strategies to navigate these challenges.
4) Legal and compliance risks
Navigating the legal and regulatory landscape is another key responsibility for treasury during M&A transactions. Compliance with local and international laws is essential to avoid costly delays or penalties.
Legal risks: The M&A deal may be subject to approval by regulatory authorities, especially if there are concerns about anti-competitive behaviour or market dominance. Treasury should engage with legal experts to ensure the deal complies with all relevant regulations and that approval timelines are factored into the overall transaction plan. Preparing a comprehensive regulatory compliance checklist for all jurisdictions involved is a proactive step to avoid delays.
Contractual obligations: Taking on the target company’s liabilities is a risk that must be carefully managed. Due diligence is critical to uncover any hidden or contingent liabilities, such as legal disputes or tax obligations. Treasury should work closely with the legal team to review existing contracts for clauses that could be triggered by the M&A, such as a change of control provisions.
5) Cultural and strategic risks
M&A transactions have the potential to impact the reputation of the acquiring company. If stakeholders perceive the deal as risky or misaligned with the acquiring company’s strategy, it could result in a negative perception or financial fallout.
Cultural risks: To protect the company’s reputation, treasury should develop a comprehensive communication plan that clearly explains the strategic rationale for the acquisition. Engaging with key stakeholders, such as investors, customers, and employees, is essential to ensure their concerns are addressed. Cultural misalignment between the merging companies could also present reputational risks. Treasury should support efforts to align the cultures of both organisations to avoid integration challenges.
Strategic alignment: Ensuring that the acquisition aligns with the company’s long-term goals is critical. Treasury should conduct a detailed synergy analysis to validate the anticipated cost savings or revenue enhancements from the deal. Regular reviews of strategic objectives will help ensure the newly acquired business fits within the broader corporate strategy.
6) Communication Risk
Finally, communication breakdowns during M&A transactions can lead to misunderstandings and operational delays, which makes clear and consistent messaging crucial.
Internal communication: Treasury should establish centralised communication platforms for M&A-related updates to ensure alignment across departments. Regular town hall meetings for all the staff or Q&A sessions can help address employee concerns and ensure transparency throughout the process.
External communication: Effective communication with investors and the market is equally important. Treasury should prepare detailed investor-relations materials that outline the financial impact and strategic rationale behind the transaction.
In conclusion, M&A transactions inherently bring a range of risks that directly impact the treasury function. From managing liquidity and leverage to integrating systems and personnel, treasury plays a central role in ensuring the financial health and operational success of the deal. By employing robust risk mitigation strategies, treasury teams can navigate these challenges effectively, contributing to the long-term success of the transaction and the organisation.