May 25, 2022

Due Diligence: The Value of Entity Management in M&A

One of the things that sometimes drives businesspeople up a wall about lawyers is our obsession with recordkeeping.  Minutes, board and stockholder resolutions, documentation of share issuances and preparation of other corporate records loom large in most lawyers’ priorities, but for business folks, that’s often not the case. Well, the next time somebody from the business side rolls their eyes when you shove a bunch of organizational minutes for a new Norwegian subsidiary under their nose, be sure to point them in the direction of this Deloitte study, which says that failing to pay due attention to legal entity management can be very costly when it comes to M&A. Here’s an excerpt:

A company with immaculately managed books conveys a sense of order and trustworthiness. Buyers don’t have reason to question general counsel or the management team; they can see that everything is as it should be. “Better entity management gives the buyer more confidence in the organization,” according to John Easterday, a partner at Deloitte Tax LLP. If, on the other hand, a business hasn’t exercised care in maintaining its entities’ corporate records, buyers may start to wonder what else has escaped the management team’s focus—and what other problems they may be buying with this deal. In our research, 59% of respondents said that poor entity management causes buyers to question whether subsidiaries are, in fact, wholly owned by sellers.

Sloppy LEM can lead to questions that ultimately decrease confidence and trust. That’s what we heard about in the cautionary tale of a private equity firm that initially offered $47 million to buy a company. But when the private equity firm inspected the seller’s records, it found that leases hadn’t been executed properly and only half of the stock option agreements were signed. These shortcomings caused the private equity firm to question the seller so much that it ended up discounting its price.

The study says that when a buyer encounters sloppy corporate recordkeeping, it reaches one of two conclusions: either the seller’s legal team is inept, or the seller is hiding something.  Neither conclusion is conducive to a successful transaction.

John Jenkins