When you talk to the parties in an M&A transaction, one of the most common problems is getting paid at closing. Hidden inefficiencies, largely due to outdated processes, cost merger parties over $5 billion each year in the US or approximately $500,000 per deal, according to a new white paper by service provider SRS|Acquiom and Capital One bank. That’s because the standard payment process takes place almost entirely offline and through regular mail – which causes time delays and introduces security risks.
Part of the reason why things are still done in this highly inefficient manner is that banks have relatively little incentive to change how they process closing paperwork. After all, M&A closing isn’t exactly a cash cow. Handling escrow balances can add to the bottom line, but for the parties putting money in escrow accounts, hundreds of thousands of dollars can sit without earning interest for months on end. Typically, private equity firms put seven to 10 percent of the total value of any transaction into an escrow account for up to 18 months while deals close, according to the paper – which means hundreds of thousands of dollars end up sitting idle for over a year.
“M&A deal technology has evolved, but some aspects of the deal process haven’t changed for decades,” says John Hughes, a partner at Sidley Austin, and chair of the American Bar Association’s Subcommittee on Private Equity M&A. “The payments process is one of those areas.”
SRS|Acquiom is trying to address this by partnering with Capital
One and SunTrust bank to build a product that brings the payment process online, and offers parties escrow accounts that also come with a return yield. Through the partnership, SRS|Acquiom says it can work with parties to get an additional 15 to 20 basis points of interest rate on the balances in those escrow accounts – which typically never see more than three basis points.
According to SRS|Acquiom, there are approximately 10,000 disclosed private M&A transactions in the US per year, with an aggregate value of $1 trillion. So it estimates the actual aggregate value of all transactions, disclosed and undisclosed, is probably about double that, i.e. about $2 trillion annually. Sources suggest that on average, about 75 percent of a transaction consideration is paid in cash; so that’s about $1.5 trillion paid out each year, which in most cases is being handed over via cheques in the mail.
THE NEED FOR SPEED
The new product should also be able to offer a big speed advantage: SRS|Acquiom’s Clearinghouse tool supposedly cuts the typical payment timeline down from 1 to 2 weeks to a few hours after payment information is submitted – and all of the information verification is done online, making for a more secure and less onerous process.
For parties that use Capital One or SunTrust for their escrow accounts, and close with SRS|Acquom, escrow balances can start earning a yield of approximately 15 basis points. Based on the aggregate value of all M&A transactions, that adds around $340 million per year in earnings on escrow, which can be divided among transaction parties.
This certainly seems like a good time to address inefficiencies in the M&A process. Ever since the crash, investment bankers have been hoping for a rebound in M&A activity – but macroeconomic uncertainty, regulatory interference and even shareholder activism seem to have been holding corporate CEOs back from going after new deals.
At time of writing, it looks as though things are finally looking up: global deal activity topped $1 trillion in April, a number not hit since 2007 (and prior to that not since the 1980s) according to data from Thomson Reuters, with various high-profile transactions helping to spread confidence throughout the corporate world. But at a time when confidence is still fragile, companies can’t afford to leave billions of dollars on the table due to poor transaction management.
Some firms seem to be catching on to this. One private equity firm recently dropped its bank in the middle of closing to use SRS|Acquiom Clearinghouse and its enhanced escrow products, according to Daren Di Nicola, director at SRS|Acquiom. “Firms always have the option to leave a bank at any point in the process, but few do unless something is really wrong – especially that far into the process,” Di Nicola tells Private Equity International.
Other changes in the pipeline also strengthen the case for an online process, including recent judicial relief on holding original stock certificates at the time of sale. One reason why the closing process has remained paper-based for so long is that shareholders have to present original stock certificates to the bank, along with several original copies of the same paperwork, which is then checked manually by someone in the bank assigned to the deal. But last year, a judge ruled that it was no longer necessary for shareholders to present the original stock certificate at the time of sale.
“Many think online submissions are not possible, due to the perceived requirement that original stock certificates be returned,” said Steven O. Weise, a partner at Proskauer Rose. “In fact, UCC § 8-207 provides all the protection the parties need to avoid the hassle of finding and submitting paper stock certificates,and the costs of surety bonds when a stock certificate is lost.”
The SEC has also issued several no-action letters allowing M&A brokers greater latitude on operations, transaction sizes, and subsequent fees. Taken together, this ought to give M&A a boost. But a faster, safer, more efficient transaction process would also help.