Contract Separation
Mergers & Acquisitions (M&As) or ‘deal-making’ is a popular option for businesses to grow rapidly. Not surprisingly, M&A activity in India has risen to around USD 125 billion in 2022 from approximately US$50 billion in 2021 (a 150 per cent growth). Most managers would agree that announcing the deal is just the beginning. Even before the ink on the deal contract has dried, managers will face the challenge of ‘executing the M&A’. This process rarely grabs the headlines, but the real value of the M&A lies here only. One important aspect of this execution process is separating the contracts of the business unit.
Separating contracts is important so contracts are housed in the correct business entity, licenses are renewed, and breaches are avoided. Proper handling of vendor and customer contracts ensures confidence and uninterrupted access to services on Day 1 (the day when the business separates from the parent entity). Incorrect handling could mean loss of value and reputation, disruptions and delays, penalties, and compliance headaches.
Typically, the execution process gets divided amongst departments, such as HR, IT, and procurement, and includes separating that department’s contracts. There are several problems in this de-centralised approach to contract separation.
An uncoordinated approach means each department would be handling contracts in its way. This means different negotiation strategies and templates that may deviate from the common goals and vision of the deal. This problem becomes even bigger when different departments take multiple services from the same vendor under a common master agreement but separate Purchase Orders (POs). It would mean inconsistent vendor communications and overwhelmed legal, tax, and compliance departments being approached by multiple departments.
No two contracts are the same. For example, contracts with the same vendors or similar services can have differing contract renewal dates or termination clauses. In addition, newer contracts can be more specialised with complex clauses and older contracts might be silent on M&A-friendly clauses, such as assignment and right-to-use. Some contracts may be under litigation. Managers need to assess each contract independently for financial or legal impact. Independent departments may not have the manpower or expertise to assess and renegotiate all contracts. Even one critical contract that has not been managed for the end-state of the organisation might affect the deal closure.
The scale of moving contracts is usually underestimated. Even a mid-sized organisation can have hundreds of contracts that can take months to track. For example, an IT service provider in India took four months to track more than 500 vendor contracts and even then, missed a few. The task of tracking and separating contracts becomes difficult, especially when different departments have their own approach to storing and managing their contracts.
Other problems exist as well. For instance, migrating contracts is a priority for the business, not necessarily the vendor. Not all vendors will easily agree to the transition expected by the business. Not planning or prioritising can mean that vendor negotiations will become an obstacle to successful deal closure. Vendors may see the M&A as an opportunity to upsell, charge high transfer fees, or book a new account at higher rates.
Having a centralised contracts team would solve a lot of the problems described. A dedicated team plus starting early can help optimise contract handling costs and achieve Day 1 readiness. Since the dedicated team will be driven by deal objectives, they can help save money by rightsizing contracts and minimise dis-synergies and stranded costs. They may even be able to incorporate M&A-friendly terms in the new contracts. They will avoid problems, such as expired contracts, overlooked inter-departmental dependencies, unbudgeted costs, and breach penalties. They will also provide a unified view of contract transfer status. Other departments will be free to focus on their core objectives and business as usual.
The contract separation process may sound tedious. However, Machine Learning/Artificial Intelligence (ML/AI)-based tools have made contract separation less labour-intensive. Cognitive contract review tools, backed by trained document reviewers, are 10 times faster than traditional contract reviews and offer greater accuracy at lower costs. By utilising these tools, the time taken by managers to reach out to vendors and customers for M&A transition is significantly reduced. Businesses with a high volume of contracts can use these tools to boost the productivity of their contracts team.
Contract separation when managed smartly can immensely benefit the business. A well-managed exercise would give management a better understanding of the business — its cost structure, services, and gaps. M&A execution happens under tight deadlines. Contract separation is an important value driver. Hence, it is important to have a clear strategy, an experienced deal team, and an early head start.
Authored by Sumeet Salwan, Partner, Consulting, Deloitte India and Tarun Soneja, Partner, Consulting, Deloitte India
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