Acquisition continues to be a preferred strategy for manufacturers seeking to increase revenue and create long term growth. Early stages of a merger usually center on factors like strategic fit, market footprint and business integration. There is another less exciting but important factor to consider during these talks: vendor contracts which can cause costly, tactical headaches if not identified early in the process. However, if t
he contracts are assessed early enough in the acquisition process, a company can reap benefits greater than expected through a due diligence process.
When combining two manufacturers there will likely be a considerable number of vendor contracts to review. Vendor contracts related to technology or proprietary materials tend to be the more complex vendor contracts to emerge during this review process. In recent years, the terms in these contracts have grown more restrictive. In addition, termination fees and similar penalties seem to have become de facto industry standards for such contracts in a number of verticals.
The Easy Way and the Hard Way
In an ideal situation, contract expiration dates for the combining companies will be closely aligned. If this is the case, there is clear opportunity to negotiate with vendor(s) for fair market prices for the now-larger entity, which will clearly have more clout following the acquisition.
However, when this is not the case, transfer fees, termination penalties, and other elements in the vendor contracts can affect the value of the deal. While it’s unlikely these items will result in the deal not getting done, it could delay a closing while also causing these late-in-the-game value adjustments, which are no fun for anyone. For this reason, involving experts in vendor contract management as early in the process as possible is recommended.
Contract Terms to Consider
What about times when a company is looking for acquisition targets and perhaps has a vendor contract that might end before the target is identified? Should the institution “go short”, limiting the term plus the amount of penalties that might be associated with longer term agreements?
Every case needs to be evaluated on its own merits, of course, but the fact is things are seldom cut and dry when it comes to this kind of decision. While going short may seem logical at first glance, an acquiring manufacturer might receive a better deal economically by signing a longer-term agreement since these often include volume based growth incentives, competitive discounts and, perhaps, considerable signing bonuses.
As a rule of thumb, the bigger the contract value, the fewer the number of competing providers – and the better the chances that the companies involved in a merger are working with a common vendor. Yet, even in cases where both companies work with the same provider, they’ll need to reconcile the specific services covered. In addition, agreements from strategic vendors vary in terms of their complexity. As most of us know, ingredients and other raw materials are good examples of the complex end of that spectrum with conversions taking months or even years and vendor contracts with terms that typically average three to five years.
By the time a company has entered active merger talks it has likely engaged legal counsel well-versed in coordinating vendor contracts. While this assistance is valuable, these resources typically lack the benchmark information and experience needed to help the manufacturer navigate through fair market pricing for the situation when it comes to strategic vendor contracts. In fact, if your company is actively seeking acquisition opportunities, it is best to engage with experienced third-party vendor contract management firms early in the process, maybe even before an acquisition is identified.