Managing M&A Risk With Collars, Earn-Outs, and CVRs

Abstract

M&A transactions expose both the bidder and target shareholders to a number of major risks both prior to the close of the deal and during the post-close integration phase. The main pre-closing risk is the possibility that fluctuations of bidder and target stock prices will affect the terms of the deal and reduce the likelihood the deal closes. After the closing, a major risk for bidder shareholders is the failure of the target to perform up to expectations, thus resulting in overpayment.

This article describes a number of tools that can be used to manage such risks, using a number of examples to illustrate the structure and pricing of such tools. In the case of pre-closing risks, offers with collars can protect target company shareholders from a drop in bidder company share prices while at the same protecting acquirers from excessive dilution. Post-closing instruments such as earn-outs and contingent value rights can be used to manage the risk of substandard performance and the overpayment that would result from underperformance.