5 Ways Accounting Knowledge Helps Lawyers Do Better in M&A Deals

胡星律师

This article was written five years ago when I completed one semester of accounting course with the part-time MBA students at Kellogg Business School, Northwestern. It was a couldn’t be better decision for me then to choose to invest time on the accounting courses in spite of the crazy schedule in the law school.

I still remember in the first class the professor started the speech with the balance sheet of Alibaba, the same year Alibaba launched its IPO on NYSE market. The accounting professor’s practical teaching inflames my enthusiasm in accounting and such enthusiasm drives me the following four years of ACCA learning journey.

This article talks about some simple concepts. Though nowdays I am writing more in-depth articles, it still inspires me some fresh ideas when I read it again today. Publish it here for sharing with readers who love law and also accounting like me.

Text of the Article
Law and accounting are twisting more and more nowadays. Accounting knowledge helps transaction lawyers do a better job in many ways. Here I will share my thoughts on how accounting knowledge helps transaction lawyers improve the quality of legal documents in M&A transactions.
Connect the basic accounting concepts to the definition paragraph of Stock Purchase Agreements (SPAs)
The basic accounting concepts including assets, liabilities, shareholders’ equity, revenue and cost relate to the definition paragraph of SPAs. Some lawyers are accustomed to drafting the definition paragraph by copying clients’ statement. I once saw a junior lawyer defined intellectual property as shareholders’ equity in a SPA. When I pointed out the mistake, the lawyer explained that his job was only in charge of legal terms. Obviously, those kinds of mistakes will put clients’ benefits at great risk. Gaining knowledge of the basic accounting concepts helps lawyers rack up a deeper understanding of the subject matter in transactions and also protect the value of subject matter when lawyers draft the confidential agreement and letter of intent in the early stage of transactions.
Notice the affects of Present Value and Net Present Value on acquisition price
Some lawyers think their major obligation is only to guarantee their clients to collect the whole acquisition consideration finally. However, this it not all that matters. Payment period is not only a matter of default risk, but also that of value of the final acquisition consideration. A simple sample is like: if you have 100 dollars at hand this month, then the 100 dollars will turn into 120 dollars the next month for economic reasons such as inflation; that is to say, if your client pays you 120 dollars the next month, it equals that your client pays you only 100 dollars now. That is how present value and net present value work. Lawyers should understand that the counter party’s delay in payment not only increases default risks, but also decreases value of the money your clients finally collect.
Link Income Statement with material contracts in due diligence investigation
Lawyers can do a better job in due diligence investigation by heeding the revenue numbers in the Income Statement of the target company. Some lawyers normally only copy the basic contract information from the material contracts to the report of due diligence investigation. However, lawyers’ work should not be limited to disclosure of contract information. By analyzing the contract information such as contract parties, payment terms and other material terms, and comparing the contracts information with the revenue numbers in the Income Statement, lawyers may dig out falsified and wrongly augmented revenue. Discovering those falsified revenues and thus lowering acquisition price for clients is transaction lawyer’s responsibility.
Integrate Statement of Cash Flows into the legal opinion
Cash flow is a good indication of health status of a company. For example, when lawyers are entrusted to investigate a client’s potential business partner, through reading the business partner’s company files registered with the relevant registrar office, lawyers find the potential business partner frequently changes its board and management team and also fails to pay the full social premium for employees on time, then lawyers may suspect that great default risk exists for the potential business partner. Under such a circumstance, if a lawyers has additional accounting knowledge, the lawyer can read and analyze the Statement of Cash Flows and may judge that the potential business partner encounters difficulty in cash flow, then the lawyer’s legal opinion issued to clients on the great default risk of the potential business partner will be more persuasive and accountable.
Do not neglect the affects of inventory and lease
Inventory relates to cost, and lease differentiates from purchase. Inventory, cost, lease and purchase matter operation of each enterprise and consequently tie to its Balance Sheet and Income Statement. Lawyers’ skill in recognizing dishonest cost capitalization and unjust lease in the nature of purchase by analyzing Balance Sheet and Income Statement will help uncover the frauds of undue augmented profits for the purpose of unjust increase of the acquisition price, and consequently help clients argue for a better and reasonable acquisition price.
This article is written for discussions only and legal opinion is not formed to any extent. The author s consent is required if you forward the article.