The Critical Role of the Board of Directors in Acquisitions Note: This paper originally was published in October 2013 by Transaction Advisors (www.transactionadvisors.com). Many are predicting the M&A market is poised to accelerate following protracted uncertainty in global markets. As these markets rebound, both strategic and financial buyers are eyeing ways to convert piles of cash idled by the economic downturn into profitable growth. M&A transactions can be used to reshape a company, whether by accelerating growth in an existing business, entering or exiting business lines, combining with another entity, or selling the company in its entirety. Depending on circumstances, M&A transactions range from friendly to unwelcome, sometimes even hostile. But in all cases, the board of directors must play a critical role in the transaction. Overview Many companies that want to grow via acquisitions lack a clearly defined strategy for doing so. Management may present potential deals to the board that are reactive. Often these deals appear on the board agenda with tight deadlines and accompanied by too much information that has little direct value. Even when deals are pushed as those the company can t afford to pass up, management may struggle to make the case for how the deal will fit with the company s strategy. Many companies build regular acquisitions into their growth strategies, but they often fail to handle the process as well as it could be managed at the board level. Much has been written as of late about the board s responsibility to improve its risk oversight role, which is a vital part of an organization s risk management process. As part of the risk oversight role, the board delegates responsibility for the day-to-day running of the company to management but retains control over all major decisions, including material M&A transactions. This risk oversight role is one of the key obligations of directors; it cannot be delegated. The board s fiduciary responsibilities increase when an M&A transaction is under consideration. Among many critical factors, the rise in litigation surrounding transactions is placing boards decisions and decision-making processes under increasing legal scrutiny. Therefore, it is important that boards maintain a record that shows a proper oversight process, regardless of other duties and responsibilities on their agenda.
As part of this oversight process, the boards of both the acquiring and target companies must decide whether a potential material transaction can proceed beyond an initial exploratory phase. Typically, the board of the potential acquirer would need to give approval to management before a material transaction is explored. Merger agreements require the approval of the acquiring and the target companies boards, as well as the target company s shareholders. In all cases, it is essential that the board become involved with potential transactions at the earliest possible opportunity. On either side of an M&A transaction, board involvement must be an active and informed process that is not tainted by conflicts of interest. What Is the Value? What Is the Risk? M&A can be a key part of an organization s strategy to accelerate growth, increase market share, and gain access to new technology, products and distribution channels. Yet, despite the best of intentions, these transactions often fail to meet value expectations. Many companies fall short of their targeted efforts to integrate people, process and technology before, during and after the merger, much to the detriment of shareholder value. Numerous studies peg the rate of failure at more than 70 percent. Such performance is unacceptable in just about any endeavor, but old lessons in M&A failures continue to be relearned by many companies. The question arises as to what role the board must have in overseeing the process of screening, selecting and pursuing M&A candidates, closing M&A transactions, and integrating acquired entities, with emphasis on reducing risk in M&A activity. Evaluating M&A opportunities can be the most high-stakes role a board plays, and potentially, one of the most frustrating. While some companies perform acquisitions regularly as part of their corporate strategy, others undertake such deals infrequently, especially major ones, and they can quickly become stressful events. Acquisitions inherently involve many uncertainties. Board actions and decisions often need to be made on an accelerated basis, and decisions made today may be second-guessed for years to come. No matter how diligently the board acts, there is often a disconnect between what the board needs to know to make the best decisions and what it can actually get from management and other sources. Frequently in the rush to make the case for a deal, management will flood the board with an excess of information documenting its rationale. However, to engage in their oversight role efficiently and effectively, boards should ask for key information to be pared down into a short board summary. This type of summary not only provides the board with the information it needs, but it also helps the management team which often becomes too focused on making a deal work articulate the strategic rationale for the deal. Key Considerations by Phase The board should start with an understanding of the strategic underpinnings of any proposed M&A transaction and use that perspective to evaluate the deal s benefits. Protiviti 2
Such strategic considerations include: Cost savings and/or additional revenues through new synergies that create new ways of doing business Cost-effective entrance into a new market Performance improvements through cost reductions Ability to command higher prices through acquiring of resources When M&A deals are proposed, it is the job of directors to ask probing questions to assess the validity and reasonableness of revenue and cost assumptions, benefits from expected synergies, and the plan to achieve those synergies. By exercising due diligence, directors can ensure that management s assumptions are tested, the deal pricing and the financing approach is evaluated, legal liabilities are investigated, internal controls are assessed, accounting policies and estimates are evaluated, cultural differences and staffing issues are understood, and related-party transactions are considered carefully. Next, the board should review the key terms of the transaction and ensure they make sense from both legal and business standpoints. Terms should be checked to see how they stack up against current market practice (e.g., the size of any termination fee). Other than price, these terms should include the transaction financing, closing conditions, deal protections and buyer walk-away rights. The so-called boilerplate should not be overlooked or included without critical analysis as they can become critical if a deal falls through. Before the deal is approved, the board should review carefully management's integration plan to make sure it understands where integration is necessary, how it is to be achieved and who is leading the integration efforts. The board needs to understand what potential obstacles could frustrate the plan s execution, especially where cultural differences may threaten the retention of key personnel. Compensation plans may also need to be adjusted where retention of key staff is a priority. In addition, directors should keep an eye on the integration of internal controls and the accounting for the transaction to ensure they are being reviewed properly Because M&A transactions are relatively infrequent for many companies, the board and management may not have a thoroughly vetted process by which to interact during an M&A process. For complex and risky transactions, the board should expect periodic updates from management at various stages of the due diligence process, as well as updates on the progress of the integration strategy after the deal is approved and consummated. To reduce the risks in these areas, the full board may take the lead during the transaction, or it may form special board committees of members with the skill sets and expertise needed to review the deal economics and integration plan and evaluate opportunities and risks. In some cases, it may be necessary to stress-test management s assumptions and rigorously examine deal pricing to avoid overpaying. Compliance and regulatory risks (such as tax, antitrust and corruption risk issues) also need to be assessed and mitigated. Questions for Directors During the deal process, boards must ask probing questions as they exercise their oversight responsibilities. Examples of some questions that boards of directors may want to consider, in the context of the kinds of risks inherent in the entity s operation, are presented below: Does M&A activity fit into management s current view of corporate strategy and why? Protiviti 3
What potential opportunities (and related risks) are there in growing via acquisition? How much cash is available to fund acquisitions, and how quickly can it be utilized? How much additional financing could be secured, from what sources and how quickly? What regulatory barriers would we need to overcome, and how likely it is they will be, bearing in mind the current antitrust enforcement environment? What are the current M&A trends in our industry? What legal developments are affecting our fiduciary duties? Do directors feel satisfied that management is responsive enough to provide them with the information they need in areas where they need to have close oversight, such as: o Key acquisition issues and potential integration challenges o An integration timeline, with key milestones and expected problems o Personnel issues, such as talent retention It s also a good idea for a board to take time to undertake an examination of previous deals to identify the experiences and outcomes, and apply lessons learned. What worked? What didn t work? Why? Were the key targets and timelines met? The answers could help inform the current decision and possibly result in a better deal. After the Deal Closes The role of the board does not end with the closing of the deal. The board must continue to provide oversight of management as it implements the transaction. Post-deal integration can often crystallize a host of issues, many of which may have been unforeseen at the time the deal was negotiated. Integration issues can bleed value from the combined entity and lead to the departure of key personnel. Such problems include, but are not limited to, cultural fit, communication habits and systems compatibility. The board should designate a member of senior management to drive decisions during the integration period and monitor progress toward the merged entity s goals. Other key considerations boards should keep in mind when evaluating any transaction: The fact that a company is seriously considering, has initiated or has been approached with an M&A deal constitutes highly sensitive information that directors need to ensure is kept confidential until the time is ripe for disclosure (as discussed below). Corporate communications in the M&A context should, as always, be coordinated through the senior executive team and approved as appropriate by the board. In most cases, the CEO will lead communication efforts, but in certain circumstances an independent chairman or lead director may be assigned. Each director should be reminded that all queries about the deal are to be directed to the official communication channels to ensure delivery of a consistent message and reduced risk of noncompliant disclosures. Finally, the board should review important disclosures about the deal, such as the announcement press release, proxy statement and/or tender offer documents. M&A transactions are typically announced only when they are at an advanced stage (such as upon the signing of a merger agreement). An announcement before a deal is fully baked can wreak havoc on the company s stock price if either or both parties decide to back out of the deal. For this reason, as a matter of policy, many companies will not respond to market rumors. Protiviti 4
Summary Continuing globalization of markets, increased competition, and increasing regulatory oversights are mandating the need for enhanced risk oversight from boards of directors. This oversight is especially important when an organization pursues growth through acquisition strategy. While M&A can be a great tool for enhancing shareholder value, management remains accountable for designing and managing the risks inherent in these types of transactions. The board s role is vital in overseeing these risks in the interest of protecting shareholder value. There should be independent scrutiny as to the strategic fit of any transaction. This should be coupled with understanding of the key due diligence, operational and cultural integration risks by asking the right questions and requiring summarized and key financial information that is relevant to the transaction. This synergistic approach between management and the board provides the greatest opportunity to better manage the risk and capture the targeted values of M&A deals. About Protiviti Protiviti (www.protiviti.com) is a global consulting firm that helps companies solve problems in finance, technology, operations, governance, risk and internal audit, and has served more than 35 percent of FORTUNE 1000 and FORTUNE Global 500 companies. Protiviti and its independently owned Member Firms serve clients through a network of more than 70 locations in over 20 countries. The firm also works with smaller, growing companies, including those looking to go public, as well as with government agencies. Protiviti is a wholly owned subsidiary of Robert Half (NYSE: RHI). Founded in 1948, Robert Half is a member of the S&P 500 index. Contacts Jim Ryan +1.314.656.1745 jim.ryan@protiviti.com 2014 Protiviti Inc. An Equal Opportunity Employer M/F/D/V. Protiviti is not licensed or registered as a public accounting firm and does not issue opinions on financial statements or offer attestation services.