M&a Issues Raise the Governance Bar

8/2/2019 M&a Issues Raise the Governance Bar

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o f d i r e c t o r s

B o a r d m e m b e r so p e r a t i n g i n t h i sm o r e s t r in g e n t e ras h o u l d a p p i y t h e i re x p e r i e n c e a n d c o u n s e lto h e l p th e i r c o m p a n i e si m p r o v e t h e l i k e l i h o o do t a c q u i s i t i o n s u c c e s s .

e r n a n c e

G overnance responsibilities forboards o f d i rec to rs haveexpanded s ign i f i can t l y i nmerger and acquisition activi-t ies moving we l l beyond s imp lyobtaining a l^airness opinion to beingentrusted wi th evaluat ing strategicrationales and reviewing the adequa-cy of post-acquisition planning.

Directors are being held to th ishigher level of governance, both inthe courts and by new legislation suchas The Sarbanes-Oxley Act of 2002.This is a reaction to behavior at thepeak of the financial cycle the ris-ing s tock marke t , burs t ing bubb le ,

governance that eventually retreat-e d , revealing the problems.

As the level of merger and acquisi-tion activity picks up fueled by anincreased availability of capital theimpac t of these changes on the acqu isi-tion landscape is starting to he felt. Inno area i.s the importance of an inde-pendent board arguably greater thanin carefully ev aluating acquisitions.

In this environment, boards shoulduse their expanded role to not onlymon i to r management , bu t a iso toincrease the probability of successfulacquisitions by adding value throughtheir additional guidance and experi-

position helping to build the busness and pass on lessons from theown experiences is, after all, presumably the reason they joined thboard in tho first place.

History demonstrates that transformational acquisi t ions are a lmosunrivaled in their staggering ability todestroy va lue fo r shareho lders wi th AOL T ime Warne r one sucexample in a long list. Boards shouldtherefore, focus enormous attentionon evaluating acquisitions, particularly addressing the reasons most commonly given for past failures.In recent Grant Thornton LLP sur


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quently cited for acquisition failures:poor in tegra t ion p lann ing , lack o fstrategic rationale and weak cuitura!fit. Conversely, the reasons most fre-quently cited for acquisition successi n c l u d e : a g o o d m a t c h , t h o r o u g hplanning and effective personnel. It'sclear that a comprehensive review ofelements related to an acquisition suc-cess or fa i lure is in tegral to theboard's role.

The question then becomes: Whatcan and should directors do in each ofthese areas? Inte gra t ion . Directors should askto review post-acquisition integrationplans and determine who is account-ab le fo r i t s imp lemen ta t i on . Th i swou ld l i ke ly cover th ree areas:1} the actions immediately necessaryafter the transaction closes, frequentlya laundry iist of housekeeping items;2) the communication plan, coveringnot only short- term communicat ionwi th customers, shareho lders andemployees but also ongoing commu-nication to address primary concernsof key stakeholders, based on solicit-ed feedback; and 3) the plan for deliv -ering intended synergies, not only inregards to cost savings through con-solidation, purchasing synergies, etc.,but also pertaining to actions intend-ed to expand revenue.

These plans wo uld highlight ongo-ing processes to generate new per-formance improvement ideas as theorganizations learn to work together.When realizing synergies is critical tosupporting the price paid for a target,the board wil l want to carefully con-sider these synergies and understandhow di f f icu l t they wi l l be to imple-ment, as wel l as their l ike l ihood ofsuccess. Strateg ic Ration ale. Directors canview several factors re lated to thestrategic rat ionale. Executives wi l lwant to demonstra te to the boardhow the acquisition will leverage thes t reng ths o f the acqu i re r an d / o rreso l ve impo r tan t vu lne rah i l i t i e s .They wil l also want to address thecloseness of fit with the existing busi-ness, since research shows the furtheraway the core activities of the target

cessful the acquisition tends to be.Information and due diligence reportson the target should also be providedto the directors, so they can gain com-fort the business really is what man-agement thinks it is, rather than whatthey want it to he.

Sadly, there are numerous exam-ples where the underlying economicsof the target have notref lected the story ofthe business as it hadheen presented. And,just as marriages basedon the premise that heor she can change theother do not have astellar record, mergersand acquisitions basedon s im i la r reason ingalso suffer. Cu l tu r e and Peo-ple, When consideringthe peop le and cu l -ture, among the ques-tions to ask are: Whatis the target's currentcul ture? How does i tdiffer from that of theacquirer? What doesthat imply for how t) i fpartners must behaveif the acquisition is tobe successful?

The board shou ldalso view people andculture from a risk per-spective. That is, if thecu l tu re and ways o fdoing business d i f fermarkedly or significantpersonnel changes arcrequired, the risk of thetransaction is far high-er. In one example, anacquirer replaced theent i re

plans for those key players.Cu lture is a crucial clement for the

boa rd to g rasp , i nc lud ing thoseattr ibutes of the target 's "ways ofworking" that make the organizationsuccessfu l , as wel l as the speci f icactions that need he taken to ensurethose elements are retained and builton . In one case, an acquirer changed

Boards of Directors'Key M&A Responsibil i t ies

Short-term actions Communication plans (immediate and ongoing) Synergy delivery plans (and likelihood they will beachieved) Internat controts comptiance plan Individuals accountable Closeness of fit with existing business Acquisition's ability to leverage strengths andresolve weaknesses Do economic reatities match the story? Other targets/options exptored Closeness of cuiturat fit tmptications for future ways of working Retention and rewards for key peopte What is it that makes the business successful? How this wit! be retained and bu itt on? Valuation, comparables, projections, revenue risk,financing structure Fairness opinion is independent from deal fee Due diligence is robust (internal and external)and directed to unc overing any significantpotential liabilities Process, deliberations and analysis d ocum ented Use of inde pend ent experts From personal experiences Not simply monitoring management Balanced perspective on weighing risks and rewards

managemen tteam after an acquisition, which wasnot, in and of i tself, bad; but wh encombined with a high purchase price,substa ntial fina ncial leverage and avolatile revenue stream, the resultingdisrup tion p roved catastrophic. Wherecertain members of management arecentral to tho ongoing success of thebus iness, the board shou ld be

many of the acquirer's nuances andm e t h o d s o f w o r k i n g , w h i c h h a dmade i t exceptional in the market-place. The target's performance con-seque nt ly fe l l back in tt> l ine w i t hindustry norms which comhinedwith the full purchase price and debtload that came wit h the acquisition ofan exceptional business provided


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A lesson in both of the examplesabove is to understand, retain andbuild on the differences that led to thetarget's success and grasp how thesecomponents wil l opera te with theadditional risk and stress placed on abusiness from the acquisition. This isexactly the perspective that greaterboard involvement can bring.Using More Independent AdvisorsAno the r new deve lopmen t i s theincreased use of independent advi-so rs to he lp eva lua te man age -ment's strategy, analysis and post-acquisition plans with the adv i-sors report ing to the board , inde-pendent of management. This helpsto ensure that a greater level ofthought and justification is given tospending such substantial funds andreduces the temptation to ignore theless exciting integration, cultural andkey people issues after the deal iscompleted. It also provides a higherlevel of defense for board membersthat they acted in the exercise of theirreasonable business judgment. Thepursu i t o f the r igh t eva lua t ionproce ss is a ho ard 's bes t defenseagainst litigation, as it demonstratesdeliberation and analysis performedby independent experts.

In the past, fairness opinions havebeen used as a defense to provide pro-tection to board members regardingthe price paid for an acquisition. Thisarea is now also under review, withthe National Association of SecuritiesDealers (NASD) conduct ing aninquiry into fees, methods and possi-ble conflicts of interest, as the invest-ment bank rendering its opinion isfrequently the same one with a size-able success fee riding on the outcomeof the transaction. As a result, in orderto provide the protection boards areseeking, they should ensure fairnessop in ions a re independen t andaddressed to the board itself.Director Risk and Liability At StakeDirectors are expected to avoid con-flicts of interest, keep themselvesinformed and have a reasonableanalysis of a proposed transaction. In

in other material matters affecting acompany, the board should alwayskeep in mind its duty of loyalty andduty of care, comments Dennis White,an attorney with the Boston office ofMcDermott Will & Emery LLP.To disch arge its duty of care, a

board will generally avoid being sec-ond-guessed by a court if the boardmembers follow the so-called "busi-ness judgme nt rule" that is, theyfollow a process that is deliberate andthoughtful and in which they ask theright questions. "One hour 'quickie'meet ings are genera l ly v iewed aslargely rubber-stamp exercises andcan be downright dangerous for aboard m ember," says White.At a minimum, it is likely for

defensive purposes that board mem-bers wil l want to document the irdeliberations and analyses of suchareas as: strategic rationale for thetransaction, other acquisition alterna-tives explored and why this potentialt a rge t i s mos t advan tageous , duediligence process and findings, valu-ation and support for projections,suitability of the financing structureb e i n g a d o p t e d , p o s t - a c q u i s i t i o nplans to deliver intended benefitsand plans to address key people andcultural issues.

The board will also want to knowthere are no hidden liabilities (envi-ronmental problems, ERISA noncom-pliance, intellectual property litiga-tion, etc.) that could turn promiseinto failure.Over and above the higher require-ments of good governance, Sarbanes-Oxley legislation has heightened the

level of due diligence for public com-panies and added certain specific duedi l igence requirements . Since theacqu i r ing company ' s managemen twill need to sign off personally on thefinancial statements of the combinedentity after closing, they will want toensure they have the same level ofcomfort about the target's financialinformation as they have of their own.Although acquirers can gain somecomfort f rom representa t ions and

warranties of the seller, these do notreduce management's own personal

also expected to be more involved insignificant transactions gaining anunderstanding of the target's account-ing policies and obligations (includingoff-balance sheet items).In addition, heightened internatcontrol requirements under Sarbanes-

Oxley's Section 404 suggest publicacquirers will also want to integratefinancial reporting processes as soonas possible. Trent Gazzaway, GrantThornto n's national director of Corpo-rate Governance, says the SEC hasoffered some relief on the timing ofimplementation of Section 404 follow-ing an acqu is i t ion . Never the le s s ,developing a compliance im plementa-tion plan covering internal controlsand financial reporting for after thedeal closes is a step towards compii-ance, and is exactly the sort of plan-ning audit committees should be ask-ing to see.

In sum mary , inc reased boa rdaccountability and liability has raisedthe bar on governance and in noarea is this arguably more importantthan in s ign i f ican t acqu is i t ions .Directors are l ike ly to becomeincreasingly involved in acquisitions,inc lud ing eva lu a t ing t r ansac t io nstrategy and post-acquisition integra-tion plan s.It is expected that board memberswill add considerable value to theseareas and will also bring additionalperspective to balancing the risks andbenef i ts of the acquis i t ion . Withknowledge of the board's expandedrole, management should consider itsprepara t ion and presenta t ions forboard meetings. The expanded role of

independent advisors to the board islikely to follow suit, moving wellbeyond fairness opinions into theseadjacent areas. If board members failto gain SLifficient comfort on these keyissues, they may recall a well-wornmaxim: "The best deals are frequentlythe ones that are not done."Ian Cookson is a Corporate FinanceDirector at Grant Th ornton LLP. Headvises clients on acquisitions, capitalraising and the saie of businesses, andcan be reached at iancookson


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M&a Issues Raise the Governance Bar