controls in place, directors will be well-positioned to contribute to
meaningful face-to-face discussion during the approval process.
(Although telephonic meetings can advance discussions, they should
only be used when real, substantive discussion with other directors has
already taken place face-to-face.) Board
meetings should not be a rehash of the pre-submitted materials.
They should provide a means for directors to elucidate what is
written between the lines, and to create discussion leading to better
board decisions. Directors can test the thinking of the deal team, not just
the data. A sampling of such
Is this proposed
transaction consistent with the company’s vision/mission statement?
Variations: How does
this deal achieve our strategic objectives? or Why are we doing this deal?
often, deals have a life of their own, arising opportunistically and
acquiring momentum through the sheer effort of the team executing the
transactions end up not being what was originally envisioned. A fundamental question is the “why” of the transaction,
and might include the following follow-up inquiries:
What alternative strategies
(to achieve the subject mission/vision) were considered and rejected? If the management team did not consider any real alternatives
about which they can speak knowledgeably, a director might conclude that
depth of strategic thought is lacking.
If this transaction is not
approved, what will happen? How
will the management team then deal with the issues this transaction is
supposed to address? This
question drives deeper into the strategic fit.
The fewer alternatives management has, the more compromised it will
be in negotiating the best terms for the corporation.
If a competitor were to step in
and pre-empt this transaction, what alternative would the management team
then pursue? This question
not only probes alternatives, but also usually leads to meaningful
discussion on how the competitors may respond.
In one case, the customers wanted to buy from at least two
different companies, for supply security reasons.
Thus, upon merger of two companies in the industry into just one
company, the customers needed to begin buying from a third competitor,
creating lost sales (negative synergies) for the acquirer.
Who is the deal champion –
and is he or she responsible for making sure the value is realized?
The chief champion of
the transaction should also be the person most responsible for executing
the post-deal integration plan and for achieving the forecast upon which
the valuation is constructed. This
person should be someone who will benefit from the transaction’s future.
The “deal champion” should be visible, presenting the proposal
to the board and asking for approval.
In more successful transactions, the deal champion is an operating
person with power to command resources to deliver the results.
For the largest transactions, the CEO is the champion.
(Note also: Each deal should have one chief champion since diluted
responsibility is no responsibility.)
Some related questions might include:
What is the previous deal
track record of the champion, and does he/she deliver on promises? A champion who has already successfully delivered on prior
transaction commitments is more likely to deliver again.
Is the deal champion likely
to stay in the current position for at least two years while the deal plan
is executed? It takes
about two annual cycles of the financial plan to determine success.
A successor does not have the same personal commitment as the
champion who asked the board for approval.
What kind of incentive
system is in place to drive the champion and his or her team toward
success and how important is this particular transaction to the
champion’s overall compensation?
A small acquisition by a large operating unit or a small percentage
of overall compensation tied to deal success is unlikely to create enough
motivation to spur achievement of the plan.
Another demotivating factor may be a failure to connect post-deal
success and compensation. Of
course, if compensation is tied only to an increase in revenues, rather
than real growth in company value, such a connection may be
much is this transaction really worth?
And how do we know that?
Although paying a few
percent more or less is not usually the difference between success and
failure, the board is obligated to ensure the price is fair to their own
shareholders. Questions about
transaction value and price focus on whether or not the analysis is
rigorous and driven by discounted cash flow concepts rather than
negotiating exigencies. Associated
Who did the valuation and
how does the valuation methodology differ from the company’s standard
valuation methodology? What
are the underlying assumptions? The
assumptions used in a valuation should be clearly specified.
A board of directors should be rightfully skeptical if valuation is
prepared by anyone who is compensated on the basis of transaction price. Similarly, if a discounted cash flow horizon of, say, seven
years is suddenly used when five years has been policy, the board should
be alerted and ask for explanation.
What part of the valuation
depends on capturing synergies? The
best practice regarding synergy is to first value the target company on a
stand-alone basis, then to identify and value each synergy separately,
with appropriate probabilities. For
example, synergies driven by market growth are less likely to be achieved
than cost-reduction synergies. Each
synergy has a different probability of being achieved.
What is the time table for
achieving the synergies? Directors
should be wary of synergies promised for a relatively distant future.
The more distant that future is, the less controllable it will be.
A careful approach only recognizes value for what can be
implemented within the first year. After
the first anniversary of a transaction, it is difficult to implement
synergistic changes. Of
course, all future synergy flowing from the first year implementation is
recognized in the year in which it occurs.
exactly, is the proposed deal structure?
Directors should not be intimidated by complex deal structures. Complexity may indicate that there are serious transaction
problems that are being handled by excessive structuring.
Sometimes, a director will assume he or she is the only director
who “doesn’t get it” and, relying on others’ expertise, may avoid
asking further questions on a complex deal structure.
Instead, management’s inability to explain the structure and its
rationale clearly may be evidence that they do not fully understand the
deal either, or worse yet, that they want to hide their interests in the
What alternative deal
structures were considered and why were they rejected? This
question sheds light on the dealmaker’s thinking and tests against the
goals to be achieved; e.g., would it have been possible to license the
technology in lieu of buying a company?
What contingencies have been
built into the deal structure? In
structuring a transaction, dealmakers may minimize risk/cost and/or
maximize returns by altering the timing or source of payments, or by
ensuring the receipt of the payments against certain contingencies.
Buyers can minimize risk in a transaction by making part of the
purchase price contingent upon realizing certain value-creating events or
avoiding specific value-destroying events.
Directors should ask about (and understand) escrows, earnouts,
“holdbacks,” milestone payments, indemnifications, and the like, all
of which may be used to minimize risk and maximize the net value that will
ultimately be achieved from a transaction.
What were the key
negotiating issues and how were they resolved?
Understanding the major points of contention between the parties
enables a director to better comprehend the compromises that were made.
This question probes the balance of power in the negotiations.
are the key due diligence issues and how is each being resolved?
Very few transactions
occur without the discovery of some significant issues during due
diligence, such as a patent being less defensible than previously hoped,
or unresolved litigation that is difficult to quantify, or unpaid taxes.
Solutions might include valuation adjustment, re-structuring,
indemnification, or even special insurance.
Directors should ask what key issues were found and how they were
handled to test the depth of management knowledge and involvement.
Related questions include:
What did you find in due
diligence that surprised you the most about the target company’s
management, products, customers, technology, markets, finances, etc.?
Surprises, by their very nature, are not implicit in the
assumptions used in the preliminary valuation and will usually require
adjustment. Discussion can
shed light on how the acquiring team dealt with such surprises.
Are there any liabilities to
be assumed by the buyer not specified on the balance sheet?
Management should identify any liabilities being assumed that are
not on the balance sheet. A
good M&A policy will specify this, and, to reinforce the policy,
directors should ask the question specifically.
What involvement have
outside bankers and consultants had in the due diligence process and how
much reliance is being placed on their opinions?
Once the deal is completed, consultants can walk away.
Bankers usually are conflicted by being incentivized on transaction
completion. Due diligence
services from the same auditor who will later give an opinion on the
financial statements of the combined company may also create a conflict. Is the deal champion fully sanctioning the third-party
opinions and are those opinions reliable?
How is the value of this
transaction going to be realized? What
is the post-deal integration plan?
Best practice is
having the full post-deal integration plan in place before a final board
approval is given (or at least before closing takes place.)
In the 2001 survey of the Fortune 1000, 47 percent of
respondents require such a plan. The
board should ensure that the M&A policy requires an integration plan,
and that for each transaction the integration plan is implemented.
Related questions include:
Is every synergy in the
valuation also incorporated in the integration plan?
It is not unusual to find millions of dollars of synergies
projected in the valuation, without any corresponding implementation of
those synergies in the integration plan.
Those synergies should be dropped from the valuation and from the
calculation of expected internal rate of return.
What does the deal champion
consider the probability of achieving the integration plan?
If the probability is less than 100 percent, the valuation should
also have been adjusted to reflect the lower probability. If it is much less than 100 percent, the company may be
overpaying, or the deal champion not fully committed, or there may simply
be too many tasks and too few people to execute.
What parts of the
integration plan are most vulnerable and what is the backup contingency
plan for those items? The
backup plan should contain a time schedule – when a particular course
would be abandoned and the contingency plan put in place.
The deal champion should be responsible, regardless of whether the
original plan or the backup is implemented.
A policy alone is not
fail-safe; it still depends on rigorous review by the board of directors.
And the only way that the board’s questioning ultimately has
meaning is through an audit of the results.
The post-deal integration plan should have commitments that can be
tested at six-month, one-year, and two-year anniversaries. At a minimum, the audit should include tracking whether the
commitment forecast upon which the valuation was based was achieved,
whether the key synergies were delivered, and whether the key milestones
such as closing a plant, reducing employment, introducing a new product,
or refinancing a loan were met fully, and on time.
The reward for the deal champion should then parallel the success
of having achieved the value and strategic intent for which the board
approved the transaction.
through the post-deal audit process, is the foundation upon which rests
management’s credibility in proposing future transactions.
Boards do not need to accept that half to three quarters of all
deals fail. Best practices are known, and need not be reinvented.
Finally, the board might also ask itself:
“Are we reviewing proposed transactions in a manner that enhances
the opportunity for success?”
initiatives should not be viewed separately from the remainder of good
corporate governance, or be exempt from controlling policy.
Reading the materials supplied by management, listening attentively
to the investment banking presentations and posing questions in one’s
own “hot button” areas of interest may fall short of finding the deal
issues that make the real difference between success or failure.
the right controls in place and by asking the most relevant questions,
even directors who lack significant M&A experience can contribute to
successful M&A initiatives.