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M&A Policy: A Board Responsibility

by Diane C. Harris

Editor’s Note: The following article is a result of a speech given by Diane Harris to the 1997 Corporate Directors’ Summit in Toronto on September 25th.

In a survey we did of Fortune 300 companies, we asked the question, “Is there a formal acquisition policy in your company?” Nearly half of the respondents said no a rather shocking number, when you consider the widely cited statistics that only one deal in five lives up to or exceeds original expectations.

In times of crisis, such as an unsolicited takeover offer, or the pressure of a seemingly attractive property in a short fuse auction situation, it is just too late to develop the policies and controls that should have been enacted earlier. It is the board of directors’ responsibility to see that appropriate policies and controls are in place before a bear hug occurs, before shark repellent is needed, before poison pills are swallowed. And the dealmaking policies should not only encompass the obvious areas of mergers, acquisitions and divestitures, but also licensing, joint ventures and other external growth structures (collectively “Corporate Develop­ment Policy” or CDP).

Each board member should ensure that CDP is adequate, on balance, to protect shareholder value, the rights of all constituencies and the viability of the corporation.

There are three major areas for CDP focus: board prerogatives, clarification of management responsibilities (including organizational process, procedures and methods), and controls.

A) Board Prerogatives -are those decisions and rights the board chooses to reserve to itself, usually some or all of the following:

1)  Strategic Plan Approval - most boards require a presentation by manage­ment on the strategic plan and approval by the board. The strategic plan is then a driver for all subsequent mergers, acquisitions and divestitures activities. Usually external growth strategies should be consistent with the strategic plan, and any inconsistent activities should be first elevated for board approval.

2) Deal size hurdles - most board policies specify a transaction level or size, e.g., a dollar amount, at which the board wants to review and approve. Some boards require that any use of company stock also come for approval. Generally, the larger the company, the higher the level of transaction before it goes to the board. We have seen policy levels as low as zero or as high as $20 million.

3)  Sale of company assets - many boards are relatively lenient about management’s exploring acquisitions, but may be very restrictive on allowing management to explore the sale of any company assets without the board’s approval. One client company has a policy that calls for dismissal of anyone who discusses the sale of company assets without having first received the board’s approval. Sometimes such policies are qualified as only applying to the sale of 5% or more of the company. Such a policy reduces a company’s risk that a discussion with another company might result in a negative impact to one of its own businesses, or might attract an unwanted offer on the whole company.

4) Report inquiries - the policy prohibition against selling assets is often complemented by a policy requiring that all divestiture inquiries be reported to the board of directors promptly. A board with this policy is unlikely to be surprised by an unwanted offer. Also, keeping a file of detailed information on such inquiries provides a database of interested parties for future divestitures.

5) Opinion letters - many boards decide case by case whether to require investment banking valuation opinion letters before buying or selling an asset. Board policy in some cases sets the level at which opinion letters will be required, often around the $50 million mark for companies of about $1 billion in size. It is best practice for the board to decide, in advance, the transaction size at which an opinion letter would be required, perhaps adding the language that all management buyouts will require a valuation opinion letter.

6) Takeover defense -boards also must decide what anti-takeover protection will be put in place, if any, such as staggered boards, poison pills, golden parachutes, change of incorporation, or defense retainers.

7) Other - some boards will set other policies such as whether or not stock may be used in deals, what are acceptable dilution ratios, which valuation methods will be required, limits on investment banking fees or requirements for post-deal audits. Sometimes such details are found in detailed procedures and methods.

“Clarifying the process can help dealmakers hone their skills.”

B) Clarification of management’s responsibilities - refers to the policies used to enforce board policies, and to ensure appropriate organizational processes, procedures and methods are in place. Supplementing the board prerogatives, management policies usually focus on three areas:

1) Organizational policies must reflect the board policies, and clarify the responsibilities of officers and other members of management. The CDP will necessarily repeat the elements of board prerogatives in order to ensure that employee’s actions are consistent with board policy company-wide. For example, if a management does not disseminate the policy requiring all unsolicited divestiture inquiries be reported to the board, how will employees know to whom to report the information and how promptly? Further, management may want to set forth its own directives on how an employee should reply to an unsolicited inquiry.

2) Additionally, management policies should reflect the approval processes below board level. For example, will there be an internal management or operating committee to review all transactions, even those not submitted to the board? How often will it meet? How will an employee post an item to the agenda?

Management policies will cover such issues as:

• When should deviations from strategy be elevated? To whom?

• Who will be empowered to contact prospective partners?

• Who will negotiate, and will there be a “qualified negotiator” concept?

• Who will sign off on valuation?

• Who will approve letters of intent?

• Who will approve investment banking fees?

• Who will sign contracts?

• Who will approve deal structuring?

• Will there be an internal champion system?

• When will the board of directors’ approvals be woven into the process?

• How will submission be made to a management committee, and at what stage of the deal?

3) Policy and process must also be reduced to procedures and methods, clarifying who will be responsible for approving, administering and changing the CDP. If a company is expecting to do a number of transactions, either for growth or restructuring, it needs process, procedures, and methods in order to coordinate activities, assure consistency and to streamline an otherwise “red tape” activity. Clarifying the process can help dealmakers hone their skills and provide additional guidance and training. Kinds of procedures include formats for presentation for approvals/signoffs; valuation methods; due diligence checklists, and formats for confidentiality agreements and fee agreements.

“Having appropriate policy, procedures and controls will help to determine whether all realistic alternatives have been considered.”

C) Controls - the directors have a right to expect that the finished work they see in formal presentations is based on healthy policy and practice, that functions well and consistently, not that each case is handled on an ad-hoc basis. Ultimately, however, having sound CDP in place is necessary, but not sufficient. Rules don’t ensure compliance, controls do. And the board needs to assure itself that the controls are also in place by doing most or all of the following:

1) Ask to see the written policies and procedures that assure key policies are appropriately implemented.

2) Insist on early postings from management instead of waiting for a well-rehearsed final presentation. The board’s responsibility, then, is to give early feedback and not wait until the train has so much momentum that it can hardly be stopped.

3) Use questioning designed to bring out the strength or weakness of the underlying strategy system. For example, one powerful question is “What alternative strategies did you reject before making this recommendation?” If management didn’t reject anything else, one has to wonder about the depth of analysis. If management isn’t willing to talk about alternatives rejected, one has to worry about the openness of management. Also, the board should ask, “If this transaction is not approved, what will you do?”, further spotlighting weaknesses in strategic planning.

4) Require a champion for every deal, i.e., a member of top management who will stand up in front of the board of directors and affirm, “I am responsible: I will get the job done.” Personal responsibility is key to successful controls, and to successful deals.

5) Use the post deal audit, at least at the six-month, one year and two year points to make sure that results track commitment.

In reality, a board faced with any crisis begins to deal with the issue long before the crisis, when the decision was first made to have or not to have policies, procedures and controls in place. It is much easier for a board to prevent, or at least deal with such crisis in a company with a well thought-out CDP.

For example, in an unsolic­ited takeover attempt, having appropriate policy, procedures and controls will help to determine:

• if a price is adequate, based on a well-reviewed strategic plan and the company’s own valuation methodology;

• whether all realistic alternatives have been considered, drawing on the experience of many presentations, of alternatives discussed, of understanding the strategic options;

• whether the company should stay independent, based on the company’s own growth opportunities, strengths, management drive, and alternatives.

With the right fundamental CDP in place, the board will be best equipped to deal with a crisis or an unsolicited offer. Having thought through its own policies in a less turbulent time, the board is then free, when most needed, to bring its whole focus to optimizing shareholder value.

Developing a CDP. Who should lead the drive for adequate policy on mergers, acquisitions and divestitures? The survey we did of Fortune 300 companies with a CDP showed that the corporate development department usually develops and administers a CDP. Our experience is that the Corporate Development Officer is well-advised to proactively lead the charge for a CDP, but he or she need not write the policy. A neutral party can stay above politicizing the process and can benchmark a wider industry base of practice, thus allowing the corporate development officer to concentrate more fully on executing the external growth strategies of the company. Whether the CDP is written internally or outsourced, the corporate development officer plays a key role in assisting the board to meet its responsibilities in the M&A arena.

Diane Harris is President of Hypotenuse Enterprises, Inc., an M&A advisory and consulting firm whose services include development of M&A policies for various sized companies (716-473-7799).


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