Category: Corporate Governance

The M&A Litmus Test: Part 5

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We have arrived at the last day of your M&A Litmus test—the most important test of this series. We’ll evaluate your…

…Good Business Sense.

Finally, do your directors really understand your business—and business in general, as in, “I am selling a bolt of cloth, let’s make a deal?”—or are they in compliance mode, focusing on this, that, or the other rule?

Doing a good job in M&A oversight really does come down to good business sense. The late, great J. Fred Weston, a mentor of mine, once boiled reasons for M&A down to ten.  One of them is to increase the size of a company and therefore increase the power and pay of managers—never a good reason for M&A. But the other nine reasons make good common sense. In closing, I’ll share Fred’s list with you now.

Ask yourselves if the merger will:

  • Achieve economies of scale by buying a customer, supplier, or competitor (“operating synergy”)
  • Accomplish strategic goals more quickly and more successfully (“strategic planning”)
  • Realize a return on investment by buying a company with less efficient managers and making them more efficient (“differential efficiency”)
  • Realize a return by buying a company with inefficient managers and replacing them (“inefficient management”)
  • Increase market share (“market power”)
  • Lower the cost of capital by smoothing cash flow and increasing debt capacity (“financial synergy”)
  • Take advantage of a price that is low in comparison to past stock prices and/or estimated future prices, or in relation to the cost the buyer would incur if it built the company from scratch (“undervaluation”)
  • Assert control in an underperforming company with dispersed ownership (“agency problems”)
  • Obtain a more favorable tax status (“tax efficiency”)

All these come down to this: Will this transaction work for our company?

So, with these five items in mind – M&A IQ, Fiduciary Duties, Strategy, Information Flow, and Good Business Sense – let me ask you: Will you pass the M&A Litmus Test?  It’s an important question.  Don’t cram at the eleventh hour. Start studying now!

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The M&A Litmus Test: Part 4

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Today is the penultimate day of your M&A Litmus Test, so we’ll continue by testing your board’s…

…Info Flow.

How good is your information flow? For the board, knowledge is not merely a source of power; it is the very key to effectiveness. The following wisdom is adapted almost verbatim from the Report of the NACD Blue Ribbon Commission on Director Liability.

When it comes to M&A information, flow is critical.  The type, quantity, format, timing, and source of the information that fuels board knowledge will vary from board to board and will also change over time for a particular board. It will also vary among board members, who have different levels of experience and expertise with different topics.

Information flow is critical for directors with respect to capital allocation decisions—in particular, mergers and acquisitions. This area requires special attention to the long-term interests of the corporation and the ways in which management’s interests may affect transactions. As the report noted, the board and management need to regularly discuss the opportunities for and threats to the company, even in the absence of any planned or foreseen transactions, so that directors have an understanding of the business context in which these issues may arise.

Depending on the size and business context of the company, notes the report, directors should periodically receive information related to, and discuss with management, the following:

  • Comparative studies and analysis concerning whether the company would be more viable by merging with, or entering into alliances with, another candidate, or standing alone;
  • Possible acquisition candidates. When discussing the fulfillment of certain of the company’s business strategies, such as entering into new lines of business, directors should receive information on possible alternatives, such as an acquisition or strategic alliance, to achieve the same objectives; and
  • The merger activity of competitors, including the impact of recent activities on the company’s market share. Competitive analysis as to other suitors for the same potential acquisition candidates might also be warranted.

Maintaining an up-to-date understanding of these issues will help directors to remain prepared for the time when management actually proposes a transaction. This is particularly critical for directors of public companies, who should understand the company’s plans and legal options for responding to unsolicited takeover offers.

In evaluating a particular transaction, notes the Report, directors should seek specific information about the price, timing, and certainty of the transaction, and should be proactive in overseeing negotiations. Directors should understand how the transaction will be financed, and the projected financial impact on the company under reasonably likely scenarios. Where the sale of the transaction warrants it, directors should seek independent financial advice from outside experts to consider together with management’s financial assessment.

Directors should also obtain a high-level analysis of the merger documentation, including an understanding of the most important representations, covenants, and indemnities contained therein and their application to the company and the transaction. In addition, directors should receive input from market and investor relations experts about the best manner in which to position the transaction and the likely reception from investors and creditors. As with any other matter before them, directors should crucially evaluate all the information they have obtained and arrive at an independent assessment instead of relying exclusively on management’s views.

Directors should also be alert to differences between management and shareholder interests in negotiating a particular transaction. For example, shareholders will be far less interested than managers in knowing who will continue to work for the merged company and with what responsibilities. These employment issues are important but they should not override concerns about long-term returns to shareholders.

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The M&A Litmus Test: Part 3

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Today is Day Three of your M&A Litmus Test (three down, two to go!), so we’ll continue by testing your sense of…

Strategy.

Does your board know its role in strategy? NACD has been emphasizing the importance of board involvement in strategy since time immemorial.  Most recently, NACD, with the help of wise counsel (thank you, Ira Millstein and Holly Gregory of Weil Gotshal), boiled down governance guidance from boards, shareholders, and management into ten Key Agreed Principles, including Principle VII: Attention to Information, Agenda & Strategy. We declared that “Governance structures and practices should be designed to support the board in determining its own priorities, resultant agenda, and information needs and to assist the board in focusing on strategy (and associated risks).”

So true! The Report of the NACD Blue Ribbon Commission on the Role of the Board in Corporate Strategy provides specific guidance:

 

  • Boards should be constructively engaged with management to ensure the appropriate development, execution, and modification of the company’s strategy.
  • The nature and extent of the board’s involvement in strategy will depend on the particular circumstances of the company and the industry in which it is operating
  • While the board can—and in some cases should—use a committee of the board or an advisory board to analyze specific aspects of a proposed strategy, the full board should be engaged in the evolution of the strategy
  • Moreover, strategy development should be a cooperative process.
  • Management and the board should jointly establish the process the company will use to develop its strategy, including an understanding of the respective roles of management and the board.
  • Management and the board should agree on specific steps for strategy development.
  • To participate effectively in the strategic thinking process, boards should be prepared to ask incisive questions—anticipating, rather than reacting to, issues of major concern.

So, what does this have to do with M&A? Here’s your answer (with help from the McGraw-Hill M&A Series that yours truly coauthors).

Buy Strategy

By being actively engaged in the formulation of strategy, boards will typically already have some involvement in considering possible acquisitions, since all acquisitions should be consistent with a company’s strategy.

The extent of the board’s involvement in a proposed transaction (for example, questions of disclosure, financing, pricing, structuring, and due diligence) will vary depending on the size of the acquisition and the risks that it may pose. If a very large company regularly buys small companies in its industry and has already developed a process for finding, acquiring, and integrating these small transactions, boards don’t have to focus on the details of any particular transaction. They can and should, however, periodically review the entire merger process, from strategy to integration, in the context of strategy opportunities, attendant risks, and operational implications, to make sure that the process is working.

Sell Strategy

Selling is a big decision, whether or not a company is private or public. Back during World War II, my dad founded a research company, which he sold after twenty years for one million dollars—in paper. The disastrous experience forced him to launch the publication, Mergers & Acquisitions, in 1964—and it’s still going strong. For public companies, the negotiation is even more critical, involving not only an entrepreneur’s wealth, but a host of fiduciary and disclosure considerations.

The board of directors of a public company being acquired via a tender offer must be mindful of its fiduciary responsibilities under state corporate law. Traditionally under state law, as represented by Delaware law and the Model Business Corporation Act, the directors’ fiduciary duty is to shareholders. In the landmark case of Revlon Inc. vs. MacAndrews & Forbes Holdings, Inc. (1986), the court described the role of the board of directors as that of a price-oriented “neutral auctioneer” once a decision has been made to sell the company.

Whether buying or selling, don’t let M&A transactions trigger micromanaging on the part of the board. Directors can help management achieve greater effectiveness. Individual board members may have expertise in various phases along the M&A route, and can help improve the process. Management would be wise to take full advantage of this expertise on an as-needed basis. Major transactions merit formation of an independent committee of the board to analyze the value of the transaction with the help of an independent third party, who can render a fair opinion. But don’t leave valuation up to the experts; boards can take an active role in determining the value of the company they are buying or selling. A great source for that knowledge is the Report of the NACD Blue Ribbon Commission on Performance Metrics, co-chaired by John Dillon and Bill White. Also, there are numerous good books on corporate valuation. (I know because I just coauthored one with Bob Monks and the worthy competition could well kill us!)

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