August 10, 2021
August 10, 2021
“No one ever says, ‘We did too much diligence, we knew too much about what we bought,’” says Steven Epstein, partner and cohead of mergers and acquisitions (M&A) at Fried, Frank, Harris, Shriver & Jacobson. In this spirit of digging deeper into M&A, NACD in mid-July partnered with Alvarez & Marsal; Deloitte; Fried Frank; and Meridian Compensation Partners to convene the Leading Minds of M&A panel discussion and answer audience questions on the board’s role in deal-making.
In addition to Epstein, subject-matter experts who composed the panel were William Engelbrecht, principal at Deloitte and leader of Deloitte Consulting’s M&A and restructuring strategy and diligence practice; Colin Harvey, managing director with Alvarez & Marsal’s corporate performance improvement practice and national solution leader for the practice’s Corporate M&A Services; Ryan Harvey, partner at Meridian Compensation Partners; and Donna Zarcone, director at CDW Corp., Cigna Corp., The Duchossois Group, and Quinnox. Here, we include select answers to questions posed to panelists by moderator Christopher Y. Clark, NACD senior director of partner relations and publisher.
How are deals different after the past 18 months?
Colin Harvey: What’s expected in due diligence during the evaluation phase is expanding rapidly and the complexity of integration is continuing to increase. The pandemic gave people a crash course in values. People are willing to act on their values and opportunities to do so are increasing; this brings a real democratization of the workforce. Translating this to the M&A process, assimilation is probably not a durable strategy. Boards should be looking for their management teams to consider people and culture as a formal portion of the due diligence process. You’ve got to be looking at who you’re buying and what’s unique about them, and asking, “Can we live up to the values of what we’re acquiring?” You have to keep a lookout for the external perceptions of both the buyer and the seller. What’s in motion with both companies from remote work to global recruiting to diversity and inclusion? Businesses need to make sure that they’re preparing clear, crisp messages on both sides of the transaction.
Does corporate purpose have a place in M&A transactions?
William Engelbrecht: In a recent survey we led with the NACD, we found that at least 30 percent of directors believed that corporate and social purpose and culture were becoming emergent issues that boards needed to address. When you think about the synergy that can be created when purpose is aligned between two merging companies, the outcome can be greater than the sum of each company’s parts. That is derived from having better alignment around the impact of purpose that that combination can create. As a result, boards should understand where purpose aligns in M&A transactions very clearly.
How can directors ensure that they draw the line between the board’s and management’s responsibilities when it comes to M&A deals?
Donna Zarcone: How important and material the acquisition is to the overall strategy will change the level of board oversight. With a game changer acquisition, which I recently went through with one of my boards, we were at a much higher level of detail on the key metrics than if it were just a smaller, bolt-on deal. Every board meeting, we had a progress update by the project manager, with full access for us to have a dialogue with him. If you don’t understand what’s going on, how can you truly support management and the pivots that they may have to make? The key to success is how quickly you recognize problems and then make those pivots, and how you document what you’re learning so that you can build that corporate muscle as you do more acquisitions. Also, getting help from experts on the rules and regulations that you may be stepping into is important. On one of my boards, we added a new committee for compliance, because we knew that it would be a key area of focus for the acquired company. It’s still oversight, not running into management’s life; but it’s putting in the processes to be able to do that oversight well.
You’ve probably heard the line that all boards should act like private equity boards. Do you agree?
Steven Epstein: Boards need to consider the perspective of an activist or a private equity owner as they evaluate how their companies are performing within the broader industry. By considering the perspectives of these types of investors, boards enhance their accountability framework. Simply looking through the lens of an activist with respect to certain issues does not mean boards are abandoning a focus on long-term shareholder value—quite the contrary. When board members consider what is in the best interests of stockholders on a long-term basis, directors are right to ask questions such as: How are we deploying capital? Do we have the right capital structure? How active is our M&A pipeline and what is the success rate of our prior deal activity? Should we be returning cash to stockholders or do we have a better way of deploying that cash? These types of questions must be considered on an ongoing basis. Boards shouldn’t wait for an activist—who knows a lot less about the company than management—to be the catalyst for these inquiries. Pressure testing the senior management team is very much within the purview of the board, and I don’t think addressing these considerations is irreconcilable with the notion of making long-term investment decisions.
What are the key executive pay issues in an M&A transaction?
Ryan Harvey: It is easy to get overly focused on the tasks and projects required of a deal and lose sight of the overall executive compensation mission of the board: maintaining a stable, talented management team, motivated and focused on the objectives of the company through the transaction. There are three key areas that typically support this mission in an M&A transaction: existing compensation elements, severance protection, and special incentives. The foundational area of focus is compensation already in place (i.e., cash incentives, equity-based compensation), and how they will be treated in a transaction. Many of the decisions around how compensation will be treated in a merger are already built into the design of existing incentives, so this is an important issue to address well in advance of commencing a transaction. The key principle here is to maintain existing incentives and retain performance alignment to the extent possible through the transaction. Severance is also foundational and supports the mission of maintaining a stable, focused management team. When structured properly, severance protection will keep the management team neutral to job loss during a time of significant uncertainty. The third element of special incentives is not always needed. If existing compensation is treated appropriately and adequate severance protection is in place, those two elements alone will often provide the support for maintaining a stable and focused management team. The most common special incentive is the retention incentive that provides an award of cash or stock if the individual remains employed through a specific date. This is very useful in locking in talent for a short period of time, but provides no performance alignment. Generally the best approach to retention incentives is to keep them focused on the most critical individuals who are at greatest retention risk—and keep it simple.
What was an unexpected challenge you’ve faced in supporting an M&A transaction?
Engelbrecht: I worked with a client that put together a deal model with a reasonable synergy forecast. Unfortunately, they did so without outlining a concrete plan for how to get there. It became a very difficult task to define how and where the organization was going to capture synergies. Ultimately, we did capture those synergies, but the lack of a plan led to extensive synergy planning sessions that challenged the leadership team. Focusing on due diligence to really substantiate what they thought they could get from a synergy perspective would have avoided substantial strain on the leadership team and accelerated value realization.
Epstein: Diligence. No one ever says, “We did too much diligence, we knew too much about what we bought.” Nonetheless, while everyone knows it is critical, the diligence process is often short-circuited by buyers, particularly in auctions for attractive assets. When sellers say, “You’re asking too many questions,” or “Do you really need more site visits?” that’s when a lot of acquirers capitulate. Sometimes that’s appropriate, but at times the decision to shortcut diligence can result in costly errors and unwelcome surprises. Maintaining transactional discipline and striking the right balance between a thorough diligence process and moving quickly is vital to excellent deal execution.
How should the board determine the futures of directors at the newly created company?
Zarcone: There must be negotiations during the transaction over how many of the board members from the acquired company will join the new cohort. In a recent situation on one of my boards, we went through an interview process to see who would come over. We put members from the acquired company’s board into committee chair roles to make it clear that the companies were blended. You have to look at the overall strategy, then put together a matrix of skill sets to figure out who fits in where.
C. Harvey: You need to take the attention to culture all the way up to the top of the stack, because even if you figure out the right folks to keep, board seats are a position of high attrition a couple of years later. Where do the members fit, where do they add value? Have a process for selecting them, but also have a process for integrating them into the new board.
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