June 2018 Issue
During a transaction, a company’s chief financial officer (CFO) will be a central figure. Though the chief executive is often the focal point of a company’s operations, the CFO will share with the CEO the key responsibility for driving a deal forward in his or her capacity as the foundation of the company’s financial function. “The CEO is responsible for both sides of the deal equation – risk and reward – and needs a strong CFO to validate the profitability thesis of the deal and help evaluate the risks,” says Frank D. Chaiken, leader of the corporate & transactions practice group at Thompson Hine.
In order for the dealmaking process to be successful, the relationship between the CEO and CFO must be strong and flexible. Over time, the CEO-CFO axis has evolved, becoming arguably the most important relationship in any organisation. This is particularly true for companies entering a merger. The relationship between the CFO and the CEO must be built on trust, collaboration and a shared view on how to move the company forward. “The CFO must understand when and on what issues to get the CEO involved,” says William Schult, the former CFO at Pro Mach Inc. “The CEO must learn to rely on the CFO to quarterback the dealmaking process. As in any other relationship, trust develops over time.”
As important as the CFO-CEO relationship is, however, the CFO must be able to stand on his or her own, particularly when a company is cycling through the transaction process, from due diligence onward. Typically, a buying company’s CFO is charged with managing the deal’s potential risks, and during the due diligence process the CFO must pay particular attention to quality of earnings, liability and financial reporting risk that will impact the target’s reported performance. “Are revenues being properly recorded at the correct time, are all required liability accruals being made to give a fair presentation of results, have all applicable taxes been paid or accrued and will any of these items have to be reported differently under the buyer’s prevailing accounting practices?” asks Jim Abbott, a partner at Seward & Kissel LLP.
Ultimately, how CFOs perform their role during a deal can determine its ultimate success or failure. “In diligence, the CFO must be aware of all streams of diligence and must consider and advise how they impact the company, especially in relation to the credit agreement,” says Mr Schult. “In particular, the CFO directs and guides any internal resources or external advisers in the financial and tax diligence areas, especially relating to levels of work to be done, assumptions to be made in pro forma financial statements, and awareness of findings that should be covered in the purchase agreement.”
Before the company begins to move through the acquisition cycle, however, the CFO has a key role to play in identifying targets, by establishing guidelines and benchmarks for the corporate development team to use in the vetting process. “These guidelines might include both positive criteria, such as sources of existing value, as well as negative. The most critical factors to identify are potential risk, hidden value and opportunities to increase profitability without damaging the unique qualities that made the business an attractive target in the first place,” says Mr Chaiken.
CFOs also need to be able to ask difficult questions before a deal is struck. Companies must determine if and how a proposed deal will materially help it achieve its long-term objectives. The CFO must also evaluate whether a target will integrate smoothly and efficiently, and whether synergies can be realised. “Among the most important role of the CFO in dealmaking is the integration of the target into the company,” affirms Mr Schult. “It is no longer just about adding up the numbers, but truly integrating the business into the company and taking advantage of synergies, both tangible and intangible.”
The CFO is critical to a successful deal, from target valuation to assessing target financial quality of earnings to identification of financial synergies to post-transaction integration. Being certain that financing is available, and that the company’s financial covenants will be complied with or can be amended or waived, is a go-or-no-go issue.
The CFO should also develop the business cases and financial models for proposed acquisitions, as well as the transaction agreement, according to Mr Abbott. “The CFO must specifically give important input to the drafting and negotiation of aspects of the definitive transaction agreement within his or her scope of responsibilities, including financial statement representations, working capital and other purchase price adjustments and earnout provisions,” he adds.
Getting M&A right is a challenge, particularly in the current climate of high valuations and stiff competition. An adept CFO can make the difference between a successful deal and an M&A disaster.
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