The role of the board in M&A
June 2019 | FEATURE | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
June 2019 Issue
M&A is an important weapon in any company’s arsenal; it can generate growth and increase shareholder value when done properly.
While historically M&A may have been driven by a company’s chief executive or chief financial officer, today it is essential that board members play their part and provide input on whether an acquisition is in the best interests of the company and its shareholders.
Important factors such as the company’s strategic direction, potential opportunities and obstacles, current industry-specific M&A trends, the company’s vulnerabilities and the demographic and other holdings of the company’s shareholders, must also be taken into consideration.
Importance of M&A
Whether to pursue a deal is often one of the more momentous – and scrutinised – decisions a board will make, particularly if it is deciding whether to sell the company which may crystalise the value of stockholders’ investment. Deals can fail. Managing a transaction requires significant resources and experience, and a failed deal can impose economic and reputational costs on acquirers and targets. So it is vital that companies, and their boards, get M&A right. “It is incumbent on the board to do what it can to maximise value for stockholders,” explains Paul M. Tiger, an M&A partner at Cleary Gottlieb. “Even on the buy-side, there seems to be a growing sense among the professional director class that M&A is one area where boards can get it really wrong – a bad deal can be crippling for a company; a good deal can unlock a lot of value.”
The role of the board is constantly evolving. Beyond simply providing conventional governance, boards are now involved in strategy development, talent management and shareholder relations. “The board’s oversight over the company’s business and affairs has been part of the fabric of corporate law and corporate governance for centuries,” says George Casey, global managing partner at Shearman & Sterling. “Delaware law, for example, says that the business and affairs of a corporation ‘shall be managed by and under the direction of a board’. The oversight role is essential as a link between the shareholders and the company’s management. With respect to M&A, the main focus over the years has been, not surprisingly, on the board’s role in a sale of the company. More recently, however, shareholders have focused more and more on the boards’ role in buy-side transactions. Partially, this was driven by a general emphasis on stronger corporate governance, partially by growth in shareholder activism and shareholders’ focus on the effectiveness of companies’ management, and partially by some very visible failed acquisitions.”
Evolution of the board
Today, the board has an important role to play in setting strategy, monitoring corporate performance and management, overseeing risk management, counselling the CEO on the most difficult challenges facing the business, championing good governance and offering constructive criticism on the company’s operations. Many of these tasks are applicable to M&A where the board must offer oversight and governance. Though deals are typically proposed by the senior executive team, the boards of both the acquirer and target must decide whether a potential transaction can proceed beyond an initial exploratory phase.
Clearly, the board’s involvement in any deal should begin well before it appears imminent and last until well after completion. For this beginning-to-end cycle to be successful, the board must adopt a holistic approach, undertaking a strategy review, risk assessment, due diligence of all varieties, deal approval and post-deal integration. The size and nature of the transaction, however, will have an impact on the board’s activity. “If the transaction is very large or high profile, for example a sale of the entire company, then the board should play a leading role – guiding management, determining key deal terms, controlling the negotiation process and expressing the final say on whether or not the transaction is acceptable,” explains Jonathan Corsico, a partner at Simpson Thacher & Bartlett LLP. “On the other hand, if the transaction is small, it is appropriate for the board to delegate much of that authority to management.”
There is nothing obliging a board to buy or sell if a proposed transaction is not in the best interests of the company and its owners. To that end, the board must carefully weigh an M&A opportunity as part of its corporate oversight. Issues such as whether the target or acquirer is a good strategic fit must be considered. And once a transaction has been completed, it is vital that boards ensure that the integration process is regularly evaluated and well managed. The board should also ask management a series of questions as part of its oversight of corporate strategy, to ensure that the directors agree with how management believe M&A fits into the company’s overall strategy.
Board members must be clear on the drivers and logic of the deal, within the framework of the company’s business plans and growth strategy. They must also be comfortable that the due diligence process will highlight and properly mitigate any issues that might arise. They must be confident that integration and cultural issues are being managed. And the board must clearly communicate its expectations about management’s obligations to inform and involve the board in the M&A process.
Establishing the right level of oversight is a challenge, however, because M&A transactions are relatively infrequent for most companies. As a result, the board and senior management teams may not have thoroughly planned out how they should interact during the deal. Where transactions are complex or difficult, the board should expect senior management to assume responsibility for a number of areas of the transaction and regularly report back at various stages of the due diligence process, as well as on the progress of the integration strategy after completion. “The board and management play fundamentally different roles,” says Mr Corsico. “The board is the ultimate decision-making body responsible for the transaction as a whole. Management acts at the discretion of the board, and all of management’s authority flows from the board. Thus, even though the board may choose to delegate significant authority to management, the board retains final decision-making authority and control.”
As Mr Tiger notes, although the board often acts on the recommendation of management, they cannot take the guided tour or delegate decisions entirely. “The directors need to make sure they are informed, they need to test management’s assumptions, evaluate company strategy, consider potential conflicts – whether of the board, management or the company’s advisers – and have conviction around the right course of action,” he says.
When engaged in M&A, the roles of the board and management need to be respected or the company will not be able to function effectively. “The board is responsible for the company’s overall business strategy, and appoints the company’s management and delegates to the management the authority to run the business on a day-to-day basis in implementing the strategy,” says Mr Casey. “Buy-side M&A has to fit the same matrix. It is the management’s role to look at acquisition opportunities and see which ones it can recommend to the board, and it is the board’s responsibility to make sure that acquisitions fit the overall company’s strategy. The board needs to understand the dynamics of the industry and the ever-changing business environment, and as a steward of shareholders’ capital, make sure that each transaction fits the overall strategic vision and allows the company to grow for the benefit of shareholders. Given the amount of investment that goes into M&A deals and the impact, either positive or negative, a transaction may have on the company overall, M&A requires more attention than routine day-to-day business issues that would not rise to the same level of magnitude.”
Going forward, the role of the board will continue to evolve and board members must be able to move with the times. “In general, boards have become more and more active over the last 10-20 years, across all aspects of business,” explains Mr Corsico. “This same trend holds true in M&A, and I would expect boards to continue to be active and even become more active in the future.”
However, the emergence of activists, including certain hedge funds, for example, has changed the dynamic in many boardrooms. From outright acquisitions of companies to forced divestitures and spin-offs, activists are heavily influencing M&A decisions. This trend is occurring not only in the US, the historical home of activist investors, but across Europe and other markets, as pressure for increased returns and competition continue to drive greater investor involvement in high-level decisions.
Responding to activists is just one challenge boards must contend with as their role continues to change. Ultimately, when pursuing a deal, the board must fulfil various functions. Though there is no ‘one size fits all’ approach to M&A, boards must be constructively sceptical about the M&A process. They must ask: Why are we doing this? Who is responsible for certain tasks? How will the company’s existing stakeholders benefit? “A board can add a lot of value by pressure-testing assumptions and asking the tough questions of management and advisers to determine if the risks posed by a deal are manageable,” says Mr Tiger. “Is this the right fit for our company, our strategy, our brand? What can go wrong? What risks do we see in integration or executing our strategy here? Are the synergies achievable or ‘pie-in-the-sky’? What risks are we overlooking? Were there scope limitations in our diligence? Have we priced in or otherwise addressed the known risks we found in diligence? If boards do not ask the tough questions, you can bet plaintiffs or other stakeholders will.”
Deal risks fall into several categories, according to Mr Casey – some of which are more intuitive than others. “Of course, due diligence and valuation come first,” he says. “A deal where no stone was left unturned, where the potential upside and challenges, and benefits and liabilities, are fully understood and reflected in valuation has a much better chance of being successful. Going beyond the basics, the company needs to think ahead, and the board needs to ask difficult questions, about an integration plan, how realistic the synergies are, and as importantly to think whether the two cultures will be able to merge into one. Disappointment in an acquisition often comes when a buyer did not have a fully developed view of what life will be like after the closing celebration. Success, on the other hand, comes when a buy-side team, with the board’s guidance and oversight, is disciplined both in the transaction process and in planning ahead and, most importantly, as dealmakers say, ‘does not fall in love with the specific asset’.”
Ultimately, the board must understand the deal structure, motivations and terms, then provide the right advice and perspective to senior management, to fulfil their principal responsibility of protecting and enhancing stockholder value.
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