Guiding light: effective board oversight of M&A

January 2023  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

January 2023 Issue

Once merely a figurehead and rarely taking an active role in corporate activities such as M&A, a board of directors is a different animal today, overseeing the M&A process to a fundamentally greater degree.

Dictating this sea change is the vastly more exuberant M&A dealmaking environment seen in recent years – a market driven by a number of factors, including supply chain resilience, portfolio optimisation, environmental, social and governance (ESG) issues and the increasing digitalisation of business models.

Moreover, despite M&A activity having slowed throughout 2022 from its record-setting pace of 2021, according to PwC’s ‘Global M&A Industry Trends: 2022 Mid-Year Update’, activity levels over the past 12 months have merely reset to pre-coronavirus (COVID-19) pandemic levels and remain significant.

“The approach to dealmaking will require a new focus in an uncertain economic environment,” believes Brian Levy, a partner at PwC. ‘Now is not the time to sit on the sidelines, but to reassess – even reset – M&A strategy. I fully expect to look back at 2022 as a pivotal moment where the successful dealmakers of tomorrow are determined by those who boldly execute on their M&A goals today.

“With inflation in many countries hitting a 40-year high, dealmakers will need to approach due diligence with a different lens,” he continues. “They will need to forecast different inflation scenarios and consider implications on market share, price elasticity, customer and supplier relationships, and employee compensation and retention.”

Essentially, across all major jurisdictions, an M&A dealmaking reset is taking place.

“As companies have globalised, they increasingly impact public policy,” observes Susan Shultz, chief executive and founder of The Board Institute. “The complexity of the risks, shareholder activism and demands for more transparency are driving board agendas. In addition, ESG is moving to the top and boards are upgrading and shedding less competent directors. Others are refocusing toward ESG and refitting their boards with functionally diverse directors.

“Boards are increasingly vulnerable to shareholder demands, activists and market gyrations which automatically trigger lawsuits,” she continues. “On the other hand, the slowdown in initial public offerings (IPOs), tolerance of dual stock arrangements and other mitigations of shareholder equity, and an increasing number of companies going private may well temper the drive to strategic boards.”

Reassessment

A major key to the reassessment of M&A strategy in turbulent times lies with the board of directors and its role in overseeing and guiding the M&A activity pursued by senior management – ensuring that the company stays aligned with the overall strategy, conducts effective diligence and actively guides value-creation efforts through to completion of the transaction.

“Boards are ideally strategic,” contends Ms Shultz. “By looking to the future, providing oversight, helping to avoid fatal mistakes and negotiating positive compromise among parties, good boards are an essential advantage.”

According to Protiviti, an effective board of directors should be a champion of strong governance for the organisation it serves. “All aspects of its oversight role are germane to M&A – with some oversight activities specific to M&A,” it states. “The board’s oversight with respect to M&A mirrors its overall focus on advising the chief executive, including offering a contrarian voice when necessary regarding strategic matters, policy approval, enterprise performance monitoring, reporting transparency and enterprise risk management.”

However, all too often, boards are an afterthought throughout the M&A process – a contention supported by the fact that many M&A deals fall short of expectations, with the majority of studies finding that between 70 to 90 percent of acquisitions fail.

“The board should be a priority,” asserts Ms Shultz. “Ultimately, it is about the people, people with integrity, respect for the culture, and vision. Independent directors from both boards should agree on the key metrics for success. Let those metrics drive the board make-up. Evaluate individual directors and have the courage to remove the weaker, less useful directors, regardless of personal allegiances.

“Consider adding one or more independent directors who could provide unique value as the companies combine,” she adds. “A strategic board can advise on potential conflicts and challenges and threats, such as with the inevitable jockeying for position among management.”

Thus, getting the right combination of talent, expertise and vision in a board engaged early in the M&A process can tilt the odds toward success. “By anticipating and addressing the red flag issues, such as conflicts of interest, management jockeying, disparate cultures, diverse objectives for outcomes, competing geographies, product dysfunction and potential customer erosion, a good board can make the difference,” suggests Ms Shultz.

Perception, assessment and enhancement

So, faced with the not inconsequential challenge of overseeing the success of a transaction, what steps should a board be taking to assist its company in making informed decisions across all aspects of the M&A deal cycle, such as planning, strategy, research, due diligence, closing and implementation activities?

According to Protiviti’s ‘10 Keys to Effective Board Oversight of M&A’ analysis, when undertaken, the following actions vastly improve board oversight and its overall focus on advising the chief executive and other members of the senior management team, which may include offering a contrarian voice when necessary.

First, view M&A through the lens of the growth strategy. Working closely with the board, companies pursuing growth through M&A should articulate the strategic underpinnings of the growth strategy and its linkage to the overall corporate strategy to provide a context for evaluating prospective targets and their strategic fit.

Second, oversee M&A as an end-to-end cycle, rather than a transaction. The board should focus on the M&A life cycle – from the acquisition target’s pipeline to the learnings from deal post-mortems, and all phases in between. The cycle begins with identifying the right markets and targets consistent with the growth strategy and acquisition criteria.

Third, determine the extent of board involvement in each phase of the process. For complex and risky transactions, the board should expect periodic updates at various stages of the due diligence process, as well as on the progress of the integration strategy after approval and consummation of the deal.

Fourth, ensure critical competencies are in place to execute the full M&A process. The board needs to satisfy itself that the management team includes individuals with the requisite skills to understand and break down the deal economics, execute approved transactions, integrate acquired businesses and avoid costly strategic errors that destroy enterprise value.

Fifth, challenge deal assumptions and expected synergies. When M&A targets are proposed, either the full board or a designated standing or special committee should assess deal assumptions and synergies. For complex deals, the board may want management to stress-test deal assumptions against well-defined scenarios and alternative futures before deal approval.

Sixth, manage senior management’s emotional investment. The board should insist that management also provide a balanced contrarian view that articulates the deal risks and what can go wrong – perhaps through a ‘red team’ that challenges deal assumptions to discover fatal flaws and temper the complacency that often follows past successes.

Seventh, constructively engage management in due diligence. Despite the best efforts of management and the board, due diligence often has inherent limitations when it is not possible to gain access to the required information. Furthermore, boards may not be giving sufficient attention to the need for due diligence directed to non-financial areas such as cyber risk and corruption risk, for example.

Eighth, understand the integration plan and its viability before approving the deal. Before approving the deal, the board should carefully review management’s integration plan. The review should seek clarity of the plan’s intended purpose, how it is to be achieved, who is leading the effort, and the change management and other obstacles that could frustrate the plan’s execution.

Finally, stay on top of the integration process. Effective integration requires continued vigilance from the board, including periodic tracking of progress, attention to managing cultural differences, making decisions quickly, retaining key personnel, staying on schedule and maintaining accountability for results.

“In summary, effective board oversight of M&A can create competitive advantage and enterprise value through consummation of successful deals,” states the Protiviti analysis. “Likewise, the board’s M&A oversight can help avert the loss of enterprise value through preventable deal failures.”

Two to tango

While senior management and the board may sometimes, and perhaps inevitably, have different perspectives on how a transaction should be conducted, it is essential that both views are considered and acted upon – a ‘two to tango’ approach that may go some way toward maximising value and minimising risks.

“Directors are responsible for decisions taken at the board level, regardless of whether they are informed or present,” suggests Ms Shultz. “A good board, experienced in M&A, can add value throughout the process. However, management should appropriately inform the board, so they can do their job. That means providing relevant information, good and bad, in a timely manner.

“All too common is the case of the board of a large, public mining company which was informed of a sizable acquisition in Brazil, just as the deal was about to be signed,” she continues. “One of the directors knew the target company and raised a red flag about their corruption. That triggered a deep dive and the decision not to go forward. Eleven months later, the target company filed for bankruptcy.”

Execute with confidence

Today, nothing is constant but change. In an M&A context, this is abundantly so, with a number of scenarios poised to test board oversight of M&A in the months ahead, including: (i) continuing global upheaval; (ii) a demand for more transparency; (iii) accelerated shareholder activism; (iv) a need for broader expertise beyond finance; (v) a forfeiting of strategic vision amid a zeal to diversify and specialise; (vi) continued calls to separate the chair and chief executive roles; (vii) increasing cyber security threats; (viii); the risk of information overload; (ix) an uptick in regulation; and (x) a greater risk of black swans.

“However, no checklist can ensure good governance, only good people can” concludes Ms Shultz. “We hear about the bad boards, yet the dramatic, untold story is the hundreds of companies, both public and private, that have avoided crises and succeeded due to the oversight, advice and counsel provided by their strategic boards of directors.”

Undoubtedly, amid high levels of global uncertainty and volatile economic conditions, the scope of the board’s role throughout the M&A process is unlikely to diminish. On the contrary, how the board perceives, assesses and enhances the strategic value of M&A will likely escalate – the ultimate aim being to provide executive leadership with the right skills to develop a strategy, pursue deals and execute with confidence when the time comes.

© Financier Worldwide

BY

Fraser Tennant