Fueled by higher stock prices, lower interest rates, and cash-heavy balance sheets, corporate dealmaking has increased from 2008 lows. In the months ahead, with conditions conducive to M&A activity, many audit committees and boards may be faced with the formidable challenge of evaluating an acquisition and helping to ensure the deal delivers the value that it should.
Historically, many deals fall short of expectations — for a variety of reasons, from valuation overreach, to optimistic projections, to failed due diligence, to poor post-merger planning and execution. By engaging in critical aspects of the M&A process — particularly early on and after the deal closes — boards and audit committees can help increase the likelihood of a successful outcome (even if that means not doing a deal at all).
To this end, we offer the following suggestions as to how the board and audit committee can help their companies capture more value in M&A.
Test alignment of the deal with the company's strategy, and challenge the value-creation potential. The board should understand their company's strategy, including its organic and strategic growth opportunities as well as key “gaps” — e.g., in talent, technology, new products and markets — and whether the company's deal pipeline has the potential to fill those gaps. Importantly, don't fall in love with the deal: Maintain the board's objectivity, be sensitive to possible management bias, and ensure that any concerns raised by the due diligence and integration teams are not overshadowed by pressures to get the deal done. Balanced due diligence is not simply a matter of asking “Why not do the deal?” but also “Why should we do the deal?”
In its oversight role, the audit committee can play a key role in helping to scrutinize the financial assumptions and economic impact of a deal as well as the financing. The audit committee should also consider the implications for the company's own cost of capital, balance sheet, and other assessments of financial strength.
Closely monitor key aspects of the due diligence process before approving the deal. Test the valuation assumptions and vet the financial and strategic health of the target, including assumptions about customer behavior and product lifecycle. Understand the target's key financial, operational, and market risks, and consider the organizational and cultural differences as well as the human capital impact of the deal for both the target and the acquirer. Are there potential cultural mismatches, particularly across geographies? How aggressive are internal forecasts for growth and customer retention? The more robust and invasive the due diligence process is, the higher the likelihood of success.
Be mindful of potential pitfalls. For example, how dependent is the deal's success on the people, customers, vendors and suppliers of the target company? Here, the audit committee can play a key role in evaluating various financial and operational risks and controls. Does the target's accounting lean aggressive or conservative? What is their policy on reserves? What about the culture around compliance and internal controls? Are there FCPA concerns in the countries where the target operates?
Examine the post-merger integration plan in detail, and track performance against the plan. A detailed, robust post-merger integration plan should be developed early on and adjusted during the due diligence process as needed. For audit committees, this is particularly important because oversight responsibility for the acquired company's financials — e.g., for financial reporting and controls, establishing reserves, internal audit's focus, controller, etc. — starts on Day 1.
After the deal closes, integration risk and execution risk — including cultural integration — should continue to be critical areas of focus. Is accountability for achieving synergies clear? Who is responsible for the execution of the merger integration plan? The board should also help ensure that senior management maintains its focus and energy throughout the integration process. Even with a robust plan, contemplated synergies are often never achieved; integration can prove much harder than envisioned; and metrics to monitor performance are often not established. The board can also emphasize the importance of an M&A postmortem.
Clarify the roles of the full board and audit committee. Oversight roles will vary by company, but generally the full board is responsible for strategic aspects of the deal — strategic alignment and value creation potential — with oversight of certain execution aspects of the transaction allocated to the audit committee. For deals that are particularly large or complex, the board may need to consider forming a special committee.
The board and audit committee can start adding value well ahead of a deal coming into play by helping to ensure that each phase of management's M&A process — strategy, valuation, financing, due diligence, closing, and integration — is robust and rigorous. â–
The authors can be contacted at auditcommittee@kpmg.com.