Financial professionals play a critically important part in all M&A activities. Often CFOs, controllers, and their functional equivalents (throughout this chapter referred to as financial officers) are logical candidates to play a central role in the acquisition process, and invariably should be involved in the transaction from beginning to end.
Although executed for strategic purposes, acquisitions are essentially financial transactions. As such, a fundamentally sound acquisition process typically draws on these skills and expertise of the financial manager:
- The ability to apply rigorous financial analysis to ensure sound decision making
- An understanding of the tax implications associated with the various forms a transaction may take
- An understanding of the applicable regulatory requirements
- The ability to model and/or critically evaluate business valuations
- Familiarity with the various financing options available as well as the ability to take a leadership role in structuring a financing package, if necessary
- Familiarity with the principles of acquisition accounting and their application
- The ability to plan, coordinate, and execute an efficient and effective due diligence review
In addition to these financial/accounting capabilities, the senior financial officer involved in the acquisition process should also have strong leadership, organizational, and communication skills. A successful acquisition requires a substantial amount of cooperation and coordination among professionals and experts, both financial and non-financial, within and outside the acquiring company. It is imperative that those providing leadership ensure that the process is rationally structured (i.e., that the steps in the process are properly sequenced) and that the efforts of all those involved are not compartmentalized (i.e., that individual efforts are integrated and that all valid inputs are synthesized).
As a member of the core team managing an acquisition, the financial officer will have responsibility for coordinating much of the planning and execution of internal and external team members. This includes various line managers within the acquiring organization, as well as accounting, tax, and legal and other specialists who may reside outside the organization and/or in corporate headquarters in the case of larger, multilayered organizations.
- Internal Coordination. The financial officer within the acquiring organization will generally be a co-equal partner with the business executives tasked with evaluating the merits of a transaction, making recommendations whether or not to proceed, and developing a plan of action, if the transaction is to be pursued. Additionally, he or she would play an important role in determining what internal resources would be needed to further evaluate the target company, to perform due diligence and, ultimately, to execute the transaction.
- Coordination of External Experts. The financial officer is the logical point of contact in dealing with a wide range of accounting, tax, legal, and regulatory issues and processes. Outside accounting and auditing resources may be accessed to conduct preliminary assessments and financial due diligence. The financial officer must also interface with the target company’s internal and outside accountants. And, he or she will have responsibility for ensuring that acquisition accounting is properly implemented. The financial officer is also the logical coordinator of input from internal tax professionals or external tax advisors. Tax expertise is drawn on early in the acquisition process to determine the tax ramifications in structuring the transaction and is involved in the post–due diligence stage to ensure optimal tax treatment prospectively. Financial and legal considerations intersect frequently throughout the acquisition process. The financial officer is the logical individual to coordinate with legal counsel to ensure compliance with regulatory requirements and coordination of tax and legal issues, including the drafting of the Letter of Intent, ensuring compliance with SEC regulations, state law, and antitrust statutes, and negotiation of the final Purchase Agreement. The financial officer also has a role to play in the financing process. This can range from the simplest type of involvement for a large company, such as notifying the corporate treasury function that money has to be wired to the bank of the sellers at closing date, to very complex negotiations with those funding the acquisition for a smaller organization.
Not surprisingly, the financial officer plays an important role in analyzing the transaction and modeling the target company’s business. This includes, among other things, evaluating the target company’s business model and financial dynamics in the context of the acquirer’s investment objectives and establishing the value of the target company.
- Financial Criteria and Metrics. The financial officer provides critical input on the appropriateness of strategic fit, the reasonableness of projections of growth and profitability and assumed synergies and efficiencies, as well as comparisons of the acquiring company’s projected performance before and after the proposed acquisition (to measure such things as potential accretion and dilution). These are important judgments and measurements for establishing a basis for a preliminary decision to proceed with a transaction.
- Valuation. Establishing a preliminary view of value and updating that view as additional information becomes available is a major role of the finance function in the evaluation of an acquisition. There is a variety of valuation methods used in the acquisition process, but larger, acquisitive organizations generally have a standard approach and models that are used to determine value, returns on invested capital, and other investment hurdles. Smaller, less acquisitive organizations may engage a valuation expert on a consulting basis. In either case, development of a credible valuation model requires a detailed understanding of the financial dynamics of both the acquiring and target companies and how synergies and efficiencies can be realized (and quantified) by the two. The financial officer is, unquestionably, in the best position to make these determinations.
Determination Of Deal Structure
The financial officer is a key player in determining how the transaction can optimally be structured. Some of the major aspects of the potential structure he or she would consider are:
- Assets versus Stock. Almost invariably, the buyer will prefer to buy specific assets (vs. the stock) of the target company, because it enables the buyer to be selective about which assets are purchased and reduces the buyer’s exposure to hidden liabilities and generally reduces its tax liabilities. Conversely, the seller will prefer a sale of stock, so that unfavorable tax treatment can be avoided and all assets and all liabilities are included in the transaction. There are special situations in which the seller can treat a stock sale as an asset sale and the buyer can realize some of the benefits of an asset sale. The financial officer, often in combination with tax specialists, can determine the range of acceptable options and quantify their costs and benefits.
- Earn-Outs. Earn-outs are an approach to risk sharing between the buyer and the seller. They provide the seller with upside potential in the form of additional consideration tied to company’s post-acquisition performance above a defined level (usually measured by revenue and/or profit). The financial officer is in the best position to determine if the use of an earn-out makes strategic and economic sense and, if so, how the earn-out should be structured.
- Working Capital Adjustments. Letters of Intent will frequently require that sufficient working capital is left in the business at the point of the acquisition to fund ongoing requirements. In such cases, if the working capital falls below that level, then the purchase price would be adjusted downward accordingly. These adjustments are designed to offset any unusual removals of cash from the business. An analysis of the working capital dynamics over time by the financial officer is necessary to determine a fair and suitable working capital target, if a working capital adjustment is contemplated.
Clearly, the lead financial officer involved in the acquisition should have responsibility for financial due diligence. This would include establishing due diligence objectives, managing the process, and reporting on its results. These functions are briefly discussed below:
- Establishing Due Diligence Objectives. Although the due diligence process varies from transaction to transaction, there are some aspects of the process that are standard, regardless of the size and nature of the transaction. This includes the overarching objectives of the review, which are to verify historical results and to validate forecasts and key assumptions (such as synergies, growth rates, and anticipated efficiencies) related to the valuation that the acquirer has established. The financial officer should be the primary architect in establishing these objectives.
- Managing the Due Diligence Process. By virtue of expertise and experience, the finance function is a logical one to take a lead role in structuring the due diligence program and process. A due diligence review is by no means the same as an audit. Constraints on time and resources limit the depth of the evaluations conducted. However, a due diligence review is analogous to an audit, and the types of procedures that should be reflected in the program are not unlike what one would find in an audit program. The financial officer and his or her staff will generally have the experience and expertise to shape the program and coach non-accountants in performing the review.
- Reporting on Results. Finance professionals are co-equal commentators, along with the business managers involved in the process, on the results of the due diligence.
Because an acquisition is fundamentally an investment decision, recommendations to proceed or to disengage will largely be based on whether due diligence supports or contradicts the valuation that has been established. The financial officer is clearly in the best position to make such determinations.
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