The M&A problem

Board directors are being forced to take on new responsibilities at every turn. Nowhere is this more the case than in the world of mergers and acquisitions: the global financial crisis has seen the M&A market shrink dramatically; a serious lack of access to credit is curtailing buying activity as companies find it difficult to secure funding or are diverting funds to shore up their own business activities.

You might reasonably assume that a fall in the number of deals would lead to less work for directors. This is absolutely not the case, however. Despite the fact that only a handful of deals are taking place, many companies have been approached or been asked to consider deals. As stock prices fall, many targets become more affordable. In this environment, board members need to be well prepared to ensure they are ready to take action if an opportunity presents itself.

But the dynamics have changed considerably. A mere three years ago, when the M&A market was running hot, the seller would typically dictate terms. Buyers were generally not in a strong position to negotiate. They were unable to press targets for a better price or to negotiate extensive protections. That has completely changed and now, with very few entities in a position to buy another, the buyer is ruling the roost. As the credit crisis spreads, trust is being eroded and almost any company, even a former titan, could be the next victim. With a lack of certainty over the health of targets, M&A due diligence is becoming more important than ever.

Buyers are being more cautious and undertaking greater financial and legal due diligence. Acquiring companies are also paying reduced prices and are successfully negotiating financing and due diligence outs, higher break-up fees, more favorable material adverse effect (MAE) or material adverse change (MAC) clauses, and contingent or deferred payment arrangements

The ‘M&A in the boardroom’ panel at Foley & Lardner’s 2009 National Directors Institute reviewed the current state of the market and provided a number of useful pointers for board members to consider. The conversation was moderated by Foley partners Steven Hilfinger and Peter Underwood. The other speakers included Walter Aspatore, co-founder, Amherst Partners; Will Frame, managing director, Deloitte & Touche; and Robin Johnson, partner, Eversheds.

The panel highlighted that one of the main drivers of greater due diligence in mergers is increased scrutiny from lending institutions. Whereas funds used to be relatively easy to come by, lenders are now placing far more intense restrictions on deals and are demanding more information before providing funds.

Beyond lender scrutiny, the other major contributors are increased liability and a more activist shareholder community. Directors who enter into an M&A transaction are taking great steps to ensure the deal is viable and that the target company is completely free of any regulatory or compliance issues that may cause problems later. There is a growing belief, which is supported by some recent judicial rulings, that failure to conduct thorough due diligence may result in professional and/or personal liability for the directors and managers approving – or rejecting – the deal.

Perhaps the most significant challenge is faced by target firms. In the current environment, where share prices are depressed, there are likely to be far more hostile and opportunistic takeovers. It is the board’s responsibility to obtain the maximum price for shareholders regardless of current financial pressures and yet many of the tools available to them, like shareholder rights plans, have been systematically stripped away by investor activists. It is these same activists who are most likely to pursue legal action against the company if it fails to maximize value in a sale.

Perhaps the best way to safeguard against shareholder litigation is to prevent a hostile proposal from being presented in the first place. In addition to the implementation of shareholder rights plans and careful monitoring of the shareholder base to identify ‘friendly’ investors, this may be accomplished through diversification of a company’s business.

Frame explained that companies that are more diversified, and therefore have less geographic or product concentration, ‘are less attractive acquisition targets.’ For this reason, corporate boards should consider encouraging management to ‘achieve greater diversification through internal initiatives as well as acquisitions.’ This can be done quite easily given the current state of the market, assuming cash or financing is available. If it is not, talking with shareholders and carefully explaining the company’s position is the best starting point when looking to avoid problems down the line.