The Science of M&A in Large Corporations

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Copyright © 2011 by William H. Venema. All rights reserved.

THE SCIENCE OF M&A IN LARGE CORPORATIONS

William H. Venema1 In 2010, Deloitte commissioned a survey of executives involved in mergers and

acquisitions (“M&A”) at 150 companies across a variety of industries. When asked what

represents the greatest opportunity for improving the effectiveness of their M&A efforts, the

respondents ranked enhancing organizational coordination and deal process at the top of the list.

That conclusion comports with what I’ve observed as a practicing M&A attorney for more than

20 years.2 What makes this paper especially timely is that the respondents to the Deloitte survey

also indicated that their M&A teams will play a leading role in the next phase of their growth.

Many articles have been written about various aspects of the M&A process, such as the

details of confidentiality agreements, letters of intent, purchase-price adjustments, earn outs,

representations, indemnities, etc. Very few articles, however, have examined M&A from the

perspective of how the process should be managed within a corporation that has one or more

core businesses (i.e., a strategic buyer). Although aspects of this paper would be of interest to

financial buyers, the focus is on strategic buyers.

ART OR SCIENCE?

A common expression in many corporations is that “M&A is an art.” And indeed that

allusion is true: great dealmakers, like great artists, are often talented individuals with great

instincts and insight. Nevertheless, the hard work of M&A has more to do with good

management practices than it does with the negotiating talents of a single person or team. To be

effective, a corporation’s M&A program should be carefully aligned with the strategy of the

corporation, proceed in accordance with a formalized process, and involve the corporation’s key

decision makers.

1 Deputy General Counsel, Mergers & Acquisitions, Computer Sciences Corporation, [email protected]. The views expressed in this paper are those of the author and do not necessarily reflect those of Computer Sciences Corporation. 2 Prior to joining CSC, I practiced in several national law firms, assisting clients with M&A transactions in various industries. I appreciate the opportunity to work with the talented M&A team at CSC whose good habits inspired portions of this paper.

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This paper refers to the manager who oversees the corporation’s M&A program as the

“CDO” (short for Chief Development Officer). Of course, the complexities of M&A require the

involvement of a number of other parties, whose activities the CDO must coordinate in order to

achieve results that further the strategic objectives of the organization. Absent a carefully

managed M&A process, the efforts of these parties can result in a disorganized mess. Many of

the individuals involved in a corporation’s M&A program do not work directly for the CDO, and

therefore, the CDO must manage the process within his or her span of influence, rather than his

or her span of control. Accordingly, the CDO needs to have good working relationships with all

of the executives within the corporation who are likely to be involved in transactions.

CHARACTERISTICS OF AN EFFECTIVE CORPORATE M&A PROGRAM

The Importance of Strategy

A corporation’s M&A program is a tool of its corporate strategy. It is the process of

acquiring—and in some instances divesting—businesses in support of the corporation’s overall

strategy. Ultimately, a corporation’s leadership team must decide whether to use the

corporation’s resources to acquire businesses, to support internal development (usually referred

to as “organic growth”), or to engage in some combination of the two. Consequently, to have an

effective M&A program, a corporation must first have a clearly defined corporate strategy and a

clear idea of how the corporate M&A program supports that overall strategy. Without a clear

corporate strategy, a corporation’s M&A program will resemble a rudderless ship: it might

move along, but whether that movement is in the right direction is a function of the winds of fate,

not skill.

Two Overarching Concepts

The steps of an effective corporate M&A program can be defined in a variety of ways.

The chart in the next section captures the essence of the process in six steps and includes two

important overarching concepts about the corporate M&A process: (i) the process must proceed

sequentially and (ii) to be efficient, effective, and constantly improving, each step of the process

must be continuously assessed.

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Sequential Process

One of the most serious problems that I have observed is that corporations often fail to

proceed in an orderly manner. The chart in the next section describes the corporate M&A

process in six steps, which I believe must be performed in sequence. The following discussion

of these steps posits that it is impossible to do a good job on the later steps if the previous ones

have not been performed. Thus, according to the chart, trying to negotiate the terms of a

transaction without a clear understanding of the corporation’s strategy, as reflected in the

corporation’s screening and evaluation criteria, would probably result in resources being wasted

and possibly more serious consequences. To paraphrase Stephen Covey, author of The Seven

Habits of Highly Effective People, the corporation might struggle to climb a ladder, only to

discover that it is leaning against the wrong wall.

Effective Feedback

The second overarching concept that is captured in the chart in the next section is that

each step of the process must be continuously assessed. In other words, there must be an

effective feedback loop at each step and within each step. Although the steps of the process are

sequential, they are not cast in stone. For example, the members of the M&A team might learn

something during the due diligence investigation that causes the corporation to revise the

transaction structure or to reconsider the acquisition altogether. Without continuous, systematic

feedback, a corporation might find itself unwittingly executing a strategy that has become

obsolete. The goal of feedback is to ensure that the particular transaction is being handled

efficiently and that the information being received by the M&A team either supports the

corporation’s decision to continue with the transaction in its current form or suggests how it

should be changed. Feedback should also serve to improve the corporation’s M&A process for

future transactions.

CHARACTERISTICS OF EFFECTIVE FEEDBACK

• Systematic

• Specific

• Timely

• Accurate

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Although informal feedback takes place in most corporations, such communication is

normally insufficient to ensure that the corporation’s M&A process is effective and efficient.

The flow of information in the feedback loop is too important to the overall success of the

corporation’s M&A process to rely on ad hoc communication among the participants.

Therefore, systematic, formal feedback should be a part of the process.

A CDO should not accept feedback about any aspect of the process that is vague, simply

because the party providing the feedback failed to do what was necessary to provide specific

feedback. Obviously, resource constraints will affect the amount of effort that someone can

devote to a transaction and, therefore, will affect the specificity of that person’s feedback.

Nevertheless, transactions often go awry not because of a lack of resources, but because the

parties involved in the process fail to perform their respective tasks with appropriate levels of

effort and care. Providing feedback is no different: it must be performed with an appropriate

level of effort and care. That is not to say that the “gut feelings” of experienced deal

professionals are not important. They are. Nevertheless, feedback is much more valuable if it is

specific and based on facts, not personal impressions.

A third characteristic of feedback is that it should be timely. Stale information is only

useful if things remain unchanged, which is rarely the case in an M&A transaction. Moreover,

feedback should never be stale simply because a party failed to provide it in a timely manner. A

key advantage of systematic, formal reports is that they increase the likelihood that important

information will be reported in a timely manner. All parties should understand, however, that in

certain instances unscheduled feedback is appropriate, particularly if the information is time

sensitive.

Finally, the information must be accurate. The consequences of making decisions and

revisions to a process based on bad information are obvious. The old saying about computers is

also accurate for a corporation’s M&A process: “garbage in yields garbage out.”

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STEPS OF AN EFFECTIVE CORPORATE M&A PROCESS

→ 1. Define Corporation’s M&A Strategy

C O

N T → 2. Establish Criteria

I N

U A → 3. Create Deal Flow

L L

Y → 4. Start Negotiations

A S

S E → 5. Carry out the Transaction

S S

→ 6. Execute Integration Plan

Step 1: Define Corporation’s M&A Strategy

In order to align the corporation’s M&A strategy with the overall strategy of the

corporation, the CDO must have a clear understanding of the corporation’s overall strategy and

the role of M&A in that strategy. Without such an understanding, it will be extremely difficult

for the CDO to manage and lead the corporation’s M&A program.

After obtaining a clear idea of where the corporation’s M&A strategy fits within the

overall strategy of the corporation, the CDO should work with the M&A team and other

executives within the corporation to define the corporation’s M&A strategy. In general, the

corporation’s M&A strategy should be designed to exploit the corporation’s strengths, shore up

its weaknesses, or do both. And, it should be grounded on solid economic reasons, not fads,

friendships, or family ties. It requires the CDO and his or her colleagues to make hard choices;

that is, they must decide what to do and, perhaps more important, what not to do. The

corporation’s M&A strategy is about doing the right things, not doing things right. Doing things

right is the focus of the implementation of strategy, which is what the remaining five steps of the

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process are about.

Although the general focus of the corporation’s M&A strategy will be on acquiring

businesses, it should also support the divestiture process. If the strategy never reveals candidates

for divestiture in a large corporation, then it is probably not a true strategy. A true strategy

weighs what the corporation is currently doing against what it could be doing with its

resources. Consequently, if the corporation’s resources could be used more profitably in new

areas of opportunity, then the strategy should suggest that old lines of business be sold and

the proceeds redeployed to these new areas through acquisitions, organic growth, or a

combination of the two.

Strategic planning involves the continual reallocation of resources in support of the

corporation’s goals, which is a process that should take place at many different levels in a large

corporation. Accordingly, for most large corporations, the corporation’s M&A strategy will

have at least three components:

• portfolio strategy,

• business-unit strategy, and

• business-element strategy.

Portfolio Strategy

The philosophy for this level of strategy is to develop a set of interrelated businesses

within the corporation that give it balance and stability. It provides a framework for categorizing

the various portions of the corporation’s business in terms of how they relate to each other and to

the corporation as a whole, in terms of competitive advantage and growth. In developing a

corporation’s portfolio strategy, three fundamental questions must be addressed:

A strategic plan should answer these questions:

• What are the corporation’s strengths and weaknesses?

• What are the alternative acquisition opportunities that are available to the corporation?

• What are the corporation’s priorities for building on strengths and correcting weaknesses?

• How do the available opportunities fit with the corporation’s priorities?

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(1) What are the boundaries of the corporation; that is, what businesses should be a part of the corporate portfolio and why?

(2) How should resources be allocated among the various portfolio businesses?

(3) How can the goals of the various businesses be aligned with the interests of the corporation as a whole?

The various businesses in the corporate portfolio may be aligned along purely financial

terms, so that there is balance among those that are able to generate cash and those that need

growth capital. Alternatively, the portfolio may be put together by joining businesses that are

related in terms of technology, know-how, or product-market niches. The latter type of portfolio

development is based on an underlying theme for the interrelationships among the businesses.

Planning for an acquisition in this context involves a search for business entities (which this

paper refers to as “Targets”) that will balance and strengthen the corporation’s overall portfolio

theme.

Business Unit Strategy

The goal of the business-unit strategy is to create a group of interrelated businesses

within the business unit that can exploit shared resources and realize other synergies. The shared

resources could include one or more of the following: technology, know-how, human capital,

products, geography, or channels of distribution. Synergies arise if the Target provides the

business unit with something that offsets a weakness of the business unit or supplements one of

its strengths. In fact, sharing resources between the business unit and the Target is often a source

of synergy, because duplications can often be eliminated.

Employing the business-unit strategy, a corporation might acquire a Target in order to

gain a foothold in a new growth market. Following closing, the corporation might attempt to

transition the Target’s customers to the corporation’s product suite or sell the customers new

products that the Target was unable to offer them. Another example of the execution of the

business-unit strategy is vertical integration, where a corporation acquires one of its vendors

(and the vendor’s know-how), to ensure that the business unit has a continuous supply of a

critical input. A fundamental aspect of the business-unit strategy is that cash flows from the

businesses within the business unit are reallocated within the business unit (sometimes, but not

always, to buy additional businesses) in order to maximize the long-term return of the business

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unit.

Business Element Strategy

The goal of the business-element strategy is to develop the corporation’s competitive

strength with respect to a specific business element that can be utilized across a number of

business units within the enterprise. Although these business elements are the same as described

above in the business-unit strategy (i.e., technology, know-how, human capital, products, or

channels of distribution) the goal of this strategy is different. Rather than strengthening a single

business unit vis-à-vis its competitors in the marketplace, the business-element strategy will

provide several business units with a competitive advantage vis-à-vis their respective

competitors, because of the particular business element or elements provided by the Target. For

example, a corporation might acquire a Target that owns certain proprietary cyber-security

software that could be used by a number of business units, albeit more profitably by some than

others. In summary, the business-element strategy leverages the benefits of an acquisition across

a number of business units in the corporation, and so, this kind of strategy is often managed at

the corporate level, not at the business-unit level.

Step 2: Establish Criteria

The next step in the corporation’s M&A process is to develop decision criteria, which are

the standards, rules, or tests by which Targets can be judged. With the assistance of their teams,

CDOs should develop two different kinds of criteria based on the corporation’s M&A strategy:

(i) screening criteria and (ii) evaluation criteria. Although a CDO and his or her team should

establish the screening criteria and evaluation criteria prior to examining Targets, the criteria are

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not static. As the strategy of the corporation evolves over time, the criteria that are used to

implement that strategy must change as well.

Screening Criteria

Screening criteria are used to ensure that the transaction being considered is

fundamentally aligned with the corporation’s M&A strategy. They define the key parameters of

an acceptable transaction. The use of screening criteria avoids having scores of acquisition

suggestions undergo detailed evaluation at great expense. Instead, any proposed transaction is

examined against pre-established screening criteria that are based on the corporation’s M&A

strategy. If a Target fails to meet any of the screening criteria, then it is turned down

immediately with little executive time diverted from day-to-day business and a minimal

expenditure of corporate resources.

Deal professionals often refer to screening criteria as “deal killers,” because if a Target

fails to satisfy one or more of the screening criteria, it kills the deal. As indicated in the six-step

flow chart above, screening criteria should be determined before a corporation begins to consider

any Targets, although these criteria will be used by the M&A team throughout the process of

Target selection, valuation, due diligence, and negotiations. It cannot be emphasized enough that

having a clear understanding of the screening criteria in advance will allow the M&A team to

address important issues early and, if necessary, terminate a transaction before precious

resources are wasted pursuing a transaction that will never close. Far too often, corporations fail

to have—or fail to apply—screening criteria, and as a consequence, they waste valuable

resources and the time and attention of key employees.

Although general screening criteria are useful, there are many other criteria that can be

used to screen Targets. Some are financial, while others are more subtle, such as those that relate

to the risks associated with any transaction. As an M&A attorney, I have frequently seen clients

GENERAL SCREENING CRITERIA

• Suitability—Does the acquisition of the Target support an aspect of the corporation’s M&A strategy?

• Feasibility—Can the Target be acquired with available resources?

• Acceptability—Will the Target provide the corporation with benefits that are worth the cost and risk of acquiring it?

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underestimate the impact of provisions in a purchase agreement that should be screening criteria,

simply because the financial implications of such provisions were not readily apparent. The

issues addressed in provisions such as representations, warranties, and indemnities can have a

tremendous impact on the riskiness of the transaction and should be considered when developing

screening criteria.

Some screening criteria are inherent in the nature of a corporation’s business. For

example, if a government contractor learns, during its evaluation of a Target, that the acquisition

of the Target would create what the government calls an “organizational conflict of interest” (an

“OCI”),3 then the government contractor would have to terminate the transaction or risk losing

its government business. Therefore, the presence of an OCI would be a screening criterion for

such an acquirer. Corporations might develop other screening criteria that could address such

matters as whether:

• the purchase price aligns with the acquirer’s valuation analysis; • the tax structure contemplated by the corporation can be achieved;

• the margins on the revenue of the Target are sufficient to ensure that the acquisition is accretive to the acquirer or the margins can be improved through synergies or better management to make them so;

• the Target’s important intellectual property has an appropriate pedigree;

• the Target’s culture would conjoin well with the culture of the acquirer; • the cost of acquiring the Target is less than the cost of generating the same results

from an internal development program (i.e., creating the same operation organically); or

• the acquirer finds no evidence of fraud or illegal acts by the Target (e.g., violations of the Foreign Corrupt Practices Act, the Internal Revenue Code, or regulations concerning money laundering or the Office of Foreign Assets Control).

Evaluation Criteria

It is likely that several potential Targets will satisfy the screening criteria. Unless the

corporation has unlimited resources (which is highly unlikely), it will have to choose from

among several Targets that passed the screening. This selection process is aided by what are

called “evaluation criteria,” which are used to differentiate among the Targets that satisfy the

3 For example, an OCI would occur if a government contractor establishes the criteria for a service or product for the government and then supplies same. If the Target performs one side of such work and the corporation provides the other, then the combined entity would have an OCI. The government can require divestiture of a business that gives rise to an OCI.

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screening criteria.

Evaluation criteria might deal with some of the same subject matter that is addressed in

the screening criteria. The difference is that screening criteria are used to screen out Targets that

fail to meet or exceed a particular standard, while evaluation criteria are used to differentiate

among those that meet or exceed the standard. For example, a corporation could use a pre-

established level of return on investment as a screening criterion and, thereafter, use return on

investment as an evaluation criterion by comparing the relative ROIs of competing Targets.

To the extent possible, the CDO should attempt to quantify each evaluation criterion, in

order to make the process of comparison easier. Generally, the so-called “hard” factors, such as

net present value, return on investment, or internal rate of return, are easier to quantify than

“soft” factors, such as the impact of the Target on the corporation’s brand or its competitive

position in the marketplace.

The synergies created by a transaction can be a function of both hard and soft evaluation

criteria. Generally speaking, corporations look for synergies that:

• remediate a weakness of the corporation,

• capitalize on the corporation’s strengths, or

• accomplish both.

For example, it is often the case that a corporation can provide the Target with certain services

following the closing without dramatically increasing the expense of providing the services.

Consequently, financial synergy is achieved because the total expense for that service following

the closing of the transaction will be less than the total expense of the two entities for that service

prior to closing. Normally, financial synergies can be calculated with a high degree of accuracy

and are thus considered to be hard criteria.

Alternatively, synergies can arise with respect to soft criteria. For example, a corporation

might look for Targets that could use the corporation’s brand to boost the Target’s sales. In

TYPICAL EVALUATION CRITERIA

“Hard” Criteria “Soft” Criteria

• Net Present Value • Effect on Brand

• Return on Investment • Effect on Competitive Position

• Internal Rate of Return

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common parlance, such a transaction would be referred to as one that “leverages the

corporation’s brand.” Although synergies involving soft criteria are more difficult to quantify,

the CDO should attempt to do so. Using the example mentioned above, the CDO could attempt

to estimate the increase in sales that the Target would achieve by using the corporation’s brand.

Obviously, some Targets might benefit more than others, and so, the corporation could use that

soft criterion as one of the evaluation criteria.

In practice, the criteria by which a corporation makes choices are rarely of equal

importance. Therefore, the CDO and his or her team should assign weights to each evaluation

criterion in order to establish its relative importance to the other evaluation criteria. As closely

as possible, the weighting of evaluation criteria should reflect the CDO’s judgment or the

judgment of acknowledged experts. This ranking could result in two criteria having equal

importance, or one criterion being slightly favored in importance, or moderately or strongly

favored. These verbal assessments can then be assigned numerical values, so that the results can

be displayed on a decision matrix that compares the alternatives.

The evaluation criteria can also be compared by conducting a “pair-wise comparison,”

which is an analytical tool that brings objectivity to the process of assigning criteria weights. To

perform a pair-wise comparison, the CDO or expert would methodically assess each evaluation

criterion against each of the others, two at a time, in order to establish their relative importance.

Conducting a pair-wise comparison in no way diminishes the importance of the CDO’s

judgment. Instead, it enables the CDO to bring his or her judgment to bear with greater precision

and enhances his or her ability to make decisions of greater complexity than might otherwise be

possible.

Step 3: Create Deal Flow

Proper Sequence

After the CDO defines the corporation’s M&A strategy and establishes the criteria to

implement that strategy, he or she must generate a flow of Targets that can be reviewed to

determine whether any of them would support the corporation’s M&A strategy. As is the case

with other aspects of a corporation’s M&A program, the creation of deal flow must take place in

sequence: it is impossible to look for appropriate Targets without a clear understanding of the

criteria that the Targets must satisfy.

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Methods to Create Deal Flow

The principal ways that corporations create a deal flow of Targets to consider are:

• using in-house resources,

• relying on a network of outside intermediaries, or

• employing a combination of the two.

Using the corporation’s M&A strategy as a guide, an in-house team can conduct a very

effective search for Targets, using the many robust sources of information available to them. In

addition, most corporations receive many unsolicited proposals from intermediaries and the

Targets themselves. An in-house team is likely to understand the corporation’s M&A strategy

and screening criteria better than an outside intermediary and, therefore, is more likely to achieve

a closer fit between the strategy and the Target.

Alternatively, some corporations rely heavily on outside intermediaries. It is often the

case that those serving on the in-house team have other responsibilities within the corporation.

Consequently, it is difficult for them to devote adequate time and attention to research and to the

review of unsolicited acquisition opportunities. Because finding good Targets is one of the

primary responsibilities of outside intermediaries, they devote the time and resources necessary

to create substantial deal flows of quality Targets. In addition, they engage in activities that are

directly related to generating a flow of Targets and often have organized databases of thousands

of prospects. To use outside intermediaries effectively, however, a corporation must carefully

explain its M&A strategy and screening criteria. Sometimes, such information is confidential,

and therefore, the corporation would need to enter into a formal relationship with the

intermediary, which would include the execution of a nondisclosure agreement. Other times,

such information is not sensitive, and so, the corporation could distribute it to a number of

intermediaries, thereby casting a wide net for Targets.

Most corporations use a combination of in-house resources and a network of outside

intermediaries in order to gain the advantages of both. The in-house team usually has a better

understanding of the corporation’s M&A strategy and, therefore, has a better understanding of

which Targets support that strategy. Depending on the nature of the business, they might even

interact with potential Targets when engaged in other aspects of the corporation’s business.

Outside intermediaries, on the other hand, have more time and resources to devote to the search

for Targets and, therefore, can usually generate a greater volume of quality Targets.

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Centralized or Decentralized

Some corporations centralize all deal flows with the CDO, while others decentralize at

least part of this step to business units or others. As discussed in Step 1 above, the corporation’s

M&A strategy is likely to have different levels, such as a portfolio strategy, a business-unit

strategy, and a business-element strategy. Because these strategies are implemented at different

levels within the corporation, it is likely that the search for Targets to support the strategies will

take place at different levels as well. Regardless of where the search takes place, the CDO

should be intimately involved with all of the deal flows in order to minimize the risk of bad or

inconsistent decision making that will damage the reputation of the corporation (as an acquirer)

in the marketplace. Targets view the ability to close a transaction as one of the most important

attributes of an acquirer. If the corporation is perceived to be an ineffective acquirer, it will lose

access to some of the best Targets.

Step 4: Start the Negotiations

Step 4 is an extremely sensitive step in a corporation’s M&A process. Whereas the first

three steps of the process are internally focused, Step 4 is outwardly focused and, therefore, more

risky. As will be discussed more fully below, there are a number of ways the corporation can get

into trouble, and so, it is vitally important for there to be controls in place to prevent missteps.

Select & Value a Target

Selecting a Target on which to focus is an important step, because proceeding with

negotiations and due diligence involve a significant commitment of time on the part of a number

of parties, as well as the expenditure of significant amounts of money. Accordingly, it is

important that there be a clear consensus among the corporation’s decision makers that a

particular Target is appropriate to pursue. At a minimum, the decision makers should agree that,

based on the preliminary due diligence, the Target:

• supports the corporation’s M&A strategy;

• satisfies the screening criteria; and

• appears to be the best Target to pursue from among the available alternatives, based on the evaluation criteria.

After the corporation selects a Target that it wants to pursue, the next step is to conduct a

preliminary valuation, based on the information available. This preliminary valuation is often

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revised later based on feedback that comes following the execution of a nondisclosure agreement

and the performance of further due diligence. Accordingly, at this stage of the process the

valuation is approximate, usually based on comparisons with comparable public companies.

Purchasers obtain ratios—commonly referred to as “multiples”—of the comparable companies’

enterprise values to their revenues or earnings or earnings before interest, taxes, depreciation,

and amortization (“EBITDA”). Then, the purchasers apply these multiples to the revenue or

earnings or EBITDA of the Target to estimate its enterprise value. Because this valuation

method is based on comparable public companies, it is only as good as the comparison is valid.

In addition, the multiples are often adjusted to allow for specific characteristics of the Target.

Enterprise value is defined as the market capitalization of the comparable company, plus its debt,

and minus its cash and cash equivalents. It is used as the standard valuation parameter when

conducting a comparable-company analysis, because it limits the impact of the comparable

company’s capital structure and cash reserves on the multiple being calculated.

Nondisclosure Agreements

Although the corporation will have conducted some preliminary due diligence prior to

selecting a Target and calculating its approximate value, it is unlikely that the Target will provide

the corporation with meaningful information without the execution of a nondisclosure agreement

(an “NDA”).

Obviously, there is a tension between the desire of the corporation to know everything

there is to know about the Target and the Target’s desire to ensure that its sensitive confidential

information is neither disclosed nor misused. The NDA is designed to provide the Target with

the assurance that the corporation will properly protect the confidential information that the

Target provides in connection with the transaction and during the course of due diligence. There

are a number of issues to consider in negotiating an NDA, although a detailed discussion of them

is beyond the scope of this paper. Nevertheless, in keeping with the theme of managing a

corporation’s M&A process, a few principles should be noted.

First, NDAs are normally unilateral. Unless there is a reason to do so, corporations rarely

provide confidential information to Targets. If, for example, the transaction calls for the

corporation to pay some or all of the purchase price in the form of the corporation’s equity, then

both parties might provide confidential information to each other, and so, the NDA would be

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mutual. If, as is usually the case, the NDA is unilateral, then the corporation should expect the

Target to press hard for very stringent safeguards of its confidential information, since it is not

making similar commitments to the corporation.

Second, if either the corporation or the Target is a public company, then the provisions of

the NDA must take into consideration the obligations of the parties under the securities laws.

Because the securities laws generally favor disclosure, they are likely to conflict with the goals

of the NDA. In addition, if the Target is a public company it will want to include “standstill

provisions” that limit the corporation’s ability to trade in the Target’s stock. The goal of these

provisions is not only to control the corporation’s trading activity—as a matter of compliance

with laws and as a defensive technique in the event the transaction is not consummated—but also

to control the sale process itself.

Finally, the corporation should keep in mind that the commitments it makes in the NDA

must be managed. For example, employees and other representatives of the corporation who

gain access to the Target’s confidential information should be made aware of the corporation’s

obligations with regard to the Target’s confidential information. In certain situations it will be

appropriate to coordinate who gets what information about the Target. When negotiating the

provision concerning the return or destruction of the Target’s confidential information, many

corporations find that it is infeasible to collect all copies of the Target’s confidential information

and, instead, require that they be allowed to certify that they have destroyed them. The

corporation should also consider whether it might be required to furnish some of the confidential

information in an investigation or pursuant to a subpoena. Many corporations insist on keeping

an archival copy of the confidential information to defend themselves against accusations that

they improperly used or disclosed the confidential information. Targets often insist on including

prohibitions against soliciting their employees for employment with the corporation. If the

corporation is a large, multi-national corporation, then managing compliance with such a

provision would be difficult, because parties who are completely unaware of the obligation might

violate it. Thus, the corporation’s ability to comply should be considered at the time the

provision is negotiated. The corporation might want to insist on not including such a provision

at all or limiting it so that it applies only to “key” employees (or to employees of the Target who

were identified to the corporation during the diligence process) and does not apply to general

solicitations that are not directed at the Target’s employees in particular.

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Preliminary Due Diligence

The title of this section is deliberate. Due diligence is an expensive process, even for

relatively small acquisitions. It is also the principal way in which a corporation manages the risk

of an acquisition, which is not necessarily proportional to the size of the transaction. Therefore,

the corporation should initially direct a small team to obtain reasonable confirmation that the

Target satisfies the corporation’s screening criteria, because if the Target fails, at any time, to

satisfy the screening criteria, then the transaction should be terminated immediately. Some of

this review can be accomplished prior to entering into an NDA, although most of it will take

place after the NDA is signed. After this initial review is completed, the corporation will

commence a more extensive due diligence examination of the Target that will continue at least

until the purchase agreement is executed and, frequently, until the transaction closes.

As with other aspects of the M&A process, due diligence should be carefully planned.

Normally, it will involve a team of individuals with different areas of expertise. If the

corporation is actively pursuing Targets, then many of the team members will be experienced

deal professionals. Depending on the Target, however, there might be a need to involve experts

who are unfamiliar with the due diligence process. If the corporation’s M&A team has an

established procedure for due diligence that is formalized and repeatable, then any new members

of the team can be quickly and fully apprised of how the process works.

Typically, an experienced member of the corporation’s M&A team will serve as the

leader of the diligence team to ensure that the team operates in a coordinated manner and

accomplishes the goals of the due diligence process.

LEADER’S RESPONSIBILITIES IN DUE DILIGENCE

• Ensure each team member understands:

� the type of transaction,

� the context in which due diligence is being conducted,

� what type of company the Target is, and

� the screening and evaluation criteria used to evaluate the Target,

• Assign roles and areas of responsibility to team members

• Establish the schedule for each step of the due diligence process

• Explain the deliverables that are expected from each team member

• Promulgate and enforce the ground rules for conducting due diligence, including how team members are to ask questions and request meetings with the Target

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Because due diligence is an evolutionary process, the review of one document might

prompt an additional line of inquiry or a need for additional documents on the same subject (i.e.,

supplemental due diligence requests). It is extremely important for the leader to control access to

the Target, because transactions are sensitive undertakings and, at least for a period of time, are

often confidential. Miscommunication, misunderstandings, and unreasonable requests for

information can ruin a transaction. Moreover, the Target’s first impression of the corporation is

often formed during the due diligence process. The leader should do everything possible to

ensure that the Target’s impression is positive, especially if the Target is conducting the

transaction as an auction. If the corporation deploys an experienced diligence team that is well

led, it can actually assist the Target in managing its time and resources.

Letters of Intent

One of the most debated topics of the entire corporate M&A process is the advisability of

using a letter of intent (“LOI”). Some corporations prefer using informal term sheets that simply

list the basic business terms being proposed, while others prefer elaborate LOIs that contain both

non-binding and binding terms. On the other side of the transaction, the temperament of the

owners or managers of the Target might dictate one form or the other. If the principals are

skittish about the transaction, they might prefer to see the details explicitly stated in an LOI.

From the corporation’s perspective, the execution of an LOI by the Target is often useful

evidence that the sellers, who might have emotional attachments to the Target, have crossed a

psychological hurdle and are ready to seriously consider selling their company. In any event, the

GOALS OF DUE DILIGENCE

• Confirm that the Target satisfies the screening criteria

• Confirm the information about the Target that is related to the evaluation criteria and look for other potential synergies

• Validate the initial valuation

• Learn more about the Target’s business, operations, and management team

• Attempt to uncover current and potential issues and risks and determine whether they are “deal killers” or can be addressed satisfactorily prior to closing or in the purchase agreement

• Refine the integration plan

•

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M&A team should make an informed decision about the type of document to be used. They

should base the decision on an evaluation of the facts and circumstances of a particular

transaction and refrain from using a particular approach because “that’s what we’ve always

done.”

As with other steps of a corporation’s M&A process, using an LOI enables the

corporation to proceed cautiously and incrementally, without committing large amounts of

unrecoverable resources on a transaction that might not close. In short, an LOI allows a

corporation to explore the prospects of a transaction with a Target and to reach an understanding

on the price, structure, and general business terms, without incurring all of the costs associated

with completing due diligence and negotiating a definitive purchase agreement. Sometimes, the

terms of the transaction are sufficiently complicated that it is helpful to describe them in writing

to ensure that the corporation and the Target have consistent expectations. Resolving difficult

issues at the LOI stage also makes the negotiation of the purchase agreement and other

documents considerably easier. Although the transaction terms that are set forth in an LOI are

usually nonbinding, the parties feel morally, if not legally, obligated to honor them.

In addition to the nonbinding provisions, an LOI can also include binding provisions that

regulate the rights and responsibilities of the corporation and the Target while the purchase

agreement and other documents are being negotiated. Corporations usually want—and

sometimes insist upon—exclusivity (commonly referred to as a “no-shop” provision), which

prevents the Target from negotiating with another party while negotiations are underway.

Frequently, LOIs establish the time frame for closing the acquisition and, sometimes, certain

other milestones that must be met prior to the closing, such as filing a request for a regulatory

approval that is required to close the transaction. Because LOIs contain both binding and

nonbinding provisions, it is extremely important that the document be crystal clear concerning

which provisions are binding and which are not.

The primary disadvantage of a comprehensive LOI is that it might burden the

negotiations with too many difficult issues too early in the process and damage the momentum of

the transaction. Some M&A professionals choose to decide on the details of the transaction after

they have conducted more due diligence and to defer troublesome issues until later in the

process. They believe that the longer the negotiations proceed, without getting bogged down, the

more likely it is that the Target will close the transaction. As the Target’s employees, vendors,

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financiers, and customers, learn of the transaction, it will become increasingly difficult for the

Target to terminate negotiations, for fear that the termination will cast the Target in a bad light,

regardless of the publicly expressed reasons for the termination. Also, the Target will have

devoted a significant amount of time, attention, and resources to the transaction, all of which

would be wasted if it fails to close.

Draft Integration Plan

Many good transactions fail to yield value to the corporation because the integration of

the Target was poorly planned (or not planned at all) or because the integration process

proceeded too slowly. The corporation has no business buying a Target unless it has a clear

concept of what it plans to do with the Target following closing. Accordingly, integration

planning should begin as soon as a Target is identified, by naming a steering committee of

relevant senior executives to oversee the integration effort. The steering committee should, in

turn, appoint a responsible person from the business unit or corporate department that is most

directly involved with the acquisition (the “Integration Project Manager”) who should be

involved throughout the entire acquisition process and who, under the supervision of the steering

committee, should be responsible for preparing and refining the integration plan up until the

closing. The steering committee should review and approve (or revise) the integration plan, so

that the plan has been vetted with all appropriate parties and the corporation is prepared to

execute the plan immediately following the closing.

Good business results rarely happen automatically; rather, they are the product of good

management. Integration is no different. Integration plans should be aligned with the strategic

objectives of the transaction, should consider the organization and culture of the Target, should

proceed systematically and quickly following the closing, and should comply with the antitrust

laws.

CHARACTERISTICS OF AN INTEGRATION PLAN

• Consideration of, and alignment with, strategic objectives of the corporation

• Determination of, and sensitivity to, the organization and culture of the Target

• Management of the integration process

• Compliance with the antitrust laws

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Strategic Justification

Integration planning begins with the strategic justification for the transaction. In other

words: What is the corporation attempting to accomplish by acquiring the Target?

If the goal of the acquisition is to generate economies of scale, then synergies are likely

to be achieved by terminating employees who are deemed to be redundant. This consequence is

either understood—or at least suspected—by the Target’s employees and, possibly, the

corporation’s employees, as well. Their uncertainty over the security of their jobs will be the

source of considerable anxiety for them, which could have adverse consequences for the

corporation if they decide to look for other employment. Accordingly, the integration plan

should proceed quickly, so that the corporation can enjoy the benefits of the synergies sooner

rather than later and—just as important—any job reductions related to the synergies soon

become old news. There are, of course, other operational expenses that can be reduced by

eliminating redundancies in areas such as R&D, new product development, distribution,

manufacturing, and supply chain.

Alternatively, if the strategic goal of the acquisition is to add new capabilities to the

corporation, then the success of the transaction will depend upon keeping the relevant members

of the Target’s team. Thus, the focus of the integration plan will be on establishing appropriate

corporate governance procedures over the Target, without destroying the characteristics that

made the Target attractive in the first place. In addition, since certain members of the Target’s

management team will undoubtedly be critical to the ongoing success of the Target, the

integration plan should address the retention and incentive plans for those key players. There

are, of course, other synergies that are focused on enhancing revenue.

SYNERGIES FROM REVENUE ENHANCEMENTS

• Cross selling new products to existing customers

• Accessing new markets and/or new customers

• Obtaining access to new distribution channels

• Improving the efficiency of the sales force

• Gaining more “bench strength” to deliver services to customers

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Regardless of whether the synergies result from reductions in expenses or enhancements

of revenue, the integration plan should explain how the corporation is going to realize them. It

should also include a detailed list of tasks, responsibilities, and deadlines, so that the plan can be

implemented quickly, without further discussion and review, following the closing. Time is of

the essence with respect to achieving synergies, particularly with respect to synergies related to

reductions in the headcount.

Organization and Culture

It is important for the integration plan to be sensitive to the organization and culture of

the Target. The corporation should not attempt to impose its standards on the Target in a

dogmatic fashion. Instead, if the Target’s organization and culture are different from those of the

corporation, then the corporation should remember that:

• It bought the Target for a reason; • The Target was attractive, even when it was structured and managed in ways that

were different from the ways in which the corporation is structured and managed; and

• In planning how it will integrate the Target, the corporation should ensure that the plan sustains the culture that enabled the Target to become attractive in the first place.

If the corporation starts imposing new people, new requirements, and new values on the Target,

then it might soon discover that the Target is very different from the company that the

corporation thought it had purchased. Corporations often begin the integration process with

those aspects of the integration plan that pose the least amount of disruption to the Target and

leave the more controversial aspects of the plan until after the corporation better understands the

business operations and personnel of the Target.

A tool that corporations can use to determine whether the organization and culture of the

Target are going to mesh with those of the corporation is the McKinsey 7S Framework, which

was developed in the early 1980s by Tom Peters and Robert Waterman. The basic premise of

the model is that seven internal aspects of an organization must be aligned and mutually

reinforcing if the organization is to be successful. If these internal aspects of the Target fail to

align with those of the corporation, then the integration plan should address how they will be

reconciled. Thus, the tool can be used to identify what issues need to be addressed in the

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integration plan in order to ensure that the corporation will realize all of the benefits of acquiring

the Target.

Management of the Integration Process

For significant transactions, directors should ask to review the integration plan and

should ensure that an Integration Project Manager with appropriate qualifications and sufficient

authority to implement the plan has been appointed. For smaller transactions, the board can

delegate this responsibility to the steering committee mentioned above.

A well written integration plan should cover, at a minimum, three principal areas. First,

it should address those actions that must be accomplished immediately following the closing of

the transaction to transition the Target to its new owner, both legally and operationally. Will the

Target remain a separate entity with its own assets, liabilities, and employees, or will it become a

shell corporation or be integrated completely into the corporation? This portion of the plan

should address such matters and should also include a list of the administrative tasks that must be

accomplished, such as ensuring that the payroll and benefits of the Target’s employees are not

interrupted. Each task should have a deadline (so that the tasks are accomplished in a

coordinated manner) and a party responsible for its accomplishment.

The second principal area that the integration plan should address concerns

communications. Effective communications can relieve a significant part of the anxiety

MCKINSEY 7S FRAMEWORK

• Strategy—the way in which competitive advantage will be achieved • Structure—the way the organization is structured and who reports to whom • Systems—processes and procedures used to manage the organization, including

management control systems, performance measurement and reward systems, planning, budgeting, and resource allocation systems, information systems, and distribution systems

• Shared Values—core set of values that are widely shared in the organization and serve as guiding principles of what is important

• Style—leadership style of top management and the overall operating style of the organization

• Staff—employees and their backgrounds and competencies • Skills—distinctive competencies that reside in the organization

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experienced by various parties as a result of the transfer of the Target to a new owner. The plan

should include short-term communications that are designed to reassure customers, vendors, and

employees that they have nothing to fear. It should also include ongoing communications that

will address the concerns of key stakeholders as the integration process unfolds. These ongoing

communications should be based on feedback that is solicited as part of the communication plan.

The final part of the integration plan is the most important. In general, it should address

how the benefits of the acquisition of the Target are going to be realized and, specifically, should

describe each step that must be accomplished in order to achieve that goal. The plan should

include a timetable for accomplishing the steps and should assign responsibility for

accomplishing each of them. Coordination is especially important with respect to acquisitions

that the corporation makes in support of its portfolio strategy or business element strategy, where

the goal is to leverage the benefits of the acquisition across all of the corporation’s business

units.

Overall responsibility for the integration will rest with the Integration Project Manager.

The front-line managers selected to be Integration Project Managers normally come from one of

the business units and, therefore, are usually supervised by an executive in that business unit.

With respect to his or her performance as Integration Project Manager, however, the executive

should understand that he or she reports to the steering committee. This reporting structure is

especially important when the integration plan relates to an acquisition that the corporation is

making in support of its portfolio strategy or its business element strategy, because no single

business unit will be responsible for the success of the integration.

Compliance with Antitrust Laws

When preparing the integration plan, the Integration Project Manager should keep in

mind that, until the acquisition transaction is closed, the parties remain independent entities that

are subject to antitrust laws. Specifically, Section 1 of the Sherman Antitrust Act (the “Sherman

COMPONENTS OF AN INTEGRATION PLAN

• Short-term administrative actions

• Communication plans (immediate & ongoing)

• Management of the process for achieving the benefits of the acquisition

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Act”) prohibits agreements that unreasonably restrain trade; the Federal Trade Commission Act

of 1914 (the “FTC Act”) prohibits unfair methods of competition; and the Hart-Scott-Rodino

Antitrust Improvements Act of 1976 (“HSR”) requires that certain acquisitions be reviewed by

the government prior to completion. These laws require that parties refrain from:

• Exchanging confidential, commercially sensitive information that could violate the Sherman Act or the FTC Act.

• Integrating their businesses before receiving antitrust clearances.

The parties would violate the Sherman Act and HSR if the acquiring corporation obtained

beneficial ownership of the Target before the necessary waiting periods expired. Such action is

referred to as “gun jumping” and can result in the imposition of substantial fines. Parties can

violate HSR by taking actions that are short of actually closing the deal, but equivalent to deal

closure. For example, potential liability under HSR can arise if a corporation engages in actions

that control or affect the decisions of its Target regarding price, output, or other competitive

metrics.

Although the parties remain independent competitors during the antitrust approval

process, and cannot coordinate their behavior in any way of competitive significance, substantial

integration planning can, nevertheless, occur. Such planning must be conducted, however, under

guidelines that prevent the improper exchange of competitively sensitive information and the

premature integration of the Target. Needless to say, integration planning should be coordinated

with qualified legal counsel to ensure compliance with the antitrust laws.

Step 5: Carry out the Transaction

When the corporation actually starts to carry out the transaction, it is likely that it will

hire outside advisors, if it has not already done so earlier in the process. These advisors could

include accountants or other professionals to assist the corporation with detailed due diligence

and/or tax planning, outside legal counsel, and investment bankers or other financial advisors.

The timing for involving these outside professionals is a function of the experience of the M&A

team: more experienced teams will be able to handle the preliminary aspects of a transaction

themselves.

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When outside professionals are engaged, however, it is critically important that the

corporation carefully define the scope of their responsibilities. If the corporation fails to define

the scope of the duties of the outside professionals, then these advisors might duplicate (and

charge for) work that the corporation has already performed or spend too much time on issues

that are of little consequence to the corporation. A corollary to the rule of clearly defining the

scope of engagements is to establish and maintain good lines of communication. The

corporation should require the outside professional advisors to provide them with effective

feedback, as described above, in order to prevent these advisors from wasting time on matters

that have already been addressed or are of little consequence to the corporation. In summary, the

corporation should coordinate the efforts of the outside advisors with each other, as well as with

the efforts of the corporation’s internal team.

Finally, the corporation should never allow the outside advisors to take control of an

acquisition. As talented as they might be, outside advisors are no substitute for the experience

and judgment of the corporation’s internal team. The CDO and his or her team usually have a

far better understanding of the corporation’s M&A strategy, and therefore, they should never

relinquish their role as the leader and manager of the transaction.

Continuation of Due Diligence

Due diligence is a sequential process. It starts in Step 4, with a focus on whether there

are deal-killer issues that must be addressed, and then proceeds along a line of increasing

specificity, as the parties involved attempt to discern the risks associated with purchasing the

Target. As the parties learn more about the Target, they should provide effective feedback to

other members of the team, which might affect the terms of the transaction or whether the

corporation should purchase the Target. As discussed above, due diligence should not be

haphazard or rote. It should be carefully planned, systematic, and tailored to the particular

Target involved, focusing on those aspects of the Target that could have the greatest impact on

the value of the Target to the corporation. As outside advisors join the internal team of people

who are reviewing the Target, planning and coordination become even more important in order

to ensure that the review is appropriate and complete and accomplished without a duplication of

effort.

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Purchase Agreement

The terms of the purchase agreement have received the most attention from the authors of

M&A articles, because the purchase agreement provides a detailed description of virtually every

aspect of the transaction between the corporation and the Target or its owners. In keeping with

the theme of this paper, I will not address the detailed guidance that has been offered about

provisions such as purchase price adjustments, representations and warranties, indemnification,

and dispute resolution. Instead, I’ll offer more general guidance concerning how this agreement

should be prepared.

First and foremost, the language of the purchase agreement should be unambiguous.

Accurate and simple agreements are naturally clear and, therefore, less likely to be the source of

disputes. If a dispute does arise, the time and expense associated with resolving it are usually

less.

Second, it is typical for purchasers to prepare the first draft of the definitive documents,

and they should be reluctant to relinquish that prerogative. The initial draft sets the agenda for

the negotiations. This phenomenon is especially important because the corporation (as the

buyer) knows what issues are important to it and will ensure that they are properly addressed in

the first draft of the agreement. If the corporation is forced to use the Target’s initial draft, it will

often find itself beginning the negotiating process significantly behind the starting line.

Third, the parties involved in preparing the purchase agreement on behalf of the

corporation should understand the goals that the corporation hopes to accomplish by acquiring

the Target. The purchase agreement will contain a great deal of detail about the transaction, and

it should reflect not only the provisions of the LOI or term sheet, but also the risk tolerance of the

corporation. Generally, the representations and warranties in the purchase agreement should

assign the risks associated with various aspects of the transaction based on which party is in the

better position to avoid a particular risk. Specifically, they should reflect the risk tolerances of

the corporation with respect to the matters addressed in the representations. The indemnification

provisions should be structured in a way that provides appropriate relief for breaches of the

representations, warranties, and covenants.

Finally, outside legal counsel should not be allowed to “over-lawyer” the transaction.

Counsel should know what is important to the corporation and when to concede on a point.

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Yielding to the demands of the Target is not losing, when the corporation is not hurt or when the

risk involved is minimal and can be contained. The objective of the negotiations is to arrive at a

solution that accommodates the concerns of both parties within the given circumstances: in

short, a “win-win” deal. Achieving a win-win deal is especially important when the owners of

the Target will continue to be involved following the closing. Over-lawyering can lead to hard

feelings that could make integration difficult or, in the worst case, kill the transaction.

Moreover, I have seen lawyers argue points that have more to do with the lawyer’s ego than they

do with the goals of the party they were representing. Such behavior leads to unnecessary

expense and should not be tolerated. If the corporation’s counsel encounters an opposing

counsel who is holding fast to an unreasonable position, then he or she should inform the CDO

or the member of his or her team who is in charge of the negotiations. Discussions between the

business persons are often a better way to resolve such an impasse.

Finalize Integration Plan

The primary reason the Integration Project Manager is involved throughout the M&A

process is to ensure that the integration plan incorporates all that is learned during due diligence,

the negotiation of the purchase agreement and other transaction documents, and the closing of

the transaction. The goal for each transaction should be to have, at closing, a fully developed

integration plan that has been refined throughout the course of the transaction and will enable the

corporation to commence the integration process immediately following the closing.

Close the Transaction

If the corporation has done its job correctly, the closing will be anti-climactic. There will

be no surprises, because the corporation will have methodically examined the Target, and

because there will have been a true “meeting of the minds” between the parties, based on the

terms set forth in the purchase agreement.

Step 6: Execute the Integration Plan

The true testament to whether the process has been successful is whether the integration

is successful. Abundant evidence supports the conclusion that most M&A transactions fail

because the integration failed. Bringing together two organizations is extremely difficult and

fraught with pitfalls. Nevertheless, if the corporation thought about integration early in the

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M&A process, prepared a draft integration plan, got the required feedback, and refined the plan

during the course of the transaction, then at the time of closing the corporation will have a

blueprint for making the acquisition successful. Alternatively, as is often the case, if the

corporation delayed the preparation of the integration plan until the closing, or created the plan

without regard to what took place during the M&A process, then the integration is likely to be

unsuccessful.

CONCLUSION

A corporation’s M&A program should be based on a strategy that is aligned with the

overall strategy of the corporation. It should be an integral part of the business, not a process

that is divorced from the rest of the organization. And, it should be managed; that is, it should be

planned, organized, directed, and controlled.

Proper planning of the corporation’s entire M&A process, as well as each aspect of the

process, is essential to ensure that the corporation’s M&A program contributes to the

accomplishment of the overall goals of the corporation. Plans should be detailed and should

identify all of the actions that are necessary to achieve success.

Next, these actions must be assigned to specific individuals. As indicated by the previous

discussion, there are numerous parties involved in a corporation’s M&A program. Some

individuals within the corporation are fully devoted to the corporation’s M&A program, while

others are involved only occasionally. In addition, there are usually numerous outside advisors

who have critical roles to play. The tasks of all of these individuals must be carefully organized

so that they function in a coordinated manner and contribute to the accomplishment of the

objective.

As important as planning and organizing are, however, they are insufficient to achieve

success: there must also be direction and control. General George S. Patton was fond of saying,

“A good plan violently executed now is better than a perfect plan next week.” He was not

discounting the value of planning, however. Rather, he was emphasizing the relative importance

of executing the plan. Complex processes require strong direction and control. This fact is

especially true with respect to a corporation’s M&A program, where time is often truly “of the

essence.”

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By applying the same practices and procedures that they use in other aspects of their

businesses, corporations can realize the full potential of their M&A programs. The goal of this

paper was to set forth a systematic way of doing just that.

The Science of M&A in Large Corporations

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