What should be the focus of CFOs handling M&A?

It can take months and sometimes years to complete merger and acquisition transactions (M&A), and even if documents are signed, work can by no means be considered completed. What should be the focus of CFOs at every stage of M&A? How can other participants in the process help merging companies and at the same time boost their own status?
Mergers and acquisitions are a type of transactions intended to transfer or consolidate company assets for growth, reduction, change of business or market position. Those involved in such transactions may be companies seeking to complete small deals from USD 1 million or mega deals worth tens of billions of US dollars.

About the author: Stanislav Skakun has been working at Intercomp for over 9 years during which he has been involved in 4 M&A transactions. Stanislav did an internship at the Russian Ministry of Foreign Affairs and accounts authorities of the Russian Federation. Stanislav has a DipIFR, CMA (U.S. Certified Management Accountant), PMP (U.S. Project Management Professional) and a Ph.D. in economics.
Станислав Скакун, директор по экономике и финансам Интеркомп
Stanislav Skakun
Head of Finance

M&A market

A record volume of mergers and acquisitions was observed recently to exceed USD 4.7 trillion in 2015, beating the previous record of 2007 (USD 4.6 trillion). With about 100 mega deals (transactions exceeding USD 5 billion), 2015 was also a record year in terms of the number of M&A transactions, and approximately 8% of global GDP has thus changed owners through M&A.

Volume of M&A in billions of USD (Sources: KPMG, AK&M)

Year       2013          2014         2015             2016     
World        2760             3640             4761            3405   
Russia         115                71               56             42   
Share of Russia           4,2%              2,0%           1,2%             1,2%     

Experts expect the number of M&A transactions to continue increasing to reach a peak in 2017 in developed countries and in 2018 in developing countries. The greatest growth rates should be expected in China, Hong Kong, the Netherlands, Mexico and India, while the most interesting countries for investment will be Great Britain, Germany and Spain, while health, information and telecommunications technologies should remain industries with good prospects.

In Russia, there has been a decline since 2014 in the volume of M&A transactions, and from a fairly impressive 4% of the global market, Russia has fallen to 1%. 450 M&A transactions were completed in Russia in 2016. According to statistics from AK&M bulletin on M&A Market, the participation of Russian companies in the M&A market showed growth for the first time since the beginning of the crisis. The total value of M&A transactions for January and February reached almost USD 7 billion which is 2.5 more than last year.

Why are M&A transactions completed in Russia? A number of industries register extremely low rates of growth, while competition is intensifying. If the market does not grow, then a possible strategy is to increase market share through M&A. M&A also partially resolve the issue of competition.

Many companies are, on the other hand, still unable to overcome the crisis, and for them M&A transactions represent a way out of the market. M&A in Russia today are an alternative to competition.

Who enters into M&A transactions?

Private equity funds professionally handle M&A transactions. The total volume of assets currently managed by private equity funds worldwide exceed USD 4 trillion. Private equity funds specializing in certain sectors find private companies which are growing fast with strong management teams capable of generating high returns on invested capital. They get involved in the management of companies as medium-term investors until they reach target indicators. Private equity funds then withdraw from companies through an IPO or by selling a stake to a strategic or financial investor with a profit for themselves.

Private equity funds handle M&A professionally.


And in the end, the chances are that they resell.

But private equity funds are not strategists. They buy companies to “repackage” and resell them.
It is not possible to keep M&A specialists on a permanent basis in ordinary companies, especially medium-sized ones. More often than not, companies set up a working group consisting of CEO, CFO and COO who are later joined by lawyers and other colleagues from security, HR and other departments.
As soon as a company begins considering an M&A transaction, an excellent opportunity arises for all top managers to look at the company through the eyes of shareholders and see how they can increase the value of their company and become a full business partner, as well as focus on strategic matters rather than operational management. This contributes to the evolution of back-office functions toward business partnership where functions which were used to be seen as supportive, such as HR and financial functions, begin to have a key, strategic importance in creating value for the company.

M&A stages

M&A transactions traditionally consist of the following steps:

  • 1
    Transaction preparation
  • 2
  • 3
    Due diligence
  • 4
    Transaction structuring
  • 5
    Transaction completion
  • 6
    Transition period
  • 7
    Final payment
  • 8
    Synergy creation

Step 1: Preparation

As soon as the parties are acquainted, and all presentations are completed, it is time to sign the first document which will most likely be “conceptual”, not binding on the parties, but will still include some important provisions the violation of which could give rise to financial sanctions. For the buyer, these are the principles on the basis of which the target company should be assessed. For example, it could be agreed that revenues will be the basis for evaluation so that the company will be acquired for 1, 2 or several times its annual revenues, and the buyer will also, of course, want to specify the risks that should be deducted from this value.
It is important to choose a good evaluation formula at this stage as it will be quite difficult to change the seller’s position and change the evaluation formula at those stages where some risks will have already arisen and bargaining begins. Although this naturally depends on the seller’s negotiating position, choosing a good evaluation formula already at this stage resolves many problems subsequently.

Simple example. We decided to deduct tax risks from the company’s value and assess document quality to determine how many additional payments could be expected following an unscheduled inspection. But what if the due diligence reveals violations of currency laws exceeding the revenues received by the company? This is already a matter which is not entirely related to tax but which could give rise to some disagreement. It is therefore better to specify these deductions with a more general terminology by stating that we would like to deduct any possible liabilities which could arise, for instance, in case of inspection from state authorities. Thanks to more general terms, this definition is more likely to still be applicable and relevant at later stages of the transaction.

The following should be considered:

  • Search for target companies: working out evaluation criteria; short-list for shareholder consideration; segment definition
  • Financial modeling based on open sources: synergies, payback periods, main hypotheses
  • Investor search: usually done by CEO but CFO may be involved
  • “Business packaging”: preparation of “road show”, “management presentation”; work with consultants

Step 2: Termsheet

A termsheet (agreement on the main terms of transaction, declaration of intent) is a document specifying the main arrangements agreed by the parties regarding the legal and financial aspects of an upcoming investment transaction between the parties.

The following important points should ideally be included in termsheets:
  • Parties to the transaction
  • Contributions to the company (what and when)
  • Ratio of interest/share before and after contributions
  • Interest/share price
  • Conditions for transaction closing
  • Confidentiality
The seller is, of course, eager to protect confidential information as it will have to provide very sensitive data about its company, while the buyer seeks exclusivity. These points must be included in the termsheet.

The following should be considered:

  • Agreement on main conditions
  • It is important to correctly define the evaluation principles. Provide for the possibility of revision
  • Agree on exclusivity
  • Agreement on main conditions
  • Protect confidential information

Step 3: Due Diligence

Due diligence is a procedure as a result of which it is possible to objectively describe an investment project. This procedure includes an assessment of investment risks, an independent evaluation of investment project, a comprehensive review of the company’s activities, a comprehensive check of the company’s financial condition and market position.

At this stage, top management is tempted to conduct this review on their own as they understand their own business like no other. The CFO might want to work out EBITDA on his/her own. They might want to engage lawyers to assess tax risks, HR director to evaluate human capital, etc. But it would be better to engage a due diligence specialist because any mistake made at this stage will be deemed by shareholders as a top management mistake. And it is a well-known fact that no deal goes as planned on paper. It is therefore better to enlist the support of an external professional, in particular as this does not preclude the involvement of any team member that could help with proper data evaluation. Many risks can be identified at this stage so it would be preferable to engage a team of strong experts to look at the company for sale.

The important point for the seller at this stage is not to give more information than requested by the buyer. Any “unnecessary” document submitted during the due diligence could give rise to additional questions and will be used to identify risks, i.e. against the seller, for additional bargaining.

Example. Successful price increase seems to indicate customer loyalty and a strong position, but the buyer can argue that by raising prices, the seller is risking an outflow of customers. Data on customer outflow resulting from price increase will be requested, and the task of measuring the effect on your business will be assigned, but these data might not be available or it would be too time-consuming to collect them.

The following should be considered:

  • Tax, financial, legal and technological due diligence
  • How to conduct due diligence: outsourcing vs. in-house?
  • Important:
  • Areas of verification: major counterparties, intellectual property, key personnel, stability of customer base, technological aspects
  • Actual data transfer is a virtual data room, strict documentation of all transferred information, recording of access, inventory, etc.
  • Important:
  • Not submit more than requested. Minimize costs. Minimize risk of staff anxiety. Depersonalize critical data

Step 4: Transaction structuring

As soon as risks are assessed and the correctness of the evaluation formula is confirmed, we can start working on the transaction structure and its legal drafting.

Perhaps the intention at the first stage was to buy a group of companies, but the actual situation is such that only one company of the group corresponds to the developed risk profile as tax issues and potential additional tax payments have been identified for the other companies of the group.

Perhaps it became clear that it will not be convenient to withdraw monetary funds in a jurisdiction under, for example, British law so it might be better to structure the transaction under Russian law. Incidentally, this option has become increasingly popular following the amendments introduced to the Russian Civil Code 3 years ago which allow providing for the same conditions as those usually prescribed under British law. So the only drawback now under Russian law is that there is no extensive court practice on М&А yet. But under Russian law it is, for instance, not required to pay tax on dividends and proceedings in Russian courts are much more affordable than in other countries. It is therefore worth weighing the pros and cons to decide under which law M&A transactions should be structured.

It is important for the seller to specify here how payments should be structured, i.e. how long the transition period should be, the obligations during the transition period, and of course, payment proportion: 30/70, 80/20, etc., which will most likely be dependent on the number of risks identified during the due diligence. Everything which is at risk will be payable at the end of the transaction term.

The following should be considered:

  • What is bought: business, legal entity or group of companies
  • Transition period
  • Guarantees
  • Applicable law
  • Important:
  • Financing – not 100% from bank
  • Payment structure (first payment, deferred payment, guaranteed payments, etc.) How long should the transition period be?
  • Important:
  • What obligations are assigned to the seller given that they will be fulfilled by its team? How to ensure that business continues as usual during transfer?

Failed M&A transactions at the structuring stage

M&A transactions often fail at the structuring stage because some issues, which were not anticipated at the beginning of the transaction, arise or are identified during the previous stages.

Buyer Target USD billion Year Reason
Pfizer's Allergan 160 2016 The U.S. Treasury introduced new rules to limit so-called inversions used by companies to reduce the value of their promissory notes by changing jurisdictions
Halliburton Baker Hughes 38 2016 U.S. and European antimonopoly regulators did not approve the deal
China's GO Scale Capital Koninklijke Philips NV 2,8 2016 Ban from the U.S. National Security Council

Step 5: Transaction completion

There is less pressure on CFOs once M&A transactions are closed. Financing has been raised, all documents are signed, and financial models have been verified and approved. So is it possible to take a back seat at this stage? Well, no, of course.

The following should be considered:

  • Issues related to integration of systems and retention of teams
  • Fulfillment of transition period obligations
  • Transfer to new owner management
  • New opportunities

Financial models do not work

No M&A transaction runs its course as in the financial modeling outlined “on paper” due to various reasons such as:
  • Team integration issues;
  • Loyalty of key customers;
  • Unknown adverse event.
Why do M&A transactions often go wrong? This usually boils down to the difference in corporate cultures and the staff managing companies. The issues related to team integration are the first reason why transactions do not run as they should. It would seem that team integration is beyond CFO responsibilities and should be handled by HR directors, but this is not the case.

The good news is that CFOs may assess the differences in teams, cultures, etc. at the due diligence stage by asking, for example, the following questions:
  • Is the employee pool sufficient for the merging company?
  • How are employees recruited?
  • What is the staff turnover rate?
  • What corporate benefits are provided: What can be added/called off?
  • How do salaries for the same positions compare?
  • Have incentive schemes been correctly put in place? Do they foster optimal behavior?
  • Which executives hold key positions in the merging company?
  • Which training programs will be required during the integration phase?
  • Which technological systems will be used by the merging company?

This information gives an objective view of how companies compare to one another. In one company, the staff turnover rate may be 8%, i.е. people work in this company on average for more than 10 years, while in another company, this rate is 40%. This means that this company has a completely different corporate culture if it has stayed so long on the market with such a high staff turnover rate.

It is possible to buy a company which is 100% the same, engaged in the same business with the same customer portfolio, but it could in fact be a completely different company, another business. It is not possible to assume that everything will be simple even if the purchased company is smaller with the same customer portfolio and provides the same services.

The financial model must therefore take into account the integration model because the benefit that can potentially be derived from a well-planned integration is very high. According to Harvard Business Review, the top 10% of successful companies earn 11 times more under M&A transactions than the 10% of outsiders.

It is very important to involve HR directors in due time to help CFOs assess the corporate culture of the company that is about to be purchased and work out how integration will take place. Even when all documents are signed, i.e. when nothing can be changed, it is worth staying informed about the business integration and using all the resources and skills to properly integrate the company because if an M&A deal leaves a hole in the budget, then no one will repay it.