This article was originally published in the NACD Private Company Newsletter.
Entering a recessionary period is always an interesting time for mergers and acquisitions (M&A); 2022 deal activity is down from 2021 but is relatively stable compared with prior periods. In this cycle, transactions are taking longer to execute due to increased regulatory scrutiny. Also, notably different than during the global financial crisis, the banking system is well-capitalized and resilient, and private capital as well as corporates are sitting on significant amounts of dry powder.
The role of the board in navigating the volatility of today remains critical. When facing a downturn and potential long-term recession globally, companies can find themselves on one of three paths: grow, survive, or die. The board must engage in active strategic oversight and assess potential transactions as buying or selling opportunities.
Companies that grow amid volatility are already in a position of strength with access to capital. The board and management are in the enviable position to pursue strategic targets at advantageous valuations. Targets are often companies in survival mode and focused on liquidity, leverage, and maintaining the core business. These boards should be considering divestitures of noncore assets or restructuring the balance sheet. If a company is entering a recessionary period with declining performance or an impending liquidity crisis, it is critical for the board to know this while it can still act to deliver the best value for shareholders. Being acquired or merging may be the best option. In any case, the board should know which path the company is on.
Mergers and acquisitions activity in uncertain times brings several key risks to the forefront of the boardroom, including strategic, financial, regulatory, and talent risks.
Boards are well served to proactively oversee a strategic assessment of mergers and acquisitions or divestiture opportunities in the case of a potential downturn. Identifying strategic targets or potential acquirers creates space for thoughtful consideration before getting caught up in the moment. Amid uncertainty, transaction opportunities can present themselves quickly. Identifying a situation as aligned with long-term corporate strategy increases speed to execution, improves valuations, and satisfies shareholder expectations.
The board must also consider allocation of resources when volatility may limit capital and management bandwidth for integration while addressing challenges in the existing business. Importantly, the board must be able to assess when management wants to do a deal and should not (as management often advocates for acquisitions brought to the board) or does not want to do a deal and should. An independent assessment from a third party or appointment of a special committee is an effective measure to clearly analyze risk and reward trade-offs.
In this environment, valuation and price matter. Boards on both sides of the table should ask for scenario analyses and valuation updates frequently during negotiations. The acquiring board should question growth projections and cost synergies with judgement and scrutiny. Similarly, the board’s role in a sale or divestiture is to obtain the highest and best value for shareholders, and one way to mitigate valuation risk is to keep management focused on executing the deal as quickly as possible.
All boards would be well served to assess proforma financials under macro stress scenarios, as well as typical synergy scenarios. Having a view of the potential downside if revenue does not grow and interest rates rise, for example, is more effective than assuming static macro factors over time.
Regulatory review of proposed mergers and acquisitions transactions has recently expanded in duration, scope, and depth. For example, competitive stakeholder reviews focus on industry, as well as employees, customers, and suppliers. In cross border deals, matters of national security, data privacy, and climate change are high priorities. Regulatory delays can erode value and put pressure on the target, which wants to close the deal as quickly as possible, and the acquirer, which will accept extra time constraints to minimize regulatory remedies.
A disciplined process mitigates regulatory as well as litigation risk. Expect transaction outcomes to be challenged and document decisions, discussions, and disagreements throughout negotiations. Scenario analyses are also effective to identify and address regulatory concerns early. The board must set longer timelines to mitigate against delays in regulatory approvals, protect against renegotiations, and maintain business operations without undue distraction.
Certain mergers and acquisitions risks remain prevalent in any economic environment. Board and management teams have a role in ensuring successful transitions before and after the deal is finalized. A mismatch in corporate and board culture is one of the most common causes of failed integrations. The board is making a big bet on the leadership team. A deal may fit strategically, but management needs to execute the integration and implement the go-forward strategy. The board must also ask if the directors collectively still provide the right expertise and talent required for the new organization.
However, the last few years have been defined by crises. Boards and management teams are still navigating through the COVID-19 pandemic and the future of work. We are facing an economic recession and global turmoil. Consider board, management, and employee fatigue. Boards must determine if mergers and acquisitions or divestiture opportunities are strategic versus reactive to the market and macro environment.
To navigate mergers and acquisitions today, the board should proactively identify risk and potential impacts through strategic assessments and scenario analyses. Additionally, expect transactions to take more time and focus from the board. Finally, in this cycle with capital in the market, know that there will be winners and losers.