Let’s make a deal

The wind of change is blowing and directors need to think differently when planning how to enter into a transaction after such a long period of economic stability, write Paul Billingham GAICD and Jonathan Dunlop GAICD.

In 1990, German band Scorpions released Wind of Change, a power ballad that Rolling Stone magazine described as “an anthem for the end of the Cold War” after the song became synonymous with the fall of the Berlin Wall and dissolution of the Eastern Bloc. It is perhaps fitting that the title of the song is today often used to describe the rapidly changing economic conditions that businesses face and which are again, in part, emanating from Europe.

The volume of deal activity in Australia shows no signs of letting up — the times bring opportunity for those with dry powder. We know that business values will inevitably be affected by external factors, but if you run a disciplined transaction process you can put yourself in the best possible position to achieve a good deal outcome. As ever, preparing thoroughly and executing meticulously is the key.

So, what do you really need to be considering in securing the best outcome for your shareholders when the wind of change blows? The times of increasing uncertainty require acute awareness of changing political, economic, social, technological, environmental and legal (PESTEL) factors.

Have you got the right people, skills and experience in place?

Deals are all-consuming for those involved and can be highly complex. You will need a dedicated person or team to run the deal, including people who can evaluate the business for sale sufficiently well to value it appropriately, conduct a negotiation and identify the critical matters involved in integrating or separating a business. If you have an in-house M&A team, great. If not, and you have nominated your CFO, make sure you backfill their day job so that they can fully focus on the transaction.

Running a deal also requires incredibly strong project management skills, as there are tight timetables, regular deadlines, masses of information to assimilate, meetings galore, numerous stakeholders — and rarely enough hours in the day.

The big deal issues should be known early so you can form an initial view about how the deal team should address them. The key market, operational, financial and legal risks and opportunities that will get focus need to be understood if you want a smooth process. Unexpected surprises can impact value, extend deal timetables or completely derail deal processes.

You are likely to need experienced deal advisers. Depending on the deal, these may include M&A and legal advisers, strategy specialists, taxation and accounting transaction diligence specialists, operational experts, technology support, and people and culture specialists. To get the most from your advisers, make sure much of their attention (and cost) is tailored to the critical deal issues and not on completing checklists.

How effective is the management team?

With all businesses now seemingly affected by rising input costs, supply chain issues and labour shortages in a way that has not been experienced for many years, smart businesses are passing on the increases to customers where they can — rationalising product ranges, doubling down on more aggressive procurement, thinning their organisations, slowing payments to suppliers, accelerating capital expenditure to improve productivity or delaying non-core major capital expenditure because costs are rising too quickly.

Understanding how a business you are looking to acquire, or sell, has responded by adopting these and similar measures is therefore fundamental. Now, perhaps more than ever, a huge part of the success of the transaction rests on the quality and adaptability of the management team.

Therefore, you should determine whether that management team has the right composition with a strong track record of achievement, a credible strategy for the business, genuine awareness of how the business might be affected by the economic headwinds, and well-considered plans for how to respond.

You should not be afraid to dig further. Assess the evidence offered that supports management assertions, stress test the responses, and bring that objective scepticism to what you read and hear. Why? Well, we know that an effective, aware and agile management team is an asset to a business. The likelihood of a successful transaction — whether you are a buyer or seller — increases when you have a management team that is on the front foot — one that has thorough, proactive and realistic plans in place.

Do the numbers support the investment proposition?

A well-populated data room is non-negotiable. The information about the business that you plan to use for due diligence should be comprehensive and cohesive. Gaps and inconsistencies impact credibility and erode value.

Robust historical financial information is vital. You need a minimum of three years of historical monthly profit or loss accounts, cash- flow statements and balance sheets, reconciled to audited accounts. The underlying quality of historical earnings should be clear, with non-operating and one-off items identified and normalised, if appropriate. Having clear explanations for movements and trends in financial performance, cash flows and working capital balances that tie into and support the sales themes provides comfort to the financial evaluation of the business.

Of course, it isn’t just about the history. A detailed three-way forecast (integrated balance sheet, profit or loss, cash flow) for a minimum of 12 months should be prepared on the same basis as the historical information, with well-documented and properly supported assumptions.

Projections going out a further four years are good practice, and while prospective financial information is informed by historical performance, the inflationary environment that the business is operating in, and how it is responding, ought to be reflected in the assumptions and sensitivities.

This is where it all comes together. You’re looking to test the quality of the strategic thinking and execution capability of management, and the resilience and vulnerabilities of the business, by evaluating recent performance. You are also running scenarios to validate or challenge the appropriateness of the measures that management has either put in place or intends to implement in the face of rising input costs, skilled labour scarcity, supply chain difficulties and so on.

Can you catch the wind?

So, back to that famous Scorpions song. Is the future really “in the air”? We think so.

Your role as a director? We think it’s to ensure the foundations for success are there. To get the best out of M&A activities, whether as sellers or buyers, you need to ensure that the deal team is properly resourced in terms of people, skills and experience. And if the business for sale has a confident, well-prepared management team that can identify and seize the opportunities that will inevitably present to reshape and grow, the probability of the transaction being successful will be enhanced significantly. Complete and accurate information, well-explained strategies and plans, and scenarios that consider the coming changes, all go towards making the deal process run smoothly and to plan.

Paul Billingham GAICD is managing director of restructuring and performance improvement and Jonathan Dunlop GAICD is managing director of transaction services at GreenMount.