A number of years ago, the financial media was buzzing with news about the possible acquisition of a large American entertainment company (Universal) by an even larger Japanese electronics giant (Sony). Assuming completion of a transaction of this magnitude, it was at least safe to assume from all obvious signs that the deal would be based upon strategy rather than a pure desire for additional revenue, or corporate ego on the part of the projected buyer.
The earliest discussions of this transaction all contained opinions concerning the future of seller's management—indicating that existing management would have their positions guarantied for a number of years. On September 26, 1990 the Los Angeles Times quoted an unnamed source as stating "Management stays in place. That's the essence of the deal. . ."
While the existing management team may have been the essence of this particular deal—and may have received contracts which guaranty tenure over a defined period—were they truly perceived by buyer as being essential? Does any buyer perceive of in-place management as being essential? More important, how can a buyer ensure the value of seller's management—and to what level?
Assuming successful operation and ongoing profitability, most acquired companies, regardless of size, should bring additional management capability to their new parent organization. Unfortunately, a significant number of buyers fall prey to the "comfort syndrome." They know, and are quite comfortable with internal management. Under control of this mistaken concept, buyers are often prone to replace various levels of sellers' management with their own people, rather than take the time and effort needed to evaluate newly acquired resources. In many cases, this syndrome begins to operate early in the process, with buyer's senior management casting about in seller's organization chart seeking "new growth opportunities" for their own upper and middle management. Appropriate changes in seller's management can certainly be made—but only after thorough evaluation.
Having performed a degree of due diligence to verify the expressed historic performance of a seller, buyer can form a judgement as to whether management is doing its job in an effective manner. When dealing with a seller large enough to support several tiers of managers, however, the key to this aspect of the process is to determine exactly which individuals are performing and which are being carried by the achievers. This can only be accomplished by reasonably open discussions between buyer and seller personnel. These talks should be face-to-face, with few, if any, of seller's top management in attendance. They should be conducted by key personnel from various disciplines within the buyer's organization—and should not be confused with those meetings necessary to discuss employee benefits and other routine matters. Group sessions are appropriate at certain levels of management, but individual meetings should be held with any supervisor whose value is questionable or conversely, whose merits have been touted as being superior.
Many sellers will attempt to prevent buyers from speaking with existing personnel below the highest level—supposedly privy to the details of a pending transaction—and certainly aware of the transaction's existence. This group of sellers will use a variety of excuses to "shield" middle and lower management—the strongest being that they must be permitted to carry on with their day-to-day functions and cannot be "disturbed" by concerns about the deal and their impending new employer.
Such concerns can be completely valid and buyers should make every effort to conduct interviews in an organized, efficient manner—with a minimal consumption of business time. Breakfast, luncheon and even dinner meetings are appropriate for this purpose and can be more productive if seller's employees are made to feel more comfortable by such informality. If a public announcement has been made, buyer must insist on some degree of access to the general management group—if only with the absolutely valid purpose of offering them reassurance concerning the future.
Sellers with multi-tiered management groups should be equally insistent that all of their managers be given the opportunity to become acquainted with, and ask questions of, their new parent. Announcement of a planned transaction does not mean that it will be completed. By keeping its key personnel reasonably aware of deal progress and allowing them a controlled degree of access to buyer, seller can help in ensuring that management does remain in place until it can be evaluated thoroughly.
A study done by Dr. Kim Stewart, at the University of Denver's Graduate School of Business, found that a large proportion of CEOs who were acquired left their new company within four years after the transaction had been completed. The study reviewed more than 500 companies, acquired from 1984 to 1988.
As might be expected, a large proportion of the CEOs who departed did so from companies acquired under hostile conditions. The fact remains, however, that 65% of CEOs who left were acquired under friendly transactions. The reason cited most often was lost autonomy. In analyzing the written comments provided by more than 200 of the CEOs who responded, the study discovered six problems which occur after acquisition.
Loss of autonomy, the most frequently cited complaint, was followed by parent firm "arrogance," which encompassed refusal to utilize and listen to acquired top management. Next came implementation of parent policies, when existing procedures were believed by the acquired CEO to be superior.
Also included were clashes between the cultures and management objectives or values of the parent and acquired firm; the parent firm's lack of knowledge and understanding of the new subsidiary's business; breach of verbal agreements made in negotiations; and loss by the acquired firm of its entrepreneurial spirit. We discussed the study with Dr. Stewart, and raised several questions, some of which we will explore in this and subsequent issues.
When a departing CEO cites lack of autonomy as the motivating factor for leaving, what does he really mean? Surely no experienced manager believes that the degree of autonomy in another, probably larger corporation, can be quite the same as running a venture which he started and built to the point where it was desirable as an acquisition candidate. And just as surely, any buyer who tries to convince seller that such will be the case is doing little more than misleading both parties. There are, of course, always exceptions.
In many cases, the CEO is one of the most important assets in a company, and acquisitions have been done with the attainment of this individual as the primary goal. Even when this is the primary reason for an acquisition, why should the situation be different from the CEO who is hired by a board of directors? In many such cases the new CEO is promised full operating latitude, only to have this situation changed by some new set of circumstances.
The first areas for exploration in any transaction are the true agendas which motivated the parties. Dr. Stewart's study indicated that the turnover rate among CEOs in hostile takeovers was more than 95%. While the study has thus quantified an existing problem, such a high turnover rate should come as no great surprise to anyone. In our opinion, any study of what makes management resist an unfriendly takeover would find job security, in one form or another, high on the list of reasons.
In the typical friendly acquisition scenario, both buyer and seller express the desire to maintain management in place. Even in the event of a management group seeking retirement, some meaningful period of transition will be agreed upon mutually. It is also not uncommon for buyer (perhaps not wisely) to promise unlimited autonomy to a soon-to-be-acquired CEO. If nothing else, this represents an unfortunate part of the initial courtship process, but one often considered to be important.
We have used, and continue to use the expression "courtship" in relation to pre-merger discussions between companies. We do so because the parallel between corporate merger discussions and individual human social relationships is very close. In both instances the entities involved are often too much involved with pursuing end results to allow time for consideration of interim problems.
In some examples, one or both parties are fully aware that they are making non-achievable commitments concerning future operation of an acquired company. We do not believe, however, that such is the case in most instances. In our opinion, such misstatements are motivated by a natural, albeit somewhat unprofessional desire to exert a positive influence on the other party.
Responsible buyers and sellers must take the time to inform themselves thoroughly as to what drives their opposite numbers in a transaction. While there is no single way to accomplish this end, it is not impossible to seek for and find the true goals of each party. Obvious signs of future dissatisfaction are too often overlooked in the mutual flush of excitement which accompanies every transaction.
The preceding examples may appear to range from trivial to ridiculous in character. They are intended only to exemplify a very genuine group of potential problems. One might argue that they are too petty even to consider in the global context of a multi-million dollar transaction. They are perhaps unimportant as individual items, but any one of them could serve to initiate a level of dissatisfaction sufficient to convince even a seasoned entrepreneur that he has made a bad choice. As an entrepreneur, he now has the option of taking his new found wealth and starting over in a financially more comfortable manner than in earlier years.
No restrictive covenant or earnout agreement can prevent this valuable manager from taking leave of an unpleasant situation. Both of the preceding techniques can delay the inevitable but that is the extent of their effectiveness. Only good planning and proper execution can ensure that acquired management will become, and remain, valuable additions to a newly combined entity.
The primary method would be the use of absolutely full and candid disclosure in any conversations relating to this subject. Such discussions should be held between seller and appropriate highly placed individuals within buyer's organization. Major agreements should be memorialized in written form.
Buyer should be fully aware of the level of autonomy enjoyed by any entrepreneur. If buyer really does not intend to operate the combined entity with the level of autonomy formally enjoyed by seller, this issue should be brought out and addressed completely. This series of conversations should be held prior to any offer being made for the target company. Barring the possibility of deliberate deceit on buyer's part, it is senseless to enter contract negotiations without an absolutely clear understanding that the new CEO will be emotionally incentivized to remain.
There are instances when an entrepreneur will be willing, and even grateful, to give up some portion of his freedom. Such circumstances should be recognized and also brought out in open conversation. This could arise in the case of a seller who has operated without meaningful managerial assistance for a protracted period of time. We are all familiar with the CEO of a small company who has been financially unable or intellectually unwilling to delegate authority. This individual will usually be willing to give up a significant portion of autonomy. This will be particularly true if "autonomy" has been defined as doing everything himself.
In this case, buyer and seller should unambiguously define those areas which will be assumed as continuing responsibilities of the buyer organization. Such assumption of "petty details" should clearly be indicated as a future benefit to seller, permitting him to devote a larger portion of his future effort to more important and presumably more enjoyable tasks. If "loss of autonomy" can be re-defined as elimination of trivial and unimportant work, the end result should be more positive.
In many cases a combination of two organizations will demand the elimination of certain "autonomous" functions formerly exercised by a selling CEO. If, for instance, the founder of a relatively small company has been required to act as the de facto head of marketing, finance, administration, and manufacturing, this will undoubtedly be perceived as part of his traditional autonomy. Most larger organizations will require that each of these functions be managed by a capable, full-time professional. Full and complete discussion will help to defuse CEO discontent in this instance, and may simply be looked upon as a re-definition of autonomy.
Even CEOs of very large companies often suffer from the same problem, for different reasons. The typical CEO is usually oriented toward one or more of the management functions referred to in the preceding paragraph. Even with a highly paid chief marketing officer on board, many CEOs consider themselves to be the most effective marketing person on staff. Enforcement of organizational discipline in such cases could definitely be perceived as a loss of management autonomy. This could be one of the more difficult problems to solve, as it could actually involve some curtailment of the CEO's previous authority.
The problem can be dealt with if it is recognized and acknowledged as such. Both buyer and seller will need to utilize their full diplomatic skills in a negotiation of how certain former responsibilities will be eliminated from the CEO's portfolio, without causing him to feel diminished in any way. This should be readily achievable if the newly acquired CEO can be integrated into the combined operation and given additional responsibilities, appropriate to his true function. (To be continued.)
One of the six complaints cited in Dr. Kim Stewart's study of management retention after acquisition was parent firm "arrogance." This was defined as refusal to utilize and listen to acquired top management, and implementation of parent policies, when existing procedures were believed by the acquired CEO to be superior. Those CEOs in Dr. Stewart's study who expressed satisfaction with the acquisition did so first and foremost based on the parent's noninterference.
Parent arrogance is probably one of the most frequent causes of management dissatisfaction in an acquisition, and also one of the most justified. If management is perceived to be weak during negotiation and due diligence, it is the responsibility of buyer to plan for additional training, or to discuss future plans for alternative utilization of the individuals involved.
If, on the other hand, management is one of the key ingredients being sought in a transaction, buyer must ensure that this asset is properly utilized and sheltered from improper interference. Buyer must educate key individuals within its organization to make certain that this takes place.
In an earnout situation, most buyers recognize the need to create a well structured plan for the newly combined entity. Such a plan is required for seller to maximize the potential for future payments. Too often, this technique is overlooked in a transaction where the purchase price is all paid at closing.
In every transaction where newly acquired management is expected to perform future service in a combined entity, the parties must define continuing goals, and spell out in the clearest terms how such goals are expected to be achieved. This should be accomplished through preparation of a detailed business plan, which outlines not only the goals which will produce future incentive compensation, but the means by which they will be accomplished. The responsibilities of both parties must be clearly outlined, in as much detail as required to be perfectly certain that they are understood by all concerned. Often such plan will have to be prepared in significantly greater detail than those normally used in running buyer's company, but the resultant clarification will more than justify the additional effort.
We suggest that the business plan for a newly acquired entity must be treated as any other plan, and modified as required by changing circumstances. As new management becomes more familiar with buyer's culture and procedures, the level of detail in modified plans can begin to diminish but this should not happen until there is certainty that less operational detail will not produce an unacceptable level of mutual understanding.
Another of the problems expressed by dissatisfied CEOs was a clash between the cultures and management objectives, or values of the parent and the acquired firm. While this might seem to be impossible in a well planned acquisition, we have seen it occur in a great many transactions. The operative phrase which must be considered is "well planned." All too often, buyer and seller are concerned exclusively with "business" aspects of a deal, and overlook the personal side. Even buyers with sufficient experience to provide for adequate future management performance may sometimes overlook certain facets that go into the creation of good future results.
Responsible individuals in most acquiring companies will study what they consider to be the more important attributes of a potential candidate company, such as finance; marketing; manufacturing, or other means of production; adequacy, or surplus of existing facilities; backgrounds of key personnel; and employee benefit plans. Many times, such studies are accomplished by individuals or departments within a vacuum, with no attempt, or minimal attempt at coordination between them. Such coordination is essential, as it is functional interaction which fundamentally defines an organization's culture.
Those individuals or departments responsible for the review of a potential candidate must be coordinated, with the combining of company cultures as one of their goals. One or more meetings of this nature might go far to clearly define buyer's own organizational culture, which heretofore may have only been followed on an intuitive basis.(To be continued.)
One of the more incredulous complaints expressed in the survey done by Dr. Stewart was that parent firms often lacked knowledge and understanding of the acquired firm's business.
We could understand this problem in the case of an unfriendly takeover, or a company that was acquired as part of a purely financial transaction. In a more traditional transaction, such a situation would be plausible, and even acceptable during the early stages of negotiation but it is difficult to accept after a transaction has been completed. If the complaint were directed at specific individuals or even groups of individuals within the parent organization, it would be readily apprehensible, but not so if truly aimed at the entire parent, or even key individuals within the parent.
The acquiring organization that has bought a company without both knowing and understanding its business has done so in violation of two of the cardinal M&A rules: (1) plan well and (2) review important candidates in depth.
As deals usually operate, it is not unusual for only a few individuals to have a complete understanding of the operations of a candidate when an offer is made and accepted. Many buyers view the due diligence process as something that involves only reviews of financial and specific operational matters, such as inventory control, or manufacturing processes. Such should not be the case.
When we assist clients with due diligence, we like to ensure that more than one representative of higher level management are part of the team. These individuals should be responsible for obtaining an overview of the candidate's business. In a due diligence review program, we refer to this process as reviewing the income stream.
This aspect of the due diligence process is deliberately vague as to specific instructions, but could be summed up by a single sentence: Through discussions with senior management and higher level operational people, discover exactly how the candidate company derives its income, and where it spends its money. This is a deliberately broad charter in what might typically be a very specific review program but it usually accomplishes what it is meant to do.
We try to impress clients with the fact that use of high level management people for this aspect of due diligence is deliberate and does not necessarily require their involvement for the full time of the review. Effective results will be achieved if management representatives come away with the understanding originally sought. In accomplishing this task, the average upper level management individual will usually leave a long list of specific questions with the due diligence team manager. This serves to accomplish two goals simultaneously: a fuller understanding of the candidate's operations and a different dimension for the detail team. (To be continued.)