Post-Merger Integration Best Practices: Ensuring a Smooth Transition

by: Smith and Howard

April 10, 2016

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Mergers and acquisitions take months (or even years) of work to conduct due diligence, negotiate the terms and obtain financing. But the hardest work comes after closing, when management is tasked with integrating two corporate cultures into one combined entity.

Bankers usually have a stake in these deals — and they can do more than watch from the sidelines. You can initiate discussions with borrowers about their progress and watch for warning signs that a deal may be eroding value, rather than creating it.

Post-merger integration best practices: Review interim performance

Successful deals add value through either revenue-building or cost-saving opportunities known as “synergies.” But overzealous buyers tend to overestimate synergies and, therefore, overpay for assets or equity. Don’t wait until year end to find out that a deal has fallen short of expectations.

As a condition of financing a sale, request that the borrower provide monthly (or quarterly) financial statements. Then take the time to compare actual results to the forecast generated during the due diligence phase. Inquire about any variances and ask what’s being done to improve any shortcomings.

To hedge against post-deal uncertainty, some companies negotiate earnout provisions, which call for the buyer to withhold a portion of the sales proceeds and make it contingent on future performance. That way, if the acquired entity doesn’t live up to the buyer’s expectations, the seller bears some of the risk of underperformance.

Likewise, the buyer may negotiate a “demerger clause” into the sales contract, which provides a means of unraveling an unprofitable venture within a prescribed time frame. Usually these clauses expire within a year (or two) of the closing date. Before invoking a demerger clause, the buyer may need to seek input from an outside financial professional to take corrective action, similar to an informal workout or restructuring.

Post-merger integration best practices: Encourage swift, decisive change

Nowadays, companies usually allow for a post-deal “honeymoon” period. During this interim phase, the companies may continue to operate separately, while everyone’s learning to get along and assessing the abilities of his or her co-workers.

After the honeymoon ends, a period of flux ensues: Duplicate positions are eliminated. Nonessential middle managers are given pink slips or asked to take early retirement. Offices close. Operating systems are combined. Uniform policies and procedures are implemented.

Although the honeymoon period gives management a chance to cherry-pick the top performers from both of the merged entities, productivity and morale often suffer while people wait for the ax to fall. Rather than delay the inevitable, it usually makes more sense to make tough choices sooner — before employees bond — rather than later.

Customers and suppliers are also more patient with disruptions that occur soon after a merger than when changes happen several years later, after the company should have settled into a predictable routine. The faster the merged entity starts moving forward, the better its chances of success generally will be.

Post-merger integration best practices: Focusing on the positive

Once management has made the necessary changes to the employee roster, office locations and operating systems, it’s essential to clearly communicate management’s vision for future success. Doing so will help minimize fear and uncertainty about ongoing volatility. After a period of flux, employees will want to settle into a new state of normalcy.

Borrowers often can restore a sense of stability by asking employees to re-sign employment and noncompete agreements — and by focusing on post-deal career opportunities. If an employee’s benefits will be reduced under the combined entity, he or she can also be offered monetary compensation to make up for it.

Once employees commit to management’s new-and-improved vision, they should be taught how to alleviate customers’ concerns about impending changes in personnel, pricing, administrative policies and quality. If not, customers may switch to a more stable competitor — and revenues will suffer.

Simplified post-deal accounting rules for private borrowers

U.S. Generally Accepted Accounting Principles (GAAP) requires buyers to allocate the purchase price paid in a business combination to the identifiable assets and liabilities. What’s left over is classified as goodwill on the balance sheet. Then goodwill and other indefinite-lived intangibles are tested annually for impairment. This happens when the fair value of an asset falls below its book value.

Impairment testing is time consuming and complicated. So GAAP has been revised to allow private companies to elect a few simplified alternatives. Instead of testing for impairment annually, private companies that acquire goodwill in a business combination may opt to amortize it straight-line over 10 years (or fewer if management can justify a shorter useful life). Private companies also may elect to include noncompetes and certain customer-related intangible assets in goodwill under GAAP.

These private company alternatives for reporting intangibles are effective for deals entered into during fiscal years that begin after December 15, 2015. But early adoption is permitted.

Asking questions

The M+A process isn’t something that borrowers handle on a daily basis. But bankers may be able to spot bad deals early, simply by asking a few questions and visiting a borrower’s facilities after the deal closes. Successful buyers love to share their success stories, and struggling ones appreciate objective input from a trusted financial advisor, be it a banker or their accountant.

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