NAVIGATING SAFELY THROUGH MURKY M&A WATERS
Think an M&A strategy is enough?  Not so.  You need a formal policy to steady the boat when you embark on your course of mergers and acquisitions.

Leader's Edge Magazine - May 2006
Author:  Robert J. Lieblein  

How is an M&A policy different from an M&A strategy? Simply put, an M&A transaction is a tactical objective to reach a strategic goal (for example, grow revenues 20% per year). An M&A policy, on the other hand, is one of the most crucial components in implementing the tactical objective. Those who follow business strategy and strategic planning already understand the concept. For others, I will explain as we sail on.

Some agency owners want to grow, but they do not approach that desire systematically. Instead, they just decide to make an acquisition then sit back and wait for a good prospect to appear. They have no policies or procedures in place to execute a successful transaction. This is like a producer going to a new prospect offering to quote on the spot without knowing any parameters that he can quote, the markets he has, what pricing levels are, or what approvals he needs. I am sure his sales manager would not recommend such an approach for the Top Performer of the Month plaque.

In the same way, even the best M&A strategy requires set policies and procedures to be successful. Why is it so important? Because mergers, acquisitions, joint ventures and strategic alliances—those elements of an external growth strategy—entail a tremendous amount of risk. The cost of failure can be enormous.

A 1999 report from consulting firm KPMG indicated that more than 80% of acquisitions fail or do not achieve the desired result. Whether or not the statistic is accurate seven years later, we can all acknowledge that failed acquisitions can have dire consequences. Therefore, before sailing forward toward an acquisition strategy, consider developing an M&A policy so that you can reduce that risk for your next venture.

Why a formal policy?

Managers of publicly held brokerages and agencies might be tempted to stop reading at this point, but they shouldn’t. Public firms and banks involved in insurance agency acquisitions all tend to have a strategy—the whys, what to look for, the territories, etc.—but very few have an actual M&A policy. Do you have a written policy that is used by all team members involved with the transaction process and spells out the dos and don’ts? The who, what, where and when? Since we all have polices for hiring, accounting, travel—in short, just about every important business process—why not an M&A policy?

Even if you have an M&A policy, it might be time to take a new look at it. Does the term Sarbanes-Oxley Act ring a bell? SOX should give you pause, too, because if your existing M&A policy doesn’t cross all the T’s—such as specifying a set of steps by your board of directors—then it may be time for a policy overhaul.

Privately held firms should think about board involvement, too. An M&A policy can help an outside advisory board perform its duties better and keep you from making a big acquisitions mistake. [See Leader’s Edge, July/August 2005 for more on advisory boards.]

Finally, consider that your agency might have changed significantly since your policy was enacted. A formal M&A policy is only as good as its assumptions, which must be based on current company structure and operations.

Policy Basics

Let’s consider the major elements of an M&A policy and procedures.

General Policy Guidelines. Commit the policy to paper and ensure it is used by all team members involved in each transaction. An M&A policy should be strategic in nature—that is tied to your strategic plan. It should be shared at regular meetings and subject to thorough reviews by all participating staff.

Guidelines for Approvals. Designate the structure and process for seeking M&A approvals and state the chain of command. Does each proposal first get vetted by an internal committee? Who takes the proposal up the management chain? Bottom line, spell out how the formal process that leads to an approval decision. And do not forget to consider whether the advisory board or board of directors should approve every deal.

Initial Assessment. Specify a process to perform an initial assessment of a target. This process should identify the criteria to be evaluated and outline your ranking system (if you use one), how the information is gathered and how it is used. [See Leader’s Edge, April 2005 for more on prescreening potential M&A candidates.]

First and foremost, the firm must be healthy with a solid history of financial performance; have good potential for revenue and profit growth; have a culture that can be integrated with yours; and have reasonable financial expectations by the current owner.

Your process should be developed from an objective to address your firm’s greatest needs. How best do you leverage your current platform? Should you expand your product mix? Do you seek to increase market share within your territory or expand beyond current markets?

After this step of mirroring the target firm against your needs in an initial assessment, you should thoroughly understand whether or not to continue pursuing the candidate firm.

Deal Structure. It is advisable to create a set of parameters that would apply to all potential deals. The structure might include the maximum amount you’ll pay based on cash return, the expected return on investment and the impact on earnings per share. Identify any contingencies in place to protect the agency. What are your goals of stock versus cash outlays? Do you seek an installment purchase? All these items are critical given the ultra competitive market by buyers for quality agencies.

Consider also your cost of capital. To arrive at workable guidelines, model the debt service that would be needed and the financial impact against market trends. Consider economies of scale, but also potential risks from market forces or cultural barriers. You need to be fully apprised of what to expect from near- and long-term results of a combined entity.

This guideline, though not a rigid set of rules, provides some parameters to get you started and may spare you and the transaction partner much time and much grief.

Valuation. Determining the value of a target firm may be the most critical element of your policy because it often is the biggest sticking point. Both parties need to understand the method of valuation. (Note that I did not say both parties must agree on valuation, but understanding the valuation process is critical.) The selling agency’s value must be brought into the realm of reality because it often starts from an inflated estimate arrived at unscientifically by the owner. Market value, and the components included in the valuation, must be unambiguous.

What guidelines might you be able to stipulate? Perhaps outline a specific model that must be followed so that every deal can be evaluated from the same perspective. That might eliminate the idea of “making the numbers work on paper” if someone wants to do a deal just for the sake of doing a deal. Do you require a third party to validate the valuation or financial model? Yes, this can be done internally, but remember SOX; a third-party validation may be a requirement depending on the size of the transaction.

Outside Experts. At times the expertise of a third party will be valuable. Experts typically used include attorneys, financial advisors and accountants. You may use the services of a specialized investment banking firm that regularly handles M&A. Do you mandate the involvement of outside experts for every deal or just for deals above a certain size? How are your advisors paid (rate per hour, success fee, or a combination of both)? How much reliance is put on third-party advice versus your own work? Much of the M&A evaluation work can be done in house, but often small or medium-sized firms don’t have the organizational structure or staff time to expertly fill all the necessary roles. Lay down some ground rules for use of outside experts when you need them.

Negotiation. Your transactions will happen more smoothly if you designate the lead negotiator and determine how much power the negotiator has without having to get approvals. Also, stipulate at what stage to bring in an attorney: when drafting a term sheet, issuing a letter of intent, performing due diligence or creating definitive agreements.

Due Diligence. Stipulate who performs your due diligence work and how extensive these efforts will be. The basics of due diligence may include evaluating a target company’s carrier and client relationships, its leases and contracts, its licenses and standing with regulators. You may also study the firm’s personnel and compensation programs and review its tax records. Consider whether you want to have a standard due diligence checklist. When will third parties be called in to assist with due diligence? How are due diligence findings communicated internally and to your board, to ensure that appropriate questions will be asked? What’s the process for resolving due diligence issues?

Integration. Because deals don’t end with the purchase, a complete M&A policy will stipulate who in the firm is responsible for integration. Consider whether you should require an integration plan be drafted before approval of the deal. If you require such a plan, must the board or an operating committee review that plan prior to approval? The process must consider how you identify, plan and communicate the most critical integration issues.

Agreements. Your policy also should outline the basic agreements that your firm requires to be in place for any external deal. These include confidentiality agreements, letters of intent, non-compete, non-solicitation, non-piracy and employment agreements. Yes, we all use these agreements but how much detail do you go into? What are the “musts” versus what is negotiable? Believe me, I have seen many deals that have problems when the musts become the negotiated items. 

Communications. Standards for communication and documentation will help you evaluate whether your M&A policy is being followed and used effectively. Standards for communications will help the board and others within the agency ask the right questions and will help them evaluate whether a transaction makes sense.

A sound and complete written M&A policy should be a requirement for all agencies that want to fuel their growth through external strategies. The policy is an effective tool that can truly enhance your chances of success. Committing it to paper—and requiring it to be followed—is the first step in giving your growth plan a fighting chance.

Just as a sailor would not leave the harbor without first checking the conditions of his lines, sheets, engines and emergency communications, neither should an agency owner embark on the course of merger and acquisition transactions without making sure his deckhands have been given proper instruction. At the least, your written M&A policy is an oversight mechanism that minimizes risk, creates consistency and helps streamline the process. At most, it will be a navigational chart to safely guide you, key staff and external consultants through sometimes murky waters.

Lieblein is a contributing writer and managing principal of WFG Capital Advisors. rlieblein@wfgca.com