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Weekly UpdatesRecessions slow the pace of M&A activity due to a divergence of seller and buyer valuation expectations and a difficult financing environment. Recessions are a natural part of economic cycles. They have occurred in the past, and will occur again in the future. Whether the divergence in valuation expectations during recessions can be sufficiently narrowed to close a deal depends on the motivations of both the buyer and seller.
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How can a board and management team increase the likelihood that their company will successfully complete a transaction? For a buyer, this means having the confidence of investors and lenders that the company is well run, can successfully execute stated business strategies with the acquired company, and can deliver promised returns. For a seller, absent nonmonetary considerations, it means obtaining the minimum acceptable price. A potential acquirer will pay more for a company if it feels the potential acquisition is well run and views it as a growth opportunity. The acquirer will pay less if it needs to fix the potential acquisition to significantly improve profitability.
Whether a deal can be financed during this or any other recession depends on whether the required amount of equity and debt financing can be raised in an environment where both are in shorter supply than in times of economic expansion. During this recession, less debt financing is available, requiring that more equity be invested in deals, lowering leverage and potential returns for acquirers, which will drive lower valuations. This widens the gap between buyer and seller expectations. Sellers may choose to wait until valuations recover, and use this time to improve its operation so it can command a higher price when the M&A environment improves.
What the board can do
The role of the board in this process is to ensure the right CEO is in place, and develop with the CEO the right long-term strategies to differentiate the company from its competitors. The board also sets growth and profitability goals and expectations for the CEO, and monitors progress on the execution of the strategies and progress towards achieving the goals.
The board needs to establish a compensation program that rewards the CEO and senior management for achieving results with an acceptable level of risk to the company, and to ensure that an appropriate portion of bonuses are paid out over an appropriate time horizon. The board needs to avoid the situation which recently occurred in the financial industry where high risk strategies were pursued, short term financial results were strong, and large bonuses paid. A few years later, these high risk strategies failed, placing some financial firms at risk of collapse.
The strategies to highlight a company through achieving great performance are the same regardless of the phase of the economic cycle. A company which has the right corporate culture, a well developed strategic direction, employs skilled leaders and managers, implements best operational practices, focuses on customers, pushes its manufacturing and product technology forward, has a strong balance sheet, does a great job managing working capital, has strong cash flow, focuses on achieving growth and generates attractive shareholder returns differentiates itself and will perform well in times of economic expansion as well as in times of recession. These attributes make a company a desirable investment and a strong acquirer, or an attractive acquisition candidate.
Tone and values
The tone at the top and the corporate culture that the CEO establishes is not only key to great financial performance, but company reputation as well. Tone establishes the values of the company, not only in terms of ethical behaviors, but all aspects of how the business is operated. The CEO sets the tone, and the board holds the CEO accountable for how well it's established and adopted throughout the company.
As a former CEO of a company with operations in 19 countries at 56 plants, I wanted all employees to do the right thing--for example, maintaining the highest standards of safety and environmental compliance--even if it meant delaying a customer shipment or falling short of a production goal. I communicated our values as well as strategic direction and goals to employees at all levels of the company. Your employees will not know what your values are, and they can't help you implement the company's plans and achieve its goals, unless you communicate with them.
One of the most effective corporate cultural norms is a culture of continuous improvement, where all employees, both salary and hourly, feel a sense of ownership in the business and are empowered to improve the aspects of the operation over which they have control, either individually, or in teams with fellow employees. In my experience, a culture of continuous improvement generates significant savings for the company when done effectively on a sustainable basis. It's also a way of setting apart the company vis-a-vis competition and is required in order to build a sustainable competitive advantage. By empowering employees, you enrich their job satisfaction, which encourages them to continuously improve the business.
Deliver on your promises
Another cultural norm is always keeping commitments, and delivering what you say you are going to deliver. For a CEO, achieving established goals builds credibility with the board, investors and lenders, and increases the probability that he or she will attract outside capital and be supported on an investment in a new product initiative or acquisition. In the event the company becomes an acquisition candidate, buyers will pay more for a company where keeping commitments and achieving results are a cultural norm. The management team needs to keep their commitments to the CEO, to each other, and to their direct reports. This helps ensure that the company continues to move forward.
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How do you get a deal done in a tough recessionary environment? If you are a buyer, you need to demonstrate to the providers of equity capital and debt financing that your company is one they should want to invest in by showing that you are financially and operationally sound, and that you are achieving the milestones of your strategic plan. If you are an acquisition candidate, you need to demonstrate the justification for your high EBITDA multiple expectations by showing that you are operationally sound, have a track record of profitability and growth, and have developed a sustainable competitive advantage. In both cases, whether a buyer or a seller, show that you have a track record of meeting goals and delivering results. Even if you don't contemplate a transaction, these are sound principles for running a successful company.
Stanley W. Silverman is the former president and chief executive officer and former director of PQ Corporation, a privately-held global company in two core businesses--chemicals and engineered glass materials. Silverman is an advisor to CEOs on leadership issues and business strategy. He is an invited guest lecturer on Executive Leadership at the Wharton School and at the LeBow College of Business of Drexel University. He is a director on the boards of A. Schulman, Inc. and C&D Technologies, Inc., as well as two private equity owned companies, Femco Machine Company and innRoad, Inc. Silverman is a member of the board of trustees of Drexel University, and serves as chairman of the board's finance committee. He is the former chairman of the board of the Soap and Detergent Association, and a former board member of the American Chemistry Council. He earned a Bachelor of Science degree in chemical engineering and a MBA degree from Drexel University, and completed the Advanced Management Program at the Harvard Business School.
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