Imagine all the things that could go wrong with an acquisition. Allow us to serve up some nightmare fuel:
A large contractor buys a century-old HVAC business that complements its services. But over its storied history, the target company worked with asbestos, exposing the acquirer to costly legacy liability.
A private equity-backed firm buys a closely held company. But integration does not go well: Nearly half the acquired firm’s employees quit out of fear of working for a PE portfolio company.
One accounting firm buys another to expand its footprint. Only, the acquired company had poor cybersecurity hygiene, opening up the acquirer to data security risks during systems integration.
“M&A is not without risk,” Renae Flanders, CFO of insurance broker World Insurance Associates. “There’s always a chance there’s something hiding in the weeds.”
But leaders of organizations with solid risk management processes in place can rest easy at night (or easier, at least), knowing they’ve thought through all the possibilities and mitigated them.
Thinking ahead. Target companies can come with a lot of baggage in the form of contingent legal risks. A legal risk earns the contingent moniker when “we know about it, but it is unresolved,” according to John Koch, a shareholder at law firm Flaster Greenberg.
Contingent risks may be known legal liabilities with no claims made against them (yet), or active but unresolved litigation, Koch explained during a panel discussion at the Riskworld conference in May. Examples include lawsuits over asbestos or PFAS exposure, a pending patent liability case, or tax liability if the IRS disagrees with the tax position of an acquirer or target company, according to panelists.
The purpose of thinking through the myriad risks of a transaction is not to be a “deal buster,” according to Laura Hatton, risk manager for Pennsylvania-based HVAC equipment manufacturer Burnham Holdings.
“I find that my job as the risk manager is to help facilitate that deal, get the deal to the risk tolerance that is acceptable to the C-suite to help it go through,” she said during the Riskworld panel discussion.
Time to integrate. But there’s plenty more to consider beyond the specter of future legal trouble, and M&A risk management work is far from over after the deal is done.
News built for finance pros
CFO Brew helps finance pros navigate their roles with insights into risk management, compliance, and strategy through our newsletter, virtual events, and digital guides.
According to a recent Travelers survey of 800 executives with risk management duties, employee training and re-skilling was organizations’ top concern following a merger or an acquisition. Other post-deal headaches include “challenges with culture and employees” and merging systems and technology, according to the survey.
Midsize firms were more concerned about employee culture compared to larger companies, while the big firms were more worried about technology and process integration, Joan Woodward, president of the Travelers Institute, told us.
“In the short term, teams will face operational challenges [and] increased stress, but over time, the adoption of new technologies and evolving risk management strategies have a lasting impact,” she said.
It’s not the risk, it’s what you do about it. Burnham’s board of directors, with lots of input from the C-suite, sets the risk appetite on a deal, Hatton said.
“That risk appetite is the sweet spot where we want to be all day every day,” she said. That “sweet spot” may change with each deal or with new C-suite leadership. Hatton said her job is to get the risk level “to where it’s tolerable to the C-suite as the buyer,” which may require her working with third parties such as lawyers or insurance brokers and carriers.
World starts its due diligence once a letter of intent is signed, Flanders noted. That’s where all functions become involved to comb through any potential risks in a deal. Every single deal goes to the CEO for approval, followed by the board of directors.
Flanders said she, as CFO, is “part of the extended deal team.” She reviews the diligence notes, discusses possible risks with the finance team, and sits in on the firm’s weekly M&A calls. About the only time Flanders asks a question is to clarify acquisition strategy with the head of corporate development.
“Again, no deal is risk free,” Flanders said, “but inorganic growth has been such a successful part of our strategy. And quite honestly, we’re…really good at it.”