After the last glass has been consumed celebrating a finalized merger, acquisition, IPO or SPAC, many forget the marathon in the coming months and years to integrate business cultures, systems, processes and internal controls. What questions can be asked and negotiated during due diligence pre-merger, acquisition or IPO to smooth post-transaction integration, identify blind spots and create the space for honest, frank discussion?
#1 – Focus on the Right Long-Term Incentives
(a.k.a., “Writing the Vows”)
It is important to identify the right incentives for the right people/teams to make choices that are in the best interest of the organization in the long term. It’s common that even if organizations offer a combination of short-term and long-term incentives, employees will favor the short-term perspective. After all, those are often the easiest for people to quantify and realize.
It’s important to ask, “Who has skin in the game to ensure a long-term view is taken for successful integration?” The answer should be clear.
Example Case: When Short-Term Incentives Hinder Long-Term Performance
A web development company (BuyMe) is looking for the right strategic partner to lead their next growth stage. Meanwhile, a technology conglomerate (iWill) is waiting in the wings for the right time to acquire a web development company to augment their existing business. BuyMe is thrilled with the offer iWill proposes, including various incentives within the first three years.
BuyMe employees are incentivized to meet annual revenue targets for each of the first three years. BuyMe successfully argues they require the continued use of the existing custom system add-ins for lead generation, contacts, status and revenue dashboards—and the focus on revenue bolsters their case. As a result, the integration of accounting systems is delayed.
However, during the three-year incentive period, iWill is heavily reliant on the accounting team (including a higher-salaried Controller) at BuyMe for at least two years longer than expected, has limited visibility to transactional data and struggles to integrate company controls, policies and procedures.
In the fourth year, iWill is forced to take draconian measures to integrate accounting systems resulting in lost revenue due to reduced lead visibility, wasted time researching and reconciling accounts and lost historical data. Looking back, a shift in perspective during the pre-merger process could have mitigated the pain of the integration.
#2 – Be on the Lookout for Unanticipated Costs
(a.k.a., “How much is a wedding cake?!”)
Pre-merger, acquisition or IPO, further conversation and discussion can assist in anticipating and mitigating other potential costs. What are some of the unintended consequences of the companies merging, like higher costs associated with separate financial systems or longer retention of accounting staff to support financials from the separate process and system? Have third-party IT vendors been used cost effectively rather than full-time, in-house IT developers?
Example Case: Third Parties and False Assumptions
With separate accounting systems and processes, the external auditors engaged by iWill determine separate testing is required since the internal controls and processes are different for BuyMe and iWill. The additional testing increases audit fees more than 50% – the Audit Board has a field day with that one!
In another case, an external third-party IT development company (weDevelop) was a long-term partner for BuyMe. Instead of hiring in-house IT developers as full-time employees, BuyMe determined it was more cost effective to budget planned sprints with weDevelop. The IT infrastructure at iWill is robust, so they do not anticipate retaining weDevelop and do not probe further to understand the bespoke services provided by weDevelop. Post-transaction, BuyMe and weDevelop successfully argue the value of continuing the relationship for more than five years, resulting in greater costs than originally included in pre-merger analyses.
#3 – Mixing Cultures Can Be a Mixed Bag
(a.k.a., “Are Our Families Going to Get Along?”)
For a company eager to be acquired, it’s easy for potential acquirers to sell how “alike” and “what a good fit” they are. However, has a sufficient pre-merger analysis been done to understand the employees and how critical transactions are processed? Have the right people evaluated who will have oversight of the newly acquired staff and integrated processes? Evaluation of how to right-size internal controls is critical; one size does not fit all.
Example Case: But That’s the Way We’ve Always Done It
Before the transaction, BuyMe was a successful privately held business celebrating its 20th anniversary. Average employee tenure was in the double-digits. When iWill, a public company, begins the internal control assessment, BuyMe employees have a difficult time understanding why processes that worked previously need to be changed. For example, BuyMe historically paid a minimum annual bonus of 9% at the year-end holiday party. For some, that became the allotted budget to spend on holiday gifts. However, the bonus program at iWill is based on different criteria and not guaranteed; BuyMe employees are understandably deflated.
BuyMe also allowed employees to request payroll deductions (e.g., to purchase stamps and movie tickets or to make contributions to gifts for other employees). The payroll deduction was then manually adjusted at the time payroll was processed. However, when iWill centralized payroll, manual deductions were no longer allowed. It seems like such a small change that greatly improves process efficiencies, but it’s surprising how much it agitates the BuyMe employees!
#4 – Don’t Underestimate the Difficulty of SOX Implementation
(a.k.a., “Living in a Home Renovation”)
New IPOs are exciting times with soaring stock prices, exploding social media mentions and ebullient employees. Fast forward to the first full year as a public company…
SOX controls anyone?
Using a top-down, risk-based approach while designing or identifying existing key controls will limit required testing and translate into annual cost savings. It is common to underestimate the time it takes the control owner to consistently document control performance and results, which are the basis for SOX test work. Therefore, any reduction in the number of key controls to test will be less work for both the control owner and the SOX auditor. Win-win!
IT General Controls (ITGC) over critical accounting systems are another oft-forgotten area. Budgets should include the cost to implement and maintain controls for each system.
Example Case: Prioritizing Controls Testing
iWill identifies 20 accounting systems as critical to financial statement accuracy and completeness. They also initially have 25 key ITGC controls for each system, resulting in 500 controls to test.
After downgrading some as non-key (i.e., when the risk was adequately justified as low) or identifying processes which are similar and can be tested together, the number is cut in half to 250 controls tested by two (2) vs. four (4) SOX auditors – real cost savings!
#5 – Make Sure to Budget for Ongoing SOX Costs
(a.k.a., “Maintenance and General Upkeep”)
While congratulating yourself on getting through the first year of implementing SOX controls, don’t lose sight of the ongoing nature of SOX costs!
The controls implemented in the first year are ongoing, and they need to be tested annually, but by whom? An existing Internal Audit (IA) team is often the logical choice. However, will SOX resources be budgeted for the additional work, ensuring other areas of risk are still addressed by IA?
Example Case: A New Department
The Internal Audit department at iWill is comprised of five (5) competent staff. However, the SOX walkthroughs, evaluation of control design and operating effectiveness, narratives and testing require two (2) full-time auditors. iWill creates a SOX department and hires a director and two (2) auditors to ensure SOX compliance.
What do M&As, IPOs and SPACs have in common? While the companies above are fictional, the examples are based on real-life issues experienced post-transaction.
It’s important the due diligence process pre-merger, acquisition or IPO includes understanding incentive levers. Companies should also delve deep enough to identify unintended consequences to manage future expenses. Ensuring the cultures within which internal controls are practiced, developed and maintained are compatible is another important factor in post-transaction success. And for managing stress and ongoing costs, companies should also prepare for both grueling, expensive SOX implementation and maintenance.
It’s easy to see what can be improved when looking back with 20/20 hindsight, but hopefully the insights we’ve discussed can help you see things clearly well before they become costly, avoidable mistakes.
If you’d like to explore how 8020 Consulting can support your business in these areas, we invite you to explore our IPO readiness and public company support services, or our M&A consulting and due diligence support services. You can also contact us to start a conversation!
To learn more about post-acquisition finance transformation, we also invite you to download our new ebook for best practices, to-do items and a simple framework for staying on track:
About the Author
Yasuko is a CPA with 25+ years of diverse finance and accounting experience across a variety of industries including entertainment, advertising, business services, telecom, retail and manufacturing in both private and public companies. She is a KPMG alumna who held leadership roles as Controller, VP of Finance and CFO at Fortune 500, middle-market and entrepreneurial companies, including Sony Pictures Entertainment, Universal Sports, Senn Delaney (a Heidrick & Struggles company) and ZOO Productions (an All3Media company). Yasuko has provided financial leadership and management to accounting organizations including FP&A, budgeting and forecasting, financial modeling, post-acquisition integration, M&A transaction support and due diligence, managing internal and external financial reporting, process improvement and system implementations. Yasuko holds a B.S. in Business and Accounting from California State University, Long Beach.