Examine Your Corporate Governance Before Initiating M&A & Financing Activity


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Sarbanes Oxley : Governance

Examine Your Corporate Governance Before Initiating M&A & Financing Activity

Businesses should start practicing self-due diligence to avoid derailing deals;

Carl Pergola
National Director Corporate Investigations Practice
BDO Seidman

As the M&A market heats up in 2005, one of the hottest issues is likely to be corporate governance. ?In the current environment, the first questions from a potential acquirer or merger partner are often: ?Does your corporate culture support effective governance and anti-fraud policies?? and ?Can you prove it??? says Carl W. Pergola, National Director of the Corporate Investigations practice at BDO Seidman, LLP in New York.

?These days, demonstrating a commitment to Best Practices in governance and a strong anti-fraud culture is a significant plus when you sit down at the negotiating table ? companies are learning that integrity is attractive in an M&A context,? notes Mr. Pergola. ?With M&A activity projected to increase in 2005, companies may have been waiting for years for the right time to attract potential suitors. It?s important to take charge of this process in advance of negotiations to maximize the value of the transaction and to remedy issues that would cause suitors to leave the table in mid-deal.?

The increased focus on corporate governance comes against a backdrop of failures that have exposed enormous blind spots among businesses at all levels of market size. While Sarbanes-Oxley has raised the bar on financial reporting disclosures, companies are still vulnerable to disconnects that allow financial statement fraud, misappropriation of assets and employee violations of ethical and legal guidelines. The Wall Street Journal recently reported on a large international acquisition that nearly unraveled because of bribes in foreign subsidiaries.

?We?re seeing more companies losing control of the transaction ? or facing significant post-acquisition claims ? due to revelations of fraud,? says Pergola. Pergola sees forward-looking companies addressing these concerns well before any major financings or transactions with comprehensive self-due diligence, including thorough analysis of existing governance and anti-fraud programs. Mr. Pergola notes that companies typically are aware months in advance that a transaction may occur. ?Companies can productively use this time,? he explains, ?to increase their value by seeking to detect fraud and develop their infrastructure for Best Practices compliance with corporate governance requirements,? Mr. Pergola states. ?Further, companies that identify and remedy corporate governance and financial problems significantly reduce the risk that those issues will emerge during the deal process and derail the transaction or adversely affect the company?s bargaining power.?

?Companies should not fear implementing efforts to find fraud,? Mr. Pergola states. ?Any fraud issue detected by the company can be remedied and further safeguards instituted.? Clients who have conducted comprehensive self-due diligence in advance of transactions are driven, Mr. Pergola says, ?By the question: Would you rather find out about fraud or governance problems six months before the transaction when you can fix them or would you rather have a potential buyer point them out to you during negotiations when the impact on value will certainly be negative?? There is real economic incentive to anticipating corporate control problems, Mr. Pergola explains. ?Companies instituting strong governance procedures will be able to spot problems before they have a detrimental effect on their financial statements.

This will help ensure that they are more attractive and reliable acquisitions,? he says. ?The overall amount of fraud in U.S. business is significant and virtually every company is exposed to fraud, from padded employee expense reimbursements to major misstatements of financial information. If a company conducts comprehensive self-due diligence in advance of a transaction, its value increases both directly by the elimination of fraud as well as indirectly by deterring other frauds which could negatively impact earnings. Companies may even be able to recover from insurers under policies covering employee dishonesty.?

It is the ability to increase Earnings Before Interest, Depreciation & Taxes (?EBITDA?) that drives the value for the transaction. If a company can identify and eliminate $100,000 in fraud and deter another $200,000, EBITDA will increase by $300,000 in comparison to before the undertaking. Assuming a transaction price is set at six times EBITDA, the company has added $1.8 million to its value and avoided potential pitfalls in the deal process.

As part of the comprehensive self-due diligence process offered to clients, BDO Seidman uses Critical Anti-Fraud ProceduresSM (CAPSM) to help businesses address governance and compliance issues through fraud detection and deterrence. Equally important, CAP aims to create a genuine and continuous anti-fraud environment by addressing companies? cultures. Based on reverse-engineering thousands of frauds, CAP focuses on Best Practices in education, background screening and aggressive investigation to harness the power of employees to create value through compliance with well-designed and effectively communicated policies on ethics and integrity. Mr. Pergola explains further that ?CAP is based on a material risk assessment for each unique company.? He noted that a typical assessment covers everything from employee/management training to internal hotlines and codes of conduct, review of existing anti-fraud procedures, and monitoring and testing compliance with policies. ?We also encourage companies to review overseas operations for possible Foreign Corrupt Practices Act violations,? adds Mr. Pergola. ?Unquestionably, governance questions can come back to haunt any transaction,? Mr. Pergola says. ?The whole idea behind comprehensive self-due diligence is to identify and resolve any problems so that you can drive value and avoid deal-breakers later on.?

BDO Seidman, LLP is a leading national professional services firm that provides assurance, tax, financial advisory and consulting services to private and publicly traded businesses. For more than 90 years, BDO Seidman has provided quality service and leadership through the active involvement of experienced and committed professionals.

BDO Seidman serves clients through more than 35 offices and 250 independent alliance firm locations nationwide. As a Member Firm of BDO International, BDO Seidman, LLP serves multi-national clients by leveraging a global network of resources comprised of nearly 600 member firm offices in 99 countries. For more information on BDO Seidman, please visit www.bdo.com .

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