Corporate Governance and Valuation: The Key to Unlocking Value in M&A

The Importance of Governance to Generate Value in M&A Transactions

Have you ever heard that “the house needs to be tidy before receiving visitors”? In the world of Mergers and Acquisitions (M&A), this metaphor is almost a golden rule. Companies that wish to attract Investors must, first of all, demonstrate solid Corporate Governance, a determining factor for the success of the Transaction.

This article explores the importance of Corporate Governance as one of the most relevant pillars in the generation of value during an M&A process. We will analyze how Governance directly impacts the Valuation, Investor confidence and post-trade success.

What is Corporate Governance and why does it matter so much?

Corporate Governance is the set of practices, processes, and policies that define the way in which a company is directed, managed, and controlled. It involves everything from transparency in accountability to clarity in decision-making and the alignment of interests between Partners, Managers and Stakeholders.

In an M&A process, these factors are crucial to:

• Reduce the risks perceived by the Investor
• Increase the predictability of results
• Avoid surprises during Due Diligence
• Improve trading conditions

The impact of Governance on Valuation

Companies with good governance generally achieve multiples of Valuation louder. This occurs because the Investor feels greater legal, accounting and strategic security when analyzing the business. On the other hand, companies with low corporate organization, financial lack of control, or conflicts between Partners may suffer significant discounts on Valuation.

A study published in REGE Management Magazine analyzed 249 acquisition announcements between 2001 and 2013, focusing on the impacts on the return of shares of the companies involved. One of the main findings was that companies listed on B3's Novo Mercado — a segment that requires high governance standards, such as capital with exclusively common shares, an independent board of directors, and greater transparency — showed abnormal positive and statistically significant returns in the days following the acquisition announcements.

These abnormal returns, higher-than-expected stock price changes based on overall market behavior, were interpreted as a positive reaction from Investors to the news that a company with good governance practices is making an acquisition. The market sees that well-governed companies tend to carry out more strategic transactions, with a lower risk of value destruction, greater capacity for post-integrationDeal and lower information asymmetry — factors that are reflected in Valuations higher at the time of sale and in long-term market valuation.

Governance as a facilitator of the M&A process

During the sale or fundraising process, companies with good governance tend to:

• Organize faster the Data Room
• Respond more quickly to Due Diligence
• Avoid contingencies and hidden liabilities
• Conquer the Investor's trust in the first conversations

In practice, this reduces transaction time and avoids rework, more restrictive clauses in the contract, or even the Investor's withdrawal. In M&A processes, timing it's essential. Delays in communicating or sending documents not only create mistrust in the potential Investor, but can also significantly decrease their interest in the transaction.

Challenges in Implementing Governance

While the benefits of Governance are clear, effective implementation can be challenging, especially for mid-sized companies. Common obstacles include resistance to change, lack of financial and human resources, and the complexity of adapting governance practices of large corporations to the reality of smaller companies.

However, some practices are accessible to medium-sized companies that aim to maximize their perceived value as a business.

Where to start?

If your company doesn't yet have a robust Governance framework, here are some tips to get started:

• Formalize the roles and responsibilities of Partners and Managers
• Keep financial statements up to date and, if possible, audited
• Establish a Rules of Procedure or Membership Agreement
• Implement accountability processes and periodic meetings
• Consider creating an advisory board

Success Stories: The Performance of FC Partners

FC Partners, in addition to its role as M&A Advisor, carries out Strategic Controlling projects, whose objective is to assist companies to raise their level of management maturity and their Governance standards. These projects have already been implemented in companies from various sectors, in several cities in Brazil.

One of these strategic controlling projects was requested by an owner of an electrical components industry for white-line automakers, with the objective of professionalizing the company's management. Among the practices implemented, the following stand out:

• Preparation of Strategic Planning
• Budget Preparation
• Definition of Performance Indicators (KPIs) by sector
• Cash Flow Projection
• Detailed monthly monitoring of the Budget x Performed
• Weekly meetings with key leaders to assist with KPIs
• Monthly meetings to analyze results and key indicators
• Monthly Advisory Board Meetings

During the preparation of the Strategic Planning and Budget, the Partners' ambitions were captured and the main business indicators that would directly affect whether or not the budget targets were achieved were measured. Once the multiannual Strategic Plan and the annual Budget were prepared, the main performance indicators (KPIs) that impact the global goals were identified and targets were defined by department, which were then monitored monthly.

In addition, FC Partners monitors the evolution of these indicators weekly with the leaders, ensuring that monthly results can be achieved with proactive measures throughout the month. By monitoring the daily cash flow, the origins of some “surprise expenses” were identified throughout the month, which began to be treated more proactively.

Over the months, the Partners gained greater confidence and comfort in their cash flow projections, so that investment, working capital, and fundraising decisions began to be carried out with greater assertiveness. The company had a history of raising short-term debt to withstand inventory changes and seasonalities that were known but were not adequately measured in terms of working capital. Already in the first full year of budget-based management, the company collected fewer loans than in previous years, due to these more assertive decision-making.

Another practical example of gain that FC Partners identified in other Governance improvement projects was the creation of a Shareholder Agreement, containing clear rules for management, autonomy, remuneration, investment and indebtedness policies, cases of division, merger or business combination, rules for changing the corporate framework and other issues relevant to the business. This case occurred at a vehicle tracking company, which was later acquired by a large Player leader in the car rental sector.

In the opinion of the Partners, the Shareholder Agreement and the Governance practices brought credibility to the Investor and were essential for the fluidity during the process and for the successful conclusion of the process, with the exclusive advice of FC Partners.

Conclusion

Corporate Governance is a competitive differential for companies of all sizes that seek growth, attract investments or prepare for M&A, transcending the mere requirement for large corporations. More than “tidying up the house”, it is demonstrating to the market that the company is reliable, transparent and ready for the next level.

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