Most FDs will go through their career without being targeted by a black knight looking to take over their business. But for some that nightmare can become a reality – when a potential acquirer comes knocking and doesn’t want to take no for an answer. While the experience may not be the most pleasant, there are ways in which the FD can take to the barricades and defend their company.

But what makes a takeover hostile? Perhaps the most famous of all spawned a book and HBO movie, Barbarians at the Gate, dramatising the ‘blood on the carpet’ deal that saw venture capitalist fund KKR drag US cereals giant RJR Nabisco kicking and screaming into a leveraged buy-out. But while the reality of most unsolicited takeovers is a little less dramatic, FDs can expect to have their mettle tested during what can become a stressful and overheated process.

“There are a range of ways in which an approach can be made,” says David Smith, a director of Deloitte’s financial advisory service, who has advised clients on both sides of the net. “Typically I’d expect it to be a call into the CEO or chairman from the offer or company informing them of their intentions, followed up by a public announcement of what they’re up to.”

A test of strength

In that scenario, Smith says that how things proceed for the targeted company will very much depend on the strength and resilience of their corporate governance structures and how well prepared they are. “As an adviser I would immediately want to know if those systems are up to scratch in terms of how the company plans to respond,” he says. “A well-prepared corporate will have protocols that come into play and a sequence of steps that get taken. That, to our mind as an adviser, is absolutely critical in helping ensure the success of whatever strategy you employ,”

Smith explains, stressing the need for the FD to lead proper and thorough preparation. That preparation, he says, should coalesce around a company manual that outlines the correct roles and responsibilities in the same way a crisis management or business interruption guide would.

“If I was being asked to assist in the preparation of the manual, there would be sections that would appear in every one in terms of key individuals and responsibilities, steps that follow, the potential white knights and so on,” Smith says. He’s also keen to point out the value of good advisers in order to navigate the complexities of The City Code on Takeovers and Mergers, otherwise known as the Takeover Code, a binding set of rules that apply to listed companies in the UK. And in particular rule three, which governs how companies should use advice throughout the process.

Rules of the game

Smith’s sentiments ring true to Simon Laffin. As chairman of Flybe and an experienced NED and company chairman, Laffin has been on both sides of the fence. For him, there are two key things that the FD and board colleagues must concentrate on. “You have to have good rule three advisers and you have to hope that the other guy gets a good rule three adviser,” Laffin says. “You do not want him to have a poor adviser.

It’s so important so I always ask carefully who’s advising the other side. I almost care more about that than I do about my own. If those advising the other side are poor quality, inexperienced or if they’ve got conflicts, you can’t be sure that they are going to react according to the rules and rationally.”

No company can hope to survive a hostile takeover without a clear understanding of their rights and obligations under the Code, which offers the FD of the target company some genuine protection as well as outlining their obligations when a hostile acquirer comes calling. “The key point for me is to maintain a good dialogue and open relationship with the principal shareholders at all times, not merely when there is an offer objective is not to make the company unattractive to a bidder.

Rather it is to maximise the value of the company for shareholders, which includes running the company with a balance between returning profits to shareholders now and increasing future profits, making optimal use of the assets you have now, and making sure the shareholders understand the value those assets. If these things are done well they will reassure existing shareholders that value is maximised so that they are less likely to agree to a sale.”

Protect yourself

Of course, smaller businesses are far less likely to face the threat of a hostile takeover – owner-managed businesses have excellent defence to reject any bid as they control the shares. However, for smaller listed companies there are ways to protect themselves from an unwelcome approach. The most obvious is to encourage employees to buy shares in the business. Filling the share register with employees that have a vested interest in protecting the business from any unfriendly acquirer is a neat – and cheap – way of building a sound defence against any approach. The same can be said of retaining a majority stake for management once the business has floated.

Going abroad

In the US, takeover rules allow a broad range of defences that include ‘poison pills’ (where a target company uses a certain amount of sleight of hand to present itself as less attractive to a potential acquirer) and the ‘Pac-Man defence’, where the target responds to a hostile pursuit by turning around and attempting to gobble up their pursuer. However, most of those defence tactics are not available for use by FDs. “Right or wrong, in the UK it’s seen as important that shareholders are given the opportunity to assess the merits of the business,” Smith says. In fact, the UK regime provides very limited scope of action for targets to use in order to stymie a bid.

“You may well hear your advisers referring to rule 21, which outlines the non-frustration principle, that essentially restricts target companies from undertaking any actions that might frustrate a bid without first seeking shareholder approval,” Smith explains. That means employing forbidden strategies like issuing shares, selling assets that might be of interest to the bidder or entering into contracts they might not do in the ordinary course of business. “Things you would see in places like the US – and to a lesser extent in Europe – are not available for management in the UK,” says Smith.

Arguing the defence

So does that leave the FD of a UK company entirely unprotected? Not quite, but in the absence of delivering a poison pill or engaging in other shady arts, his main defence strategy will have to be one based on argument and persuasion. This is where the FD has a real advantage. Smith explains: “That gives you the chance to communicate with your shareholder base and the broader market to articulate the value that you see in the business that isn’t necessarily reflected in the value of the offer on the table.” Persuading shareholders that the attempted takeover should be rejected will typically involve the FD building out a financial forecast that reassures investors to stick with the status quo. “You will need to put out an alternative set of plans and the FD will be key in the development of those,” says Smith.

“Profit forecasts are often used, and there are certain procedures that mean project forecasts are required to be prepared in a certain manner, with the CFOs taking a lead on that.” On the use of quantified financial benefit statements – that Smith says is “a fancy word for cost savings” – and other key financial analysis that doesn’t fall under the prescribed procedures of the Code the FD will be expected to take the lead, as well as in the production of verification materials.

Laffin, coming from a finance background but having worked extensively as a non-exec during his career, says the quality of this material will be critical in persuading shareholders that the FD and his board have a better plan for the business than a hostile acquirer, and that they have a better understanding of the company’s underlying value than this acquirer. “When it comes to a valuation, your rule three advisers will give you a good idea on what the control premium is going to be, typically 20% to 30% depending on the business,” Laffin says.

“But they will ask for numbers from the executives, and the non-execs will want to know: what’s the financial forecast? They will turn that into different valuations for your company and the non-execs are very important because they need to apply a really cold hard look as to whether they believe the executives’ forecasts.” Ultimately, the FD will not have to face a hostile takeover alone. With a board and advisers lined up in lockstep, some of the burden will be shared. But there’s no doubt that, as in so many other arenas, the FD will play a central – and irreplaceable – part.

Latest research

Since Christian Doherty wrote this article in 2017, he and others have carried out further research into hostile takeovers.

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