The role of the financial executive in deterring hostile takeovers.

• Author: Clemens, Richard G.

The role of the financial executive in deterring hostile takeovers Hostile takeovers are not bad by definition, although management usually reacts as if they are. Assuming that the company's interests are served by repelling a takeover attempt, what planning must be done in advance and what can be achieved by different defensive strategies? Whether a hostile takeover attempt will be successful is greatly dependent on the defensive measures that have been implemented long before the tender offer is launched. There are a number of reasons why planning for hostile takeovers is especially important. In the first place, a tender offer typically expires in 20 business days. There is little time to start thinking about and implementing effective defensive strategies in 20 business days.

Second, the corporate law of Delaware and other states clearly favors defensive strategies that are implemented well in advance of a hostile takeover attempt. In the absence of a takeover attempt, courts generally apply the "business judgment rule," which is a presumption that in making decisions the directors of a corporation are acting on an informed basis, in good faith, and in the honest belief that the action taken is in the best interests of a corporation.

When a board of directors takes action designed to defeat or obstruct a specific takeover attempt, the question arises of whether the directors may be acting in their own self-interest, to entrench themselves in office, rather than in the best interests of the corporation and its shareholders. The courts place a higher burden of proof on the directors after a hostile takeover has been launched, requiring them to show that they had reasonable grounds for believing that a threat to corporate policy and effectiveness existed and requiring that the defensive measures be reasonable in relation to the threat posed.

The third reason why planning for hostile takeovers is important is that many effective defensive measures take substantial time and effort to put in place. For example, amendments to the articles of incorporation require a shareholders' meeting. Financing must be arranged for a corporate restructuring.

The creation of a special team to deal with possible takeover attempts is well advised. The team should include the CEO, the CFO, general counsel, and other key executives, as well as outside legal counsel, an investment banking firm, and probably a shareholder relations firm. It is also desirable to keep the board of directors familiar with the planning undertaken by the special team and its recommendations.

The CFO is in an excellent position to evaluate the vulnerability of the company as a target. Is the company's stock trading at or below book value? Does the company have a low price/earnings ratio? Is the company's debt/equity ratio low? Does the company have undervalued assets or significant assets that could be readily sold? Is the company's stock selling at a low multiple of its cash flow? Is the break-up value of the company significantly above the market price of its common stock? If enough of these questions are answered with "yes," the chances are very good that your company is popping up on the computer screens of acquisition-minded companies and corporate raiders.

As part of the analysis of the company's vulnerability, it would be a useful exercise for the CFO to go through the full process of preparing a plan for the leveraged buyout of the company: How much equity would be needed to do a leveraged buyout? How much additional debt could the company tolerate? What assets could be quickly sold to pay down the debt? This is precisely the exercise that a raider goes through in determining whether to bid for a company. When the CFO and his staff force themselves to go through the same process that a raider would, they will develop a much better idea of their vulnerability and the possible means of reducing it.

An investment banking...