Navigating the Waters of M&A: The Pivotal Role of Internal Audit

Mergers and acquisitions (M&A) refer to the consolidation of companies or assets through various types of financial transactions. These processes are key aspects of corporate strategy, finance, and management, allowing companies to grow or downsize, and change the nature of their business or competitive position.

• Mergers: This occurs when two companies, often of approximately the same size, agree to go forward as a single new company rather than remain separately owned and operated. This action is known as a "merger of equals." Both companies' stocks are surrendered, and new company stock is issued in their place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.

  
  

• Acquisitions: In a simple acquisition, the acquiring company obtains the majority stake in the acquired company, which does not change its name or legal structure. An acquisition may be friendly or hostile. In friendly acquisitions, the companies cooperate in negotiations; in hostile acquisitions, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller company by a larger one.

These activities are often aimed at increasing synergies, gaining new technologies or products, entering new markets, and other strategic benefits that may boost growth and profitability.

In the high-stakes realm of M&A, the role of Internal Audit extends well beyond mere financial examination, stepping into the crucial arenas of operational, strategic, and cultural integration. As corporations pursue growth through M&A, Internal Auditors stand as vital pillars, ensuring these ventures achieve their intended synergies and value enhancements.

The Strategic Value of Internal Audit in M&A

• Due Diligence: Beyond the Numbers At the heart of any successful M&A transaction lies a thorough due diligence process, and it is here that Internal Audit can play a critical role. Internal Auditors can go beyond traditional financial checks to scrutinize the integrity of operational systems, the effectiveness of internal controls, and compliance frameworks of the target company. This comprehensive evaluation helps in uncovering hidden liabilities, assessing the quality of earnings, and identifying potential cost synergies or revenue enhancements that could be realized post-merger.

  
  

• Risk Identification and Mitigation M&A activities are fraught with various risks ranging from financial discrepancies and legal entanglements to strategic misalignments. Internal Audit's function involves a proactive assessment of these risks, facilitating a clearer understanding of potential challenges that might arise from the transaction. By identifying these risks early, Internal Audit helps in formulating mitigation strategies, thereby safeguarding the acquiring company’s assets and reputation.

  
  

• Seamless Integration Planning The success of any merger largely depends on the smooth integration of people, processes, and technology. Internal Audit evaluates the compatibility and functionality of merging systems and advises on best practices for integrating operations. This includes harmonizing financial reporting systems, aligning business processes, and ensuring uninterrupted operations during the merger transition, all of which are critical for achieving operational efficiency and realizing the full potential of the merger.

  
  

• Cultural Due Diligence A significant yet often underestimated challenge in mergers is the alignment of corporate cultures. Internal Audit conducts cultural audits to map out the values, behaviors, and business practices of both entities. Insights derived from these audits are crucial for managing the human side of M&A, facilitating smoother integration, minimizing resistance, and promoting a unified corporate culture that aligns with strategic objectives.

  
  

• Post-Merger Reviews and Continuous Improvement After the merger, Internal Audit’s role shifts towards ensuring that the newly formed entity adheres to its strategic objectives and operational benchmarks. Through continuous monitoring and post-implementation reviews, Internal Audit provides ongoing feedback and insights on operational efficiencies, compliance adherence, and performance metrics. This iterative process not only helps in fine-tuning operations but also ensures that the merger continues to deliver value long after the deal has been closed.

Challenges to integrate Internal Audit in the M&A process

Incorporating Internal Audit effectively in the M&A process presents several challenges that can impact the overall success and smoothness of the transaction. Here are some of the main challenges:

• Timing and Resource Constraints: Internal Audit teams often have limited time to perform thorough due diligence and risk assessments due to tight M&A timelines. Additionally, the complexity of M&A transactions may demand more resources than what is typically available within an Internal Audit department.

  
  

• Access to Information: Gaining access to all necessary information can be difficult, especially in hostile acquisition scenarios. The target company may not be willing to share critical data, which can hinder the audit team’s ability to conduct a comprehensive review.

  
  

• Scope and Depth of Analysis: Determining the appropriate scope for the audit and deciding how deeply to delve into each area can be challenging. There’s a balance to be struck between thoroughness and the practical limitations of time and resources.

  
  

• Integration of Diverse Systems and Processes: M&A often involves integrating disparate systems and processes, which can be complex and time-consuming. Internal Audit needs to evaluate these systems for compatibility and advise on integration strategies, a task that requires deep understanding and foresight.

  
  

• Cultural Differences: Cultural integration is one of the most nuanced challenges in M&A. Internal Audit must assess the cultural aspects and help manage the human side of the merger, which is often overlooked yet critical for the success of the integration.

  
  

• Evolving Roles and Expectations: As the M&A progresses, the role of Internal Audit can shift dramatically, from pre-deal evaluation to post-merger integration and ongoing improvement. Adapting to these changing roles while maintaining oversight can be demanding.

  
  

• Maintaining Independence and Objectivity: Internal Audit must remain independent and objective, but this can be challenging in the politically charged atmosphere of an M&A, where different interests and perspectives may influence the findings and recommendations of the audit team.

  
  

• Regulatory and Compliance Issues: Navigating the complex regulatory environments, especially in cross-border transactions, adds another layer of difficulty. Ensuring compliance and understanding different legal frameworks are crucial for a successful audit and integration.

Addressing these challenges requires careful planning, skilled resource allocation, and a proactive approach to risk management throughout the M&A process. By anticipating and preparing for these hurdles, Internal Audit can provide invaluable insights and support to ensure the M&A achieves its strategic goals efficiently and effectively.

Example of Success: Pfizer-Wyeth merger

A notable example of successful integration of Internal Audit in the M&A process is the acquisition of Wyeth by Pfizer in 2009. This merger, valued at approximately $68 billion, was one of the largest in the pharmaceutical industry and involved significant challenges due to the scale and complexity of the integration. The effective role of Internal Audit was instrumental in ensuring a smooth transition and maximizing the strategic value of the merger.

The effective integration of Internal Audit in the Pfizer-Wyeth merger not only ensured compliance and risk management during the transition but also supported strategic alignment and operational efficiency in the post-merger entity. The proactive and comprehensive approach taken by Internal Audit was pivotal in the smooth integration of the two companies, contributing to the overall success of the merger and helping Pfizer achieve significant growth and expansion in its market capabilities.

Conclusion

Internal Audit’s involvement in M&A transcends traditional auditing roles, positioning it as a strategic partner that ensures thoroughness in due diligence, efficacy in integration, and sustainability in performance. By leveraging the expertise of Internal Audit, companies can navigate the complexities of M&A with greater assurance and enhanced capability to capitalize on new opportunities.

For organizations contemplating M&A, the integration of Internal Audit throughout the merger process is not just beneficial; it is essential. Empowering Internal Auditors to participate from the preliminary due diligence phase through to post-merger integration ensures not only the protection of assets but also the successful realization of the strategic goals envisioned by the merger. As such, enabling and acting on the insights provided by Internal Audit should be a priority for any company looking to thrive through M&A activities.