Did any board member suggest that Bank of America should go ahead and invoke the MAC?

No, not at that point…most people thought the severity of the reaction meant that they (i.e., U.S. Federal Reserve and Treasury) firmly believed it was systemic risk.

—Ken Lewis, former chairman and CEO of Bank of America during U.S. Attorney Deposition on Executive Compensation February 26, 2009¹

On October 8, 2002, Fred Goodwin, then CEO of Royal Bank of Scotland (RBS), outbid Bob Diamond, the head of Barclays Capital, to conclude his long quest to purchase ABN AMRO Bank for $96.5 billion. Goodwin had built RBS from a small regional bank to a global powerhouse that was one of the largest banks in the world. For his efforts, Goodwin was voted “Businessman of the Year” by Forbes magazine in 2002. He had earned the name “Fred the Shred” for his ability to ruthlessly take out people while reducing the cost of operating the companies he acquired. Forbes proclaimed, “In a tough era for lenders, Fred Goodwin has built his bank into the world's fifth largest with a market cap of $70 billion.”² Goodwin had a pragmatic approach to acquisitions, leveraging his instinct and experience running businesses to buy and transform companies.

Five years later, this jewel of an acquisition did not live up to expectations. Credit losses in the ABN loan book, key employee departures, an inability to integrate the complex ABN AMRO computer systems, and an overall downturn in the economy drove RBS's stock price from a high of over £7.00 per share ($4.2 per share) to a low of less than 50 pence per share (31 cents per share). Material adverse events in the company proved that a purchase price of close to $100 billion was more than ABN AMRO was truly worth.

With the continued deterioration of the economy and the rising of a Great Recession, the issues surrounding this deal became more and more apparent. Indeed, by the time of the depths of the recession in December 2007, for the same $100 billion that RBS used to buy ABN AMRO, an investor could have purchased 100 percent of Goldman Sachs, RBS, General Motors, Citibank, Deutsche Bank, and Merrill Lynch all together.³

What Can You Get for $100 Billion?

Despite his best intentions and a desire to enhance the value to RBS shareholders by purchasing an exciting new business, this unfortunate acquisition cost Fred Goodwin his job. Thousands of shareholders who had invested in RBS stock lost all of their value. Goodwin was summarily dismissed from RBS, villainized by the press, and received threats on his personal safety. He was forced to leave his home and retreat to a friend's Majorcan Villa to avoid the press and an angry public. It was not until May 2016, over eight years after the fateful acquisition, that Goodwin was finally cleared of all criminal charges relative to the RBS deal.

This book is not intended to cast blame on CEOs, investment bankers, or other advisors unfortunate enough to be involved in failed transactions. I have found these constituencies to be hardworking and largely interested in the success of the companies they work for. Rather, it is to probe why deals don't work and the risks implicit in major transactions such as RBS paying close to $100 billion to purchase ABN AMRO. Through a review of past failures and the reasons behind these failures, we can better anticipate the potential pitfalls of future deals and avoid the disruption to a company and destruction of wealth to shareholders when deals don't work.

In the mergers and acquisitions (M&A) profession, due diligence is defined as the work accountants, lawyers, human resources, risk departments, senior executives, and other key personnel of the buyer complete prior to agreeing to purchase a company. Take the analogy of a newly married couple who wish to buy their first house; we will call them the “Wilsons.” The Wilsons typically look through the real estate listings, talk to a realtor, visit several properties, and narrow the search down to one house. At this point they will do a more detailed review of the property, looking for areas that may be damaged and in need of repair or replacement, or areas that the seller should correct before he sells the house. The Wilsons will likely hire outside experts such as an inspector to examine the house, an appraiser to verify the home's market value, a lawyer to help negotiate terms, and so forth. In essence, the Wilsons will want to be more than comfortable with the home before they commit money to purchase it.

Similarly, in successful acquisitions, a corporate or financial buyer of a company will analyze the financial position of the target, meet with key management, review the operations, update the company's financial projections, and investigate legal liabilities, all to determine if the company is worth the price being paid. Deal teams will hire consultants, lawyers, and accountants to help them with this process. Once complete, the buyer will sign a contract to purchase the company at a specified price over a certain time period.

In larger M&A deals, there is normally a time period between actual agreement to purchase (signing) and the completion of the transaction (closing). This time is used to satisfy contingencies such as government approval for the deal to happen, shareholder consents, employee union agreements, or agreements from other parties who need to consent to the transaction. Once all of these have been satisfied, the buyer and seller will move toward final closing of the transaction. It can take months to close a deal after contracts have been signed. This time between signing and closing is one of the most risky parts of the entire M&A process.

Take the example of the Wilsons, who now own the perfect home (as a result of completing very good due diligence!) and decide they need a car to go with it. They decide to buy a used car to save money and enter into a contract to purchase the car on Monday (signing). During the week they will withdraw the cash, arrange for financing and insurance, and then pay for and take possession of the car on Friday (closing). The Wilsons will absolutely want the car to be in the same condition on Friday that it was on Monday when they agreed to purchase it. But what if the owner decided to drive across the country from Tuesday to Thursday? What if the car was in an accident on Wednesday? Clearly the Wilsons will want some protection that the car will be in the same condition on Friday as it was when they agreed to purchase it on Monday if not to be able to walk away from the purchase.

Buyers in the M&A world face the same challenges. The target continues to function between signing and closing and is subject to the external risks of the business, the economy, and other acts beyond its control. Therefore, a buyer is at risk as they have agreed to purchase the company at signing, but the existing management team continues to run the company on a daily basis, hopefully well, for the buyer. A legal clause referred to as a material adverse change (MAC) has been crafted by attorneys to protect the buyer during this period between signing and closing.

An MAC allows the buyer to walk away from the deal if the target does not continue to run the company effectively or the firm incurs material changes that make the company less valuable. Attorneys have made the MAC clause much more complicated over the years. For example, years ago MAC clauses allowed buyers to walk away from transactions for the occurrence of natural disasters, acts of war, or terrorism. Unfortunately, due to the turmoil in the world since then, such events are no longer infrequent and these are no longer legitimate reasons for a buyer to walk away from a deal. But the concept remains the same. The buyer can back out of the deal if certain other bad things happen between signing and closing

The combination of due diligence and an MAC provision sounds perfect. In theory, the buyer gets to spend as much time as they want reviewing the corporate records; meeting with key employees; understanding the legal, environmental, and risk issues; and gaining an overall comfort with the target operations before agreeing to the purchase. Further, the MAC clause allows the buyer to walk away if material unusual events occur after they have agreed to buy in concept, but before they make final payment.

But many CEOs of major corporations do not exercise these rights as buyers or do enough due diligence to fully understand what they bought. Whether it is RBS's purchase of ABN AMRO or Bank of America's purchase of Merrill Lynch, these mistakes can have dramatic impacts for their company, their shareholders, and their careers. But bad deals continue to happen time after time. What are the factors motivating CEOs to put their careers on the line to acquire large companies? Why does this continue to happen despite highly publicized acquisition failures and the potential civil and criminal liability for the individuals involved? Why are successful companies not satisfied with where they are, pursuing a logical and orderly method of organic growth to improve their performance?

This book attempts to answer these questions. Whether you are a corporate CEO, an investment banker directly involved in M&A, an attorney, a human resources executive, a CFO, or a casual reader of business books, it will provide guidance on how to avoid these mistakes going forward. Landmark M&A case studies, such as Bank of America's purchase of Merrill Lynch and Kraft's purchase of Cadbury, will be used to answer these questions and provide hard evidence as to why these errors that defy common sense continue to be committed by well-established, successful, and highly intelligent businesspeople.