The Critical Role of Culture in Mergers and Acquisitions w/ Aaron Falcione | S4S11 | JKLAdvisors.ai

Founders of the what we affectionately call our employees, because we're all founders in this company. And making sure, looking at those sometimes really simple day-to-day decisions through the lens of, does this support and reinforce our culture or not? And if not, let's take another look at it. That something doesn't feel right. So that's the stuff that happens on a day-to-day basis.

Yeah, thanks. Good to see you, and thanks Jeff for inviting me.

Yeah, thanks. As Sandra mentioned, I've been doing some form of HR consulting, M&A consulting for most of my career. I heard the reference to 28 years, and it made me take a step back and reflect on just how long I've been doing this. My career started at PwC. It was actually Coopers & Lybrand at the time, and Coopers & Lybrand merged with Price Waterhouse. So my early experiences were in an M&A environment with all of the changes and uncertainties that brought. So I had some real lived experience that then translated into moving into a practice where Sandra and I worked together for many years, advising companies who had decided to go through a corporate transaction, a merger, an acquisition. What would often happen is those companies would be focused entirely on the financial aspects of whether the deal made sense or not. Eventually, the management team of those companies started to wrestle with how we're going to think about integrating this company, how we're going to think about the blending of the workforces and the cultures and the leadership teams. That is often where Sandra and I would come in, and we would play pretty instrumental roles in helping them think through the decisions that stood in front of them and guide them through some of that decision-making. That career path took me in a lot of different directions. I left PwC and joined Siemens. I was at Siemens for about 10 years, a large German industrial company, in their M&A team where they were making enormous investments in the US. They were acquiring companies on a regular basis, it seemed, every quarter, to build out their presence here in the US. So I got a chance to see the processes from more of a strategic buying standpoint versus just an advisory standpoint. That led me to Merck, known as MSD outside of the US, where I spent about five years living and working in Switzerland in an HR role supporting our Emerging Markets region, which included Middle East, Africa, Latin America, Asia Pacific. I took on progressively larger responsibilities within the organization until about two and a half years ago when Merck decided to spin off a company, and that's this company that I'm in now called Organon. Organon is a spin-off, so again, lived experience through a transaction, in this case a divestiture. I've been the CHRO here from the very beginning, and I think some of those lessons we'll dig into as we get into this. I'm talking to you from Jersey City, which is where our global headquarters are based, just outside of New York. I live in Manhattan. I've been living in New York City for the better part of 28 years, off and on aside from a few stints outside. Married for 23 years, really proud of that, and we have two little dogs, Shadow and Sunny are their names, and they're the object of all of our affection.

That's right, which just goes to show that when you feel pain when you hear 28, I'm right there in there with you, Aaron.

It's a great question. I will admit upfront I'm biased here. I have a strongly held belief and a bias based on my background and my experience and the role that I play, but I really firmly believe, and I think I could back this up with lots of experience, that people make or break a deal. If you think about the process during an M&A transaction, the teams working on those transactions, the managers, are focused primarily on the financials and making sure that the economics of a deal make sense, and that's appropriate. But quickly, what happens is success of an M&A transaction really depends a lot on how you then deal with some of the attendant people issues that the announcement of a transaction starts to provoke. When I think about where I spent a lot of my time even today here at Organon, because we've done some transactions since the launch, I make sure that our HR organization is prepared and up to the task to ensure that they are helping guide managers and decision-makers in a deal process through the really tricky people-related issues. I'll give you a couple of examples. There's a kind of an equation when you think about it. If you survey companies that have gone through a transaction, an overwhelming majority, upwards of 80% of companies that have gone through a merger or an acquisition, would indicate that they would prefer to have gone faster through that process, not slower. The belief is that a prolonged transaction, a prolonged transition, erodes value. So if you can find ways of minimizing the depth and the duration of a transaction, you can actually create incremental value through an accelerating process. The things that prevent companies from moving fast is typically a preoccupation with people selection, employee productivity decreases, a mind-numbing set of questions around what happens to my pay, my benefits, who I report to, will I even have a job. There are a ton of people implications where HR involvement can have a really positive impact. When I conclude it all, my biased perspective is that HR is perhaps the most critical function in ensuring success of a deal. I acknowledge my own bias because I'm sure other functions would declare their most important, and it speaks to the notion that we're all probably true. Everyone plays a critical role, but I do know if you fail to address the most urgent people issues, the distraction that that causes will substantially reduce your probabilities of successfully capturing the value that underpins the deal price to begin with. So we really focus on getting after that from the earliest days, even before a deal is announced, we start thinking about what's it going to be like to integrate, what's it going to be like to start working together, do we have an early read on the management team, can we start to think about who the management team of the combined entity should be, and do that in a structured and somewhat dispassionate way.

Absolutely. There are a couple of principles that run throughout the process. One of the principles is you cannot not communicate. I don't know if that's grammatically correct, but it suggests this idea that even silence communicates something. You can either communicate something proactively with decisions and forethought, or you can communicate through omission and leave the speculation to the rumor mill and sometimes become victimized by a swirling set of rumors across a workforce around things that are important to them. One of the techniques that Sandra and I used to use all the time was we would use communication as a catalyst for decision-making. It sounds almost too simple to be impactful, but it really is one of the most impactful strategies companies can employ. You simply sit down and ask, 'Here are the questions that your stakeholders are going to ask. What's the answer?' And the answer doesn't have to be a decision; it can be 'I don't know yet, but here's the process we're following, here's the timeline in which we believe we should have an answer.' It's questions like: Will I have a job? Who do I report to? Is my sales territory going to be impacted? What are my benefits? Eventually they get to some higher order questions about what's our vision, what are our values as a company, what's our culture going to be like. But there's a model that we tend to follow, which is trying to answer the questions in the order in which they're asked. Most employees, when there's a deal announced, they're not necessarily asking about the vision of the company; they're asking about their parking space, to be honest. It's what's important to them. The first question that most people ask in a big transaction is 'Will I have a job?' It follows Maslow's hierarchy of needs; it's basic safety and security kinds of issues. Once you resolve those, they can start to move up the pyramid and start to ask higher-order questions, which ultimately get to 'Do we share values as a company? Does this company espouse values that I align with?' Unfortunately, most senior executives want to start with the values and the strategies and the visions because that's what they've been so focused on. That can be helpful, but you have to recognize there's a lot of noise in people's heads, and they're not probably able to absorb some of those things until their first questions are going to be answered. Some of the things that we do from an HR standpoint is to try and help management focus on those primary things first, help drive some decision-making, and if not decisions, here's the timeline and the process by which we can do that. That has some calming effect on the broader stakeholder groups that hopefully then allow you to move quickly instead of frantically.

I will tell you, not to belabor the point, but I'll just share one anecdote that I think could be a cautionary tale. I was brought in on a deal where we were brought in late, and it was day one. They had announced, and I was sitting with the CEO of the acquired, the acquiring company, and he was about to go into a company-wide town hall meeting. This was a technology company back in the early 2000s. He was quite frankly a little dismissive of my advice. I probably wasn't advising in a good way; I didn't find my way to influence him. He was a little dismissive of this notion of needing to be prepared to answer questions or pivot to more process and timing kinds of answers. He went out and started addressing the employees, and one person raised their hand and asked a fairly rude question, a provocative question around pay and benefits. The CEO matched the bravado of the question and said, 'This is the way we're going to do it, and if you don't like it, you can leave.' It was this sort of adversarial dynamic. I'll never forget because the person said, 'Okay,' that was his only response, and he left. That happened to be the lead engineer of the software. That company subsequently, a year later, sold for literally pennies on the dollar of what they acquired the company for. The entire business collapsed. It really came down to a pivotal moment where there wasn't enough care taken with someone that they just didn't know, and the whole thing unraveled. The sellers of that company actually came back in and bought it for pennies. It was an amazing series of transactions, but I attribute a lot of the way that all played out to that one moment.

I think culture always has an influence. Whether it becomes the influence that elevates to being a go or no-go kind of factor, it can be rare. But I do have a couple of examples where in my analysis, and to be honest, these were sort of vulnerable moments in my career where I'm giving guidance and advice where I know the deal team really wants to do a deal, there's a lot of energy and momentum to complete a transaction, there's strategic rationale, there's approvals that have been sought and had. For me to come in and say I've got a major concern because of the culture, which is a bit of an esoteric concept, it's not always commonly understood what we mean by even the word culture, it's an amorphous concept, it required a gut check for me. I had to position it properly. There was one situation when I was at Siemens where we did end up walking away, and the primary reason we walked away from a deal was a fundamental cultural misfit. The way I made the argument was a combination of factors: management team attitude, our confidence in our ability to retain the management team. I used some of the artifacts that were available to me in the due diligence process, namely performance and reward systems that this company had in place, the magnitude of compensation that the management team had, the nature of compensation between fixed and variable. These are all things that give you a sense of how they drove performance and how congruent that model was to where we were. If the value proposition was predicated on integration, my argument was integration has huge and somewhat emotional hurdles to go through because we're going to have to affect people's pay. If we know that's a path, we have to evaluate this deal with an assumption that we're not going to be able to retain the management team. If we don't feel like we can retain the management team, do we still feel that this is a good deal? So I walked through a scenario where we assumed within a fairly short period of time we would have 50 to 60% attrition on the management team. As I started posing those scenarios, a cold chill came over the whole thing, and people said, 'You know what, this is perhaps too risky.' We walked away. I reflect on it now and I think it was the right answer, I really do. But at the moment, I was quite anxious about my advice. That's a high-risk maneuver as the HR lead advising into an M&A deal on something that is as fungible and amorphous as culture.

We walked away. We pivoted to a different company in a similar field because this was part of a strategy. We shifted our focus; there was a sequence of deals that we were thinking about doing in order to break into a new market. We pivoted over to a different company, did that, found success. An interesting full cycle in the story was later, that management team in fact did some of them turn over, and I think they had started to realign some of their incentives. We ultimately came back and acquired that company that we had previously walked away from, but we did it from a position of strength. We had already gotten into this new area of business for us. We went back in from a position where we weren't totally dependent on retention of the management team. I could ask the same question: 'What would this deal be as valuable to us if 50% of the management team left?' And the answer this time was yes, because we could absorb the business and we had the intellectual horsepower and the know-how in this industry now to operate it with or without them. It gave us a totally different negotiating posture in the whole process, and it was successful.

Yeah, and that topic, the whole notion of how do we make sure if part of the strategy behind a corporate transaction of any sort is to break into a fundamentally new field or a new market or a new area that you don't have experience in, then it amplifies these talent issues all the more because half of why you're breaking in is because you want that idiosyncratic knowledge that you yourself don't have. If you're bolting on a company, if you're expanding on an existing capability, it's not quite as relevant. It's not insignificant, but I think it does change the risk factor and the risk posture that you're able to take as you go into these things. That whole cycle, that whole continuum, was in full display on the story I just told.