Research consistently shows that M&A transactions fail at a rate of 50% to 80%. As one observer succinctly noted, the odds of being successful are not much better than tossing a coin. This is bad enough for large corporations with sufficient resources to weather the storm, but it can be devastating for small to mid-size firms where a failed deal could bankrupt the company.
To help you overcome these odds, this article describes five common reasons why acquisitions fail and then tells you how to avoid each pitfall.
1.) Wrong target or poor strategic fit
A surprising number of companies end up buying a business for no better reason than the fact that it was available or “it seemed like a good idea at the time.” To understand this phenomenon, you must appreciate that most acquisitions are by their very nature opportunistic. Transactions originate from a multitude of sources, ranging from contacts with merchant bankers to senior executives having a casual conversation with a buddy on the golf course. However – and this is important to note – once a transaction starts, it quickly gains momentum and can be difficult to stop. External advisors may be eager to push the transaction through in order to collect their fee, or senior executives may be reluctant to lose face by walking away from a transaction.
The key to avoiding a poor choice is to do your homework long before you begin evaluating potential targets. This entails developing a 3- to 5-year strategic plan that outlines the industries and markets you want to be present in, your revenue and profit goals, and so on. Preparing this plan should help you determine which of these goals can be met via organic growth and which will require M&A activity. Once you understand the role that M&A needs to play, the next step is to establish a list of “essential criteria” that a potential target company must possess in order to be considered. The criteria chosen will vary greatly but may include items such as minimum revenue or profitability thresholds, market leadership positions, or strong R&D capability in a field you wish to enter. Once the list of criteria has been developed, you can use it to screen potential acquisition targets. It’s important to note that targets may not meet all the criteria on your list but they should certainly meet most of them. If they don’t, the odds of a successful transaction will not be in your favor.
2.) Paying too high a price
This is a very common problem that unfortunately cannot be overcome after the purchase, no matter how good a business you just bought. Most often, this error stems from inadequate business involvement in developing the valuation model. Given the sensitive nature of M&As, it’s quite common for transactions to be handled at a corporate level with little or no field input or involvement. When this happens, teams of analysts end up producing spreadsheet models to justify the acquisition price with very little understanding of whether the assumptions they are building into the model can be delivered in reality. Such modeling exercises lead to aggressive assumptions in key areas like sales growth and synergy savings that the local management team is going to have to deliver against when the transaction is completed.
To avoid overpaying for an acquisition, use the following strategies:
- In developing the valuation model, ensure you have the active involvement of the management team who will be responsible for the acquisition. Not only will this lead to more realistic assumptions but it will also ensure that the managers have a sense of ownership for delivering against the acquisition plan.
- Make sure sufficient margin of error is built into the valuation model to allow for unanticipated circumstances. Avoid the temptation to price for perfection.
3.) Inadequate due diligence
Failure to perform adequate due diligence may be understandable given the time pressure involved in most acquisitions. However, I have found that the biggest mistake made by most companies is to essentially outsource the due diligence work to external advisors. I’m by no means suggesting that these firms are not technically competent to do the job, but without your input they are unlikely to fully understand what it takes to run your business successfully. Often these firms produce detailed reports that focus on what I term the “confirmatory” aspects of the deal, such as confirming that the company has clear title to the land and buildings, has the necessary certificates to operate in a country, has filed all of its tax returns on time, and so on. Although the above requirements are absolutely necessary, they are by no means sufficient and must be supplemented by a high level of focus on the reasons you are interested in the acquisition in the first place.
The key is to put together a business team that has a clear understanding of the valuation model and its key assumptions so they can verify that the desired outcomes can be delivered. This needs to be a senior-level multi-functional team who can assure that no major red flags exist. They should focus on answering key questions that are critical if the business plan valuation model is to be delivered. This will include items such as the following:
- If the plan calls for a major increase in sales, does sufficient spare capacity currently exist or will the current facilities need to be expanded? If expansion will be needed, is sufficient space available?
- Are the current manufacturing standards and processes acceptable, and is the end product something that your company would be happy to be associated with?
- Do current labor practices and pay scales meet your company’s standards or will there need to be a major overhaul after the acquisition that may dramatically impact current profitability levels?
- Does the company employ certain sales practices that your corporation could not be associated with?
The questions that need to be answered will differ for each acquisition, but the key is always to get some of your experienced people involved to “kick the tires” and get comfortable with the business and its operations before you move on to the next phase. Above all, remember that the external advisors can be relied upon to do a good job in regard to compliance aspects of the due diligence exercise but ultimately are unfamiliar with what it takes to successfully run your business. Failure to recognize this can lead to nasty surprises after the deal has closed.
4.) Post-acquisition integration issues
In the rush to get the transaction completed, potential challenges related to integration are often overlooked. Making matters more complicated, you are often dealing primarily with soft issues such as the culture of the company being acquired, the reactions of key employees, and so on. However, failure to anticipate and address potential issues in this area can have serious consequences. Typically, three key items need to be addressed:
- You must develop a detailed integration plan that has been signed off on at the highest levels of the company, and it must be prepared very early in the acquisition process. This plan needs to be written with care and ideally be prepared and endorsed by the leadership team that will be responsible for running the business once the transaction is closed.
- You will need to organize a capable management team that is going to be tasked with delivering the business plan following the acquisition. This team needs to have the support of senior management, and they must be fully conversant with the key assumptions made in the valuation model and feel comfortable that they can deliver against it. Ideally this management team should have many years of experience working for the acquiring company and be regarded as subject matter experts in their respective fields. Successfully integrating an acquisition will place a lot of pressure on the new management team, and they must be up to the job. If you find yourself contemplating an acquisition but are unsure whether you have the management team to run it post-acquisition, then you are most likely better off walking away from the transaction.
(c) You need to communicate, communicate, and then communicate some more. It’s often cited that the biggest issue faced by employees of an acquired company is a lack of communication that leads them to feel alienated. The period following an acquisition can be a very nerve-wracking time for employees of the acquired company as they wonder what life in the new world will be like and whether they will be able to keep their jobs. The only way to handle this uncertainty is via an open communication process, especially with key employees whom you want to retain. Your messages must be clear and straightforward and above all they must be well thought through and agreed upon before the acquisition takes place. Making this up as you go along is invariably asking for trouble.
5.) Lack of experience
Research shows that companies with a lot of experience in managing M&A transactions (for example, General Electric) have a much higher success rate than the norm. This should come as no surprise as such companies generally have a very clear view of what areas they need to focus on, what their acquisition criteria are, and how much they are prepared to pay. And above all else, they are not afraid to walk away from a transaction if they can’t get what they want.
For companies who lack experience in this area, the M&A process can be very stressful and time-consuming. Invariably the transaction will involve senior management and a range of external advisors, and as said earlier once a transaction begins generating momentum it can be quite difficult to stop. Senior management’s time gets increasingly taken up by the transaction and it distracts their attention from running the core business. This time pressure, combined with reluctance to be seen as failing in a transaction, causes many companies to push ahead with an acquisition even though they are having second thoughts about it. If you find yourself in this situation, I would offer the following advice:
- If you do not have the in-house expertise to manage an M&A transaction, then find a good advisor that you feel comfortable dealing with. This advisor’s role should be to provide comfort that you are not missing something important and to free up your time so you can concentrate on running your core business. It’s also important to ensure that there are no inherent conflicts of interest with the advisor, such as their fee being dependent upon the acquisition actually taking place. Remember that what you need is experience and advice, and whatever fee you end up paying is likely to be small in comparison with the cost of a failed acquisition.
Finally, understand that if you are in doubt about the acquisition’s attractiveness, its price, or your ability to manage it post acquisition, then there is a very good chance that you’d be better off simply walking away.
If you would like more information on executing M&A transactions successfully, please contact Donal by clicking here or call +662-6511-164