Contributed by Robert Sher
I have noted previously that the most successful acquirers don’t see all acquisitions as being equally challenging. They know acquisitions fail on average 50% of the time, so they evaluate each deal on risk and complexity, then decide if they have the competencies to deal with them. They make deals with their eyes wide open.
We have found 12 risks and complexities in every mid-market business acquisition we come across:
#1: M&A skills and experience. How much acquisitions experience is on your leadership team, and how long have those executives been with your company? Firms whose executives don’t have deep acquisitions experience or are newly hired will face many more surprises and problems. They need to know how to integrate any acquisition just as well as they know the acquirer’s people, culture, strengths and weaknesses.
#2: Cultural differences. How different are each company’s values, beliefs, work styles and behaviors? When there is a vast difference, integration gets complicated fast and the “people” problems are slow to resolve. For example, I just met with a large firm where the norm is that executives hit their numbers or “die trying.” The company does not tolerate poor performers. That kind of culture often gets into trouble when it buys closely held middle-market firms from $20 million to $50 million in revenue. These firms typically have been run for years without formal business planning or a high-performance culture, and collaboration with the parent company has suffered as a result.
#3: Size of acquisition. Compare the revenues of the acquirer to the revenues of the target: This percentage is a key indicator of bumps ahead. Most acquisitions below 10% are small enough for the acquirer to integrate without risking core operations or financial stability. At 20% or above, there is significant complexity and higher risk.
#4: Amount of integration required. Merging operations and financial systems is hard work. Some companies are purchased and left to run on their own. They make only periodic financial reports to the parent, and the new ownership structure may not be publicized. This is almost no integration at all. On the other hand, a merger of equals, in which factories, teams and IT systems are merged into one, is a massive integration challenge.
#5: Earn-outs. When the owner/managers of acquired companies must earn a portion of the acquisition price after the deal closes, it seems like a great way to bridge the gap between how buyers and sellers perceive the acquisition price. If the acquired company performs well, the seller gets more since it proves that the acquirer bought a healthy business. In practice, however, earn-outs are hard to manage due to conflicts of interest, resource allocation disputes, and egos. Bad feelings, litigation, and morale issues often abound.
#6: Operating team’s involvement. In some companies, the CEO and/or the corporate development department find, assess and buy businesses largely on their own. Once they’ve done the deal, they hand it over to the operating executives to integrate and operate. This dramatically increases the integration’s complexity and risk of failure. In contrast, some companies involve their operating executives from start to finish. Assuming they are interested, enthusiastic, and have the time and energy to devote to an acquisition, they decrease the risk and improve the outcome.
#7: Murky due diligence. The purpose of due diligence is to gain clarity on what you’re acquiring and its future prospects. When due diligence is cursory or the truth is illusory, it makes for surprises that increase complexity and risk. A manufacturer conducted limited due diligence in buying a retail business that it thought was highly profitable. After the close, the manufacturer discovered that the retailer was actually losing money. It took a year to diagnose the problem and six months to fix it. After adding the losses to its purchase price, the acquirer found its return on investment vanished to nothing.
#8: The need for unpopular actions. Some acquisitions, especially of distressed companies, require the acquirer to make harsh, even drastic changes – e.g., layoffs, plant closures and cancellation of projects. These actions have a chilling effect on the morale of the acquired company, and hence, performance.
#9: Change required of acquirer. Many companies make acquisitions to shake up their own organizations. The biggest of these are called transformational acquisitions, and they are often mergers of equals. When two companies embark on massive change, they can suffer enormous distraction and decreased productivity.
#10: Visibility of change to customer base. The greater the change in brand image of the acquired entity, the greater the complexity and risk. In a merger of equals, often a new company brand emerges, which is a complex process. The more severely that the merged company changes pricing, products and services, the more complexity increases.
#11: Expertise in acquired line of business. Many businesses choose to acquire companies they fully understand. Many are direct competitors or companies in the same industry. In a worst-case scenario, an acquirer with strong industry knowledge could run a firm it acquired even if all its employees left. This reduces the complexity and risk. When I was CEO of an art publishing company, I made sure this was the case with all my acquisitions. But many companies buy firms in other industries to diversify the portfolio. The fact is these deals are much more complex and risky.
#12: Cash available to manage complexity. Acquirers that spend all their available cash on buying a company will have no money left to manage the integration. Acquirers often underestimate or even ignore what kind of investment it must make to support an acquisition’s success. If you have extra cash to invest in integration without destroying your ROI, your chance of a respectable result increase.
If many of these 12 factors are sending alarm bells about a business you’re about to acquire, you may very well be about to “bite off more than you can chew.” The strategic need for the deal better be high because the integration is likely to keep you up for many nights.
Robert Sher is the founding Principal of CEO to CEO and has been a Member & Director of the Alliance of Chief Executives since 1996.