by Tom Allen
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Changing business models and progressive, tech-infused industries have spurred a collective rush for reinvention. As legacy approaches to profitability are squeezed by emerging tech, evolving consumer needs and new regulatory scrutiny, companies are turning en mass to M&A. For many, M&A represents the best, last hope to compete and avoid a slow decline to obsolescence.
But deal making itself cannot save a flailing company. To survive, shareholder value must grow with the introduction of each new acquisition and implementation of each post-merger integration. While this seems obvious, the reality of the experience is different: value killing deal practices are surprisingly regular, startlingly hurtful, and must change for M&A to restore companies to significance.
In this article, three of the most notorious value-killers are discussed. For each we discuss how applying smarter M&A practices can turn the tide of value erosion.
1. Poor Planning is Killing Deal Value
In the midst of a complex acquisition, dealmakers often fail to articulate clear objectives or offer the bigger, guiding picture to stakeholders. This is particularly true when examining a deal’s financial benefits. A key first component of the deal process is having a defined plan with clear objectives that articulates how the business plan will succeed. When M&A becomes a lifeline for companies losing ground, the type of deal that gets targeted is often one that tries to fundamentally reinvent a business model and redirect a company's course. These deals are different and, naturally, massively difficult. They require particularly careful planning, with integration plans, outcomes and the interdependent elements of the existing and acquired company all requiring consideration. This type of deal is uncharted territory – and needs a level of planning diligence above and beyond what tends to apply for deals in more familiar industries/sectors or product lines.
Add the reality that deal makers are under incredible pressure with an inordinate amount of hope riding on deal outcomes and planning becomes even more crucial. These deal pressures often manifest as rapid, disconnected activity, with companies believing that more deals will improve the odds of success. When this line of thinking ensues, everything unravels.
Important areas, such as significant one-time and recurring financial realities, are often overlooked. One chemical manufacturing company in a McKinsey study publicly committed itself to reducing annual expenses by $210 million, at a one-time cost of $250 million as part of its acquisition rationale. However, had more due diligence been applied to estimating the overall cost, a more accurate budget would have been set at around $450 million instead. This gross underestimation left the company running over budget, failing to deliver on promises made during M&A, and falling short of revenue targets.
However, focusing solely on costs in M&A, without any vision for future revenue growth, is also a mistake that can prove disastrous. Revenue estimates are equally as important and represent a critical area to “get right” during deal planning and due diligence. Another classic study shows that a merger with a 1% shortfall in revenue growth requires a 25% improvement in cost savings to stay on-track to create value. But by exceeding revenue-growth targets with a newly-acquired company by just 2 to 3% can offset even up to a 50% failure on cost-reduction.
2. Reliance on Ad-hoc Processes is Killing Deal Value
As deal volume and complexities rise, having a systematized, efficient, playbook-driven approach to deal making becomes a non-negotiable. If M&A is to ever deliver value it must be disciplined. While consistency and standardization may look different industry to industry, having clearly defined and detailed action steps will reduce inefficiencies, costly due diligence oversight and move deals to value establishment more quickly. Deloitte refers to companies that have adopted systematic deal engines as “advantaged acquirers”. These companies – through use of disciplined processes – tend to be able to identify value-creating targets earlier and avoid the under-performers. They then enjoy a competitive deal edge and outperform on shareholder value delivery. This happens because every stage of the transaction process is detailed and go/no-go decisions can be made intelligently and defensibly. They don’t waste time commencing due diligence or negotiating on poor fits, or on companies that don’t meet strategic criteria agreed by company leadership. Instead, some of the benefits they find include:
• Raising diligence and integration issues before valuation and negotiations begin;
• Improvement from iterative learning after each deal to sharpen processes and reassess how to be more efficient;
• Building board credibility and trust (read: faster exec decision making!) through successful deal making;
• Saving time and financial resources by not focusing on inappropriate deals.
Ad hoc approaches invite disorganization and hurt value making potential. On this point, Harvard Business Review concludes:
"So many acquisitions fall short of expectations because executives incorrectly match candidates to the strategic purpose of the deal, failing to distinguish between deals that might improve current operations and those that could dramatically transform the company’s growth prospects."
3. Ignoring Soft Deal Factors - Such as Culture, Kills Deal Value
Retaining company culture, while easy to dismiss during periods of more technical merger pain, is one of the more important ways to sustain value; even long after the merger is complete. Another McKinsey study found that 92% of business executives felt that past M&A activity would have "substantially benefited" from greater cultural understanding prior to the merger. In many cases, the acquisition target is attractive in large part because of the talent it offers. By ignoring cultural integration challenges or neglecting to consider how a large, legacy corporate culture may be discordant with a flatter, free-flowing startup environment, for example, an acquirer may drive away the innovative minds that drew them to the target company in the first place!
One advisory firm suggests prioritizing a compatibility assessment to “try to quantify “soft” cultural factors such as how the company conducts meetings and makes decisions, the physical environment, hierarchical structure, work hours, dress code, age of employees, communication style, and employee and customer sentiments.”
Another value is to keep owners and those “faces” of the organization involved. While advisors may be appointed to shepherd companies and intervene in processes, this should not preclude company leaders’ involvement to remind teams from both sides why this deal is beneficial. Ultimately, having leaders from both companies communicate the respective values of each culture and together weigh in in key areas where post-merger integration may be challenged can cut off any cultural clashes before they impact deal return.
Scrutinizing value killers and assessing how existing processes lead to value loss are first steps towards improving acquisition strategy and deal outcomes. From this, deal teams can ask better questions, propose steps for improving, sidestep future pitfalls and better manage deal risks. The sheer volume of deals and complexities of a target's technology in this age of M&A will always present risks and challenge even the most tightly aligned processes and people. But by attacking spots where deal value erodes most often and most rapidly, companies can turn the tide of the value loss trend.