The high failure rate of M&A transactions has been well documented. A Harvard Business Review article estimates it at 70% to 90%, and a McKinsey study found that about 10% of large deals were cancelled post announcement. But why?
Understanding the reasons deals fail can help venture capital and private equity investors avoid a similar fate. Here are some common pitfalls to be wary of when selecting your next investment.
The impact of misaligned cultures is hard to overstate. Insistence on the target adapting to the acquiring company’s culture can damage important factors that gave rise to the target’s original success. Key employees leave, and leadership vacuums arise and are addressed too late or are filled by the wrong people.
All too often, the problem isn’t a failure of diligence, but a failure to heed warning signs. In the throes of auction mentality and FOMO, the focus is on the benefits of the acquisition to the exclusion of the costs, particularly the cost of distraction from the core competencies that made the buyer (or the target) successful in the first place. Expected cost synergies often fail to provide sufficient savings to warrant the price paid.
Discipline is required to evaluate the integration plan and customer responses to new offerings. Diligence should center around identified goals. A valuable question to ask is, “in the absence of a deal, would the acquiree pay for access to my assets?”
According to the Harvard Business Review, acquirers often “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. As a result, companies too often pay the wrong price and integrate the acquisition in the wrong way.”
If the expected value is to come from cost savings, back-office synergies will not be sufficient to warrant the cost of doing the deal. The savings need to be at the operational level. Economies of scale are most likely when the buyer has high fixed costs that can be leveraged to support increased volume.
If price increases based on improvements customers will pay for are expected, diligence should help bear out that thesis. Similarly, if cross-selling opportunities are the goal, diligence must investigate whether the customer will see value in procuring the target’s product from the new vendor.
Often, buyers rely excessively on checklists and quantitative approaches to diligence. Attention to human, strategic, and operational alignment is neglected. The integration plan is an afterthought, when it should be front and center.
Value increases only if performance enhancements exceed priced-in expectations. Can the target disrupt the existing status quo in the future, delivering new and unexpected products to an expanded set of buyers, or are expected performance enhancements tied to the existing product and customer base? Are the target’s products trending to commoditization or innovation?
The strategic goal will help determine the method of integration. If the goal is to improve current performance, a tight integration eliminating duplicative costs and providing opportunities for cross-selling or product enhancements is likely warranted.
When the goal is to revolutionize, your target may be best left largely intact. If agility is critical to the target’s success, folding it into a larger entity in the name of synergies or consistent optics may destroy value.
If the deal structure involves an earn-out component, it is vital that the integration plan addresses obstacles to achieving the agreed-upon milestones. If the acquirer is relying on its existing employees to deliver services critical to meeting the milestones, they must ensure the employees’ incentives are aligned with those of the target. Frequently, necessary resource requirements are ill-defined or the commitment to provide them is lacking.
In the drive to quickly realize cost synergies, customers may be neglected. Small decreases in sales, even temporarily lost sales, are common and can quickly exceed the savings. It is critical to deliver a transparent, cohesive explanation to customers of the value of the new entity before they form negative assumptions as to risk and continuity of product and service quality.
Communications to employees, while more likely to be part of the integration plan, are often not executed well. Piecemeal delivery of restructuring plans, particularly staged layoffs, result in fear and flight that undermine performance and endanger retention.
A disciplined approach focused on a realistic, objective assessment of valuation creation for the customer by leveraging the assets of the combined entity can substantially reduce the risk of failure.
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