In my last post, Why Innovation Through Acquisition Is Such A Darn Good Idea, I commented on the crucial importance of mergers and acquisitions in the business innovation ecosystem. From an entrepreneur’s-eye-view, M&A provides lucrative shareholder exits. Viewed through the lens of the public company, innovation-through-acquisition can be a legitimate strategy for entering exciting new technologies or markets by first allowing startups to do the de-risking.
And yet history shows that, in at least half of all cases, after the deal closes, acquisitions sour. (There are dozens of studies and papers, and estimates of how many M&A deals fail to meet financial expectations run from 50 per cent to as high as 90 per cent.)
So all too often from a startup’s perspective, the good news is that entrepreneurs, option-holders and investors cash out, but the bad news is that the employees find themselves in an oxygen-starved bureaucracy and the startup’s customers end up confused or even orphaned. And from the acquiring company’s perspective, it’s all too common for the business advantages they sought – some combination of access to new products, access to new markets or geographies, market share increases, growth faster than purely organic growth, and/or economies of scale – to simply fail to materialise.
I’ve sat on both sides of the fence in M&A on multiple occasions, selling my startups to public companies as well as being on the acquiring side. I’ve witnessed things from the executive seat, the board seat, and as an advisor, and I’ve experienced superb outcomes, mediocre results, and unmitigated disasters.
From that perspective, here’s my list of 6 key reasons why M&A deals come unravelled after the fact – and what you can do about it:
1. Misgauging Strategic Fit
If the acquisition is too far outside the parent company’s core competency, things aren’t likely to work. A company that sells to its business customers chiefly through catalogue and Internet sales ought to be very cautious about acquiring a company that relies on direct sales – even if the products are, broadly-speaking, in the same industry. Similarly, a company whose traditional strength lies in selling products to businesses might want to think twice before making a foray into a consumer-oriented business. Consulting firms have been known to acquire software companies driven by the rationale that the parent’s client companies use these sorts of software apps, and the applications are in the same broad domain as the consulting firm’s expertise; then they discover that selling B2B applications is wholly different from managing consulting engagements. An honest strategy audit up-front is the answer: don’t stray beyond your core competencies, and ask whether the target company fits your strategy, your operations, and your distribution channels.
2. Getting the Deal Structure Or Price Wrong
We all understand that if the acquiring company pays too much in an auction environment, it’s going to be tough to get the acquisition to show a positive ROI. To protect themselves, some acquiring companies like to structure acquisitions with half or more of the purchase price held back based on achievement of future performance hurdles. But watch out: such earn-outs can backfire on the acquiring company in unexpected ways. If, for instance, a major payment milestone is based on post-acquisition sales performance but 99 per cent of the sales people are working for the parent company – and therefore are neither aware of nor incentivized by the sales milestones – then the acquired company employees may well feel demoralized due to having scant control over achieving major payment milestones. I’ve seen similar things happen with product-delivery-oriented earn-out payments: the good news is that the parent company hires in dozens of additional product developers, but the bad news is that only a tiny proportion of the newly-constituted product team knows about or is incentivized by achievement of a major earn-out milestone for the acquired company. In both cases, well-intentioned deal structures that held back payments based on future performance ended up having unintended consequences and souring the deal. The better bet – easier said than done – is negotiating a fair price up-front.
3. Misreading The New Company’s Culture
Just because your two companies are in the same industry doesn’t mean you’ve got the same culture. It’s all too easy for the acquiring company’s integration team to swagger in with “winner’s syndrome,” and fulfil the worst fears of the new staff. Far better if they enter the new company’s offices carrying themselves with the four H’s: honesty, humanity, humility, and humour.
4. Not Communicating Clearly — Or Enough
In the absence of information and clear communication, rumours will fly, and people at the acquiring company will assume the worst. Communicate to the entire team, not just the top executives. Communicate clearly and honestly and consistently. If there’s bad news, be sure to deliver it all it once, not piecemeal, and make it clear that that’s all there is – that folks don’t have to worry waiting for another shoe to drop. And when you think you’ve communicated enough, you’re one-quarter of the way there.
5. Blindly Focusing On Integration For Its Own Sake
Don’t assume that all integration is good. I’ve watched all too often as the parent company insists on fixing things that aren’t broken: The acquired company has established a strong brand, but the parent insists on “improving things” by replacing it with something that blandly blends with the corporate naming conventions. New standard operating procedures are imposed that suck all the oxygen from the room and demoralize the team. A small sales team has clear account authority, but the parent knows better and makes the newly-acquired offering the 1,400th anonymous product in its sales force’s price list. The acquired product works perfectly well as-is, but the parent company insists on rebuilding it so that it fits into the parent’s technical architecture – thereby punishing customers and freezing all product enhancements for years. The bottom line is don’t be too heavy-handed. If this company was worth acquiring, it’s probably worth trusting, funding and encouraging to thrive.
6. Not Focusing Enough On Customers And Sales (vs. Cost Synergies)
The most fundamental scorecard of acquisition success is financial performance, and on that count it’s far more important to focus on revenue growth than cost control. An insightful McKinsey study (published a decade ago, but whose conclusions remain completely valid) pointed out that small changes in revenue can outweigh major changes in planned cost savings. A merger with a 1% shortfall in revenue growth requires a 25% improvement in cost savings to stay on-track to create value. Conversely, exceeding your revenue-growth targets with your newly-acquired company by only 2 to 3 per cent can offset a 50 per cent failure on cost-reduction.
And the worst thing you can do is have a sales drop-off immediately after the acquisition – which is all too common given confusion among the newly-merged team and the customer base – because you can never make up those lost sales. Knowing the paramount importance of uninterrupted revenue – read: sales momentum – the first thing the parent company ought to do in concert with the acquired-company team is get out in front of customers, tell them what’s going on, and reassure them. Yet it’s amazing how rarely that happens. As with the acquired company’s staff, with their customers, in the absence of clear communication, rumours and negative assumptions will fill the void. So get out in front of your newly-acquired customers, tell them they’re still loved, and provide them with a clear, comfortable, consistent and honest story. And when you think you’re done communicating with your new customers… you’re probably one-quarter of the way there.
Jim Price is a serial tech entrepreneur who also teaches entrepreneurship and innovation at Michigan’s Ross School of Business. ©2012, James D. Price.
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