Avoiding the most common M&A failure points: Part 1
Why many acquisitions fail to produce benefits and how to avoid the pitfalls
Note: This is educational only. You must obtain professional advice when considering any M&A transaction.
CEOs tend to share a personality trait. They like to pursue and close deals—whether it’s winning a new customer, buying a company, or selling their own company. Unlike winning most new customers, selling their company or buying a company is a “bet the farm” proposition (literally, in the case of selling.) And, unlike winning new customers, most CEOs have little experience buying or selling companies.
Drive for the deal, combined with lack of experience, can result in the CEO becoming fixated on closing rather than focused on all the factors critical to a successful merger and acquisition (M&A) outcome. This is no small concern, as many studies have been done on the rates and causes of M&A deal failures across multiple industries. The consensus is that somewhere between 40% and 60% of all M&A deals fail to meet the goals set forth by Buyer.
If you’re Seller, do you care if Buyer succeeds? Generally, yes, for two reasons:
- Many transactions contain future payments to Seller contingent on the performance of the acquired assets, or that are at least at risk if Buyer performs poorly and can’t afford to make “guaranteed” payments.
- Even if the transaction contains no future payments, most Sellers exhibit concern about the future well-being of their employees and customers, and they know that outcome is dependent, at least to some degree, on the future well-being of Buyer.
In this article, we’ll examine the most important factors that go into avoiding the most common pitfalls on the road to a successful M&A outcome. For clarity, we’ll do so from Buyer’s point of view, trusting that Seller can discern which factors are most important to their own goals.
Unclear or mistaken strategy
It may be that you get everything else right about your M&A deal, except the strategic reason why you’re doing it to begin with. Here’s a classic in the solution provider business:
- You’re a product-centric solution provider (that is, more than 60% of your revenue—not gross profit—comes from product resale).
- Most of your customers are mid-to-enterprise in size.
- You mistakenly believe the way you should get into the managed services business is to first (or only) target managed services in the small-to-medium-business (SMB) space.
- You buy an SMB managed services company.
- You struggle to win very many customers (SMB or larger), and even if you do, it doesn’t seem like the managed services business will ever be material to your company overall.
There are multiple reasons why buying an SMB MSP almost always fails to benefit a product-centric company. Lack of meaningful commissions for big-dog sales reps, inability to cross-sell offerings between customer sizes, too many SMB customers needed to make an impact on the bottom line, technical capability mismatches between customer sizes, and so on.
Similarly, SMB managed services firms will sometimes mistakenly buy companies that specialize in custom application development or private cloud/hosting.
The strategies generally don’t work for solution providers who are making billions in revenue, because there’s no reason they would work better for smaller solution providers. Strategies that do work for solution providers include using M&A to add similar talent and offerings for customers of the same size, adding customers of the same size, adding closely adjacent geographies, and other lower-risk strategies. Think base hits, not grand slams, and you will more likely score runs.
Paying too high a price & better alternatives
The old saying in M&A is, “You can never pay too little.” That said, even if you pay literally nothing, you are stepping up to spend and risk a great deal. Carefully consider the pitfalls addressed here and calculate what you will be investing to avoid or overcome them.
If you’re buying a company like yours, primarily to add customers like you already have, consider that you are mainly buying time:
- Let’s say you want to add $1 million in managed services revenue. In today’s M&A market, put too simplistically, you’ll pay around one times that amount to buy the revenue: $1 million.
- A best-in-class SMB MSP will charge the average 34-user customer about $68,000 in annual recurring revenue, meaning it will take about 15 such customers to add $1 million in managed services revenue.
- Let’s say you’re currently adding one new such customer through organic sales per month. That means it will take about 15 months to add $1 million.
- If you’re at best in class in sales and marketing cost efficiency, you’ll spend about $150,000 or so winning those customers.
If you win them on your own, those 15 new customers will cost you around $150,000. Buying them will cost you five or six times as much. Is it worth it? Perhaps, depending on your value creation strategy (i.e. how much cash flow you want to build in what period of time), your available resources, and your other options for growth.
Perhaps you doubt that you can win the 15 new customers organically in 15 months. Let’s say it will take you twice as long (30 months) to win 15 customers, and all the while you’re paying sales and marketing costs. So now your cost to win those customers organically is, say, $300,000. Is the acquisition more effective in terms of cost and risk?
How much would you have to spend on sales and marketing to accelerate those 15 organic wins into 15 months from their current 30 months? You double the $150,000 to $300,000, but you hit your 15-month growth goal. Now, is the acquisition still more effective in terms of cost and risk??
One way to manage this risk is to know what your Best Alternative to No Agreement (“BATNA”) is. During the negotiation, it’s helpful to know at what price you would be better off investing your money elsewhere. This is called, “knowing your BATNA,” and is a well-established risk mitigation technique.
Too few resources
We’ll examine this more in the section below dealing with integration but suffice to say that integrating an acquisition is much like winning a very large customer—except that it’s also like adding many normal-size customers at the same time.
How much time in reserve does your management team have? How accustomed are their people to receiving big slugs of delegation, and how much time in reserve do they have? How much time in reserve do you have? How much cash in reserve?
When planning the resources needed to successfully integrate a new acquisition, it would be wise to consider the planning advice given by an experienced trekker to a novice planning his first backpack through the remotest reaches of the Grand Canyon. That advice would be: Estimate all the supplies you need, add 50%, then double that.
There is no good guideline for the extent of resources needed to perform a successful integration. A better way to help mitigate this risk—and a host of others—is to buy companies that are one quarter or less your size in people and revenue. The demands are more likely to be at least survivable.
Again, think base hits, not grand slams.
Too much geography
Adding geography can be a reason for buying another company, often as a potentially safer, lower cost, and quicker way to enter a new market. After all, even if your organic sales are rapid in your current market, you’re less well-known in the new market. Plus, starting with acquired customers who can quickly add local credibility and provide gross margin may not be a bad idea.
That said, you or your top managers should expect to visit the new geography at least twice a week for the foreseeable future—and more often in the first year. It’s important to remember that prospects and customers that invest in IT realize that they’ll get the best value and risk mitigation when they deal with the top people in your firm. Likewise, your new employees need in-person leadership from you, not just from their old local boss, who is now coping with a great deal of change and may be wondering about their own future.
Our observation is that most CEOs and top managers will visit a remote office frequently enough to help it be successful if it’s close enough geographically that:
- You can have an early breakfast at home before leaving for the location.
- You’ll get there early enough to have two or three substantive meetings with employee, vendors, customers, and prospects.
- You’ll get home that night in time for a late dinner.
If that’s possible, you’ll more likely go often enough to make the location successful. If that’s not possible, you probably won’t.
Stay tuned for Part 2 of Avoiding the Most Common Merger and Acquisition Failure Points. We’ll be discussing Operational Maturity Levels©, how to plan a successful integration, expectation management, and more!