Acquisitions create excitement. Executives considering the purchase of another company invest long hours thinking about the value of the target company and how it would strategically and financially fit with their own. Across the table, executives considering the sale of company also think about value but they’re often more concerned with cashing out than with future benefits.
Assuming both buyer and seller appear motivated to conclude a transaction, buyers will perform due diligence, devoting time and energy to understanding asset values, free cash flows, markets, key personnel and whatever sources of value they identify. They’ll look for synergies, they’ll value the acquisition and, if all goes well, negotiate a purchase price acceptable to both buyer and seller, and consummate the deal.
Research suggests that only about 50% of all mergers and acquisitions produce the expected benefits so, when considering an acquisition, how can an acquiring company perform more meaningful due diligence? To my mind, buyers must analyze and vet:
- The opportunity;
- The people;
- What can go wrong; and
- The deal.
Vetting the opportunity means analyzing how both companies create shareholder value and estimating the economic impact of the acquisition, i.e., the value of the new entity vis-à-vis the pre-transaction value of the acquiring company. Will the new entity have greater access to markets, greater capacity, sustainable competitive advantage, new sources of raw materials and products, enhanced skills and know-how? The acquirer’s valuation of the investment will reflect these and other sources of value, requirements for additional downstream investments and the time required to realize the benefits. Offsetting the benefits, of course, is the risk of something going wrong.
The better the acquiring company understands the target company’s business and its ability to create value, the greater the likelihood of realizing the anticipated benefits and creating appreciable wealth for the acquiring company’s shareholders.
An in-depth understanding of the target company’s business also enables sound decision making regarding employees. Will the new entity need to retain a full cohort of employees from both the acquiring and target companies? At a minimum, the acquiring company must identify, retain and keep motivated those individuals employed by the target company who have specific skills, relationships and/or knowledge. Whether you follow Richard Branson, Jim Collins, Peter Drucker or someone else, people make a company and people are, indeed, a company’s greatest asset.
It’s not enough to understand the potential of an acquisition. For the half of mergers and acquisitions that failed to deliver the expected benefits, something went wrong. What? Could it have been avoided? Perhaps, if the acquiring company’s due diligence had included a rigorous debate about potential downstream problems.Acquiring companies must consider what can go wrong and fail to do so at their peril. What assumptions about the target-company’s business, culture and systems underpin the valuation? How do these assumptions allow for market downturns, new competitors or currency fluctuations? Are the assumptions realistic or might they call to mind the following “Dilbert” strip by Scott Adams.
Acquiring companies cannot eliminate risk but they can mitigate it. Performing sensitivity analyses and assigning probabilities to potential outcomes will lead to a more robust estimation of future value. Moreover, this effort will help forestall or altogether avoid future problems. At the very least, it will lead to a better understanding of the challenges of forming the new company.
The deal, last on the list, establishes the amount and timing of the acquiring company’s investment. Ideally, it incorporates all potential benefits and known risks, and reflects a shared, fact-based valuation of the target company that appeals to both buyer and seller. However, before consummating the deal, both parties should once more consider the long-term consequences of no-deal. This helps avoid a push for closure because of the time invested to date or, perhaps, the undue influence of commissioned third parties who stand to profit from the deal. At the risk of sounding trite, both companies’ interests are best served when buyer and seller perceive the transaction as win-win.
… and with the documents signed, the real work begins.