The final phase of the M&A lifecycle involves executing the Sale & Purchase Agreement and undertaking the challenge of integration.
The final phase of the M&A lifecycle involves executing the Sale & Purchase Agreement and undertaking the challenge of integration.
We finished Planning, passed the Evaluation Phase, and are now in the Execution Phase. In the final phase of the M&A Lifecycle, we will execute the SPA, transfer funds, and begin integrating the target company. Value is captured or lost based on the results of the integration.
Before the close process, financing considerations have long taken place, having been explored in strategy creation. Nonetheless, it is not unusual for a buyer to try to “Re-trade” the deal in the days immediately before the closing. The momentum of the deal is often used to extract concessions from the seller when the purchasing party is sophisticated and aggressive. If the seller has pre-announced the transaction to employees, customers, and or suppliers, this last-minute negotiating is the most difficult to resist. Expect surprises in the run up to the closing.
There are a variety of ways that buyers can successfully finance a transaction. Large, sophisticated buyer will have many options to secure financing including out of their own cash balances or unused credit lines. This lowers the risk of a “broken deal” for the seller and having to go back out to market to re-sell the company. Deals that don’t close are often viewed as “suspicious” or “problematic” in the next round and values almost always go down in a second-round offering. Whenever possible avoid financing contingencies. As a seller wait for the buyer to “show me the money” before allowing your stakeholders to know a transaction is likely.
Most buyer will use a combination of the below methods & capital sources to cover the purchase price:
• Cash balances on hand
• Funds raised by PE firms for investment (they may have to be secured through a “capital called” from the investors)
• Roll over financing already in place (think leases, vehicle loans)
• Fresh loan financing from banks
• Fresh loan financing from non-banks (lots of different flavors in this approach)
• Seller Financing
• Earnouts
Earnout is a purchase method that attempts to maximize the selling price of a company by putting part of the purchase price “at risk” over a period of years. The chance to earn another turn or two of EBITDA is very enticing to most sellers. Don’t be fooled, this deal structure is very complex and rarely delivers as expected. Earn-out allows a buyer to negotiate to pay a portion of the purchase price contingent on the target company's future performance after the transaction. In theory, this is an ideal situation for the buyer, they under pay and the seller takes the risk to earn a few extra turns of EBITDA, however, the challenges are many. In practice, earn-outs are very complex, multi-year agreements with contingencies and conditions that can strap management from optimizing company performance and their own position. Management loses the discretion of an owner and is out of control of the funding sources they had pre-sale. They have a mission but don’t have full control of the resources needed to efficiently and effectively execute.
A better strategy for a seller is to start the negotiations demanding an earn-out at a significant premium over the initial offer. Negotiate the absolute highest final value of the firm with an earn-out structure. Once that value is set offer a discount from that amount for a non-earn-out deal. If an earn-out is your only option, keep it simple and keep it short.
There seems to be confusion over LBOs that we want to take a second to clear up. A Leveraged Buyout (LBO) is an acquisition of another company primarily financed through debt that uses the assets of the target company as collateral. An LBO may still use equity consideration, but it will comprise a much smaller portion of the purchase price than the debt. The debt will be some combination of the above forms of borrowing, usually with several tranches of debt of different tenors, rates and collateral sources. In an LBO, the objective is to finance the purchase price with the most debt possible. In a real-world scenario, the buyer may use bonds issued to their fund investors as a way to mix and match their returns. Generally sophisticated investors bring in long standing banking partners and an extensive roster of risk tolerant lenders that understand very high leverage deal. Loan levels of 7 to 12 time EBITDA are often available through these sources, sources most medium size companies have no access to. Very large deals are often financed with 144A type bonds. Bonds issued under this SEC rule can only be purchased by and traded with very sophisticated financial entities. Once again, this type of financing is generally not available to small and medium size owner operators. This access to risk tolerant capital is some of the value that a private equity buyer brings to the transaction.
From the onset of the strategic visioning a buyer needs to identify the type of integration they plan. Many deals by sophisticated buyers rely on the “holding company” model. Under this method the buyer is an investor with no plans to disrupt the structure of the company. They will arrive with capital, advice, and possibly their own management team. In large private equity organizations, they may offer (on insist) that banking, insurance, technology, and audit be done with their preferred partners, but the acquired company is not “integrated” into another organization. In other cases, where the strategy is not simply to be an investor but to be an operator, the buyer may already have a “platform company” in the same industry as an acquired company. Strategic buyer often integrate acquisitions into their core business processes. In both these cases all integration activities may have to wait out an earn-out period.
Day One represents the first day of new legal ownership. Be prepared for unexpected turn over. Long term employees without incentives to stay will often quit during this phase. Expect your competitors to aggressively court your best / most valuable employees. This recruiting is not limited to the salespeople. Going after production & logistics experts is common.
Post-closing is a risk filled period where you may or may not realize all your plans for the acquisition. The integration process is long, arduous, and significantly more complex than composing the deal itself. Most studies report an M&A failure figure of 70-90%, primarily pointing toward integration failures as the cause. Any prior issues will become apparent during integration, including overpayment, poor diligence, and overly optimistic assumptions.
So why do some leading organizations cite M&A as a reliable way to achieve growth? Generally, if they do a lot of deals, they will have developed transaction and integration expertise. They will have teams that are experienced at technology integration, data conversion, and HR stabilization. Companies with these in house capabilities are the exception. Some organizations hire outside firms (the Big 4, for example) to staff and run their integrations if they are infrequent acquirers. Failed deals almost always trace their underperformance to avoidable mistakes that were missed. The fuel that powers continued deal making is that successful deals will make up for bad deals, that is if you can survive a string of failures.
It's not a reliable strategy to make many acquisitions and wait for the star performer to save the day. Simply becoming a serial acquirer doesn’t guarantee long term success. The experience of multiple acquisitions does not always translate into improvements in M&A prowess. On average, serial acquirers have the same failure rate as occasional acquirers. It has been said that almost all a deal's value is in the “buy”, that is to say if you overpay for a company you may be in a hole you can never dig yourself out of. Not succumbing to the “zeal for the deal”, being willing to walk away if you can’t get your price is the most critical element in successful transactions. Then the emphasis should be placed on identifying the correct integration approach and timeline early on to overcome challenges.
Every PMI consulting firm will boast their integration playbook as superior. There is no one correct way to structure and manage integration, but proven methodologies executed by experienced staff can lower the risk of failure. Below is a review of some the opportunities and pitfalls you may face in any transaction.
From start to finish, integration is a deep exercise in change management. The IMO is a large, complex team with an enterprise-level view of all sides of the integration, requiring contributors from all major functions throughout each organization. In large companies, the IMO may be comprised of hundreds of employees and consultants from both companies. It is a myth that only large transactions with highly complex synergy environments require an IMO. Every transaction can benefit from an IMO, and the size and complexity of the office will scale with the transaction.
The IMO's job is to ensure the integration process captures the most value from the deal while reducing disruption of normal operations. An IMO is not the same as a Project Management Office (PMO), and leaders need to appreciate the difference in complexity, scope, and objectives. The IMO should be led by a C-level executive with significant authority and will likely manage functional workstream leaders directly or set up multiple PMOs to execute a given set of workstreams. Generally, the IMO is focused on coordinating the integration, and the PMOs will focus on siloed execution.
Workstreams are functional teams that execute on the most narrow objectives in the integration. The number and variety of workstreams will be based on the acquirer's strategy, the degree of integration planned, the transaction’s complexity, the presence of an earn-out, among other things. Workstreams in some transactions may be combined or separated based on the above factors. Common workstream examples include:
Changing a company’s core beliefs, its norms, its view of history, shaped by years of stories and generations of story tellers is often a tale of overt as well as covert resistance. People don’t like to change, they don’t like to be disrupted. Creating a clear understanding of “what’s in it for them” is a critical first step in bringing two distinct groups together. Expect major difficulties in this realm. We know from earlier that failure in post-merger integration is a cause of many failed deals. Still, cultural clashes are often one of the most overlooked challenges of the integration process. Numerous studies analyze the best approach to solving the culture challenge depending on the cultures and industries of the merging companies. We recommend establishing a dedicated culture workstream to manage this process closely.
The right communication strategy is another critical component of the integration's success. The communication strategy will vary based on the company cultures and stakeholder involvement, but in general, over communicating, over explaining and repeating key messages many times has shown to be effective in overcoming resistance. Communication plays a vital role in maintaining employee morale as well as the achievement of strategic objectives. A part of the communication workstream will involve the creation of a matrix that identifies the correct audience, content, and timing of the communications.
Acquiring a company and integrating it creates something new. It is by definition innovative at the enterprise level. It is impossible to anticipate all the variations and reactions that may be encountered along the path to this new combination of people, assets, and capabilities. Leadership during this kind of critical, rapid, high impact change requires patience, determination, and agility. Be prepared to pivot, to improvise, and to re-direct when evidence points in a new direction. To succeed with any business strategy, you must balance rigorous adherence to a comprehensive plan with evolutionary adjustments based on new information and changing circumstances. Blind over-commitment to the plan will lead to failure, just as constantly changing the course and the priorities.
Great companies can manage transformations. They can absorb news products, new markets, new capabilities. They can model opportunities and conduct timely thorough evaluations. They can build plans and project teams. They can adjust to new information and changes in circumstances. They can react and respond in highly dynamic environments. They can learn from their mistakes without punishing innovators. Acquisitions and integrations require leadership and risk taking. Those that succeed will use these skills to grow faster and more profitably than their competitors.
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