When acquisitions don’t deliver – Going for broke

Acquisitions that fail to meet expectations and deliver value can easily topple previously stable businesses. So what typically turns a potential success story into another sorry statistic? GrowthBusiness finds out.

From international corporations down to mid-market minnows, every man and his dog seems to be jumping on the acquisition bandwagon these days. It’s easy to see why. Tagging extra commercial concerns onto a thriving venture is the quickest way to expand, giving immediate commercial and tactical benefits from economies of scale, beefed-up turnover, fast routes into a fresh market and access to new customers. Buying a fully functioning business is always more attractive to thrill-seeking entrepreneurs than relying on organic growth alone, which can be slow and uninspiring.

A buy-and-build strategy can be immediately lucrative too, generating bonuses for management and staff in both the acquired and acquiring company – and, of course, for investors. Last year, according to the Office of National Statistics, the value of the mergers and acquisitions (M&A) market in the UK almost doubled, reaching an estimated £133 billion. Private equity continues to be the one of the key drivers in corporate transactions, accounting for around 30 per cent of all UK M&A deals between 1999 and 2005, according to the British Venture Capital Association.

The return of swathes of strategic trade buyers into the fray has added momentum, further strengthening the UK’s position as the most active single regional market for M&A in Europe. For corporations with healthy balance sheets, cash to spend, maximised organic growth, enhancing value through acquisitions is the next logical step.

So, why is it that, with such a thriving sector and many positive benefits to acquisitions, so many crash and burn? Depending on which market reports you read, between 70 and 90 per cent of all acquisitions either fail completely or fail to meet shareholder expectations. And it’s not just small, inexperienced or under-funded firms making M&A mistakes. As Time Warner’s short-lived, loss-making AOL acquisition proved, even the big boys get it wrong.

‘If an acquisition doesn’t deliver, it’s either for strategic reasons or because of poor execution,’ believes Richard Green, joint managing director of August Equity (formerly Kleinwort Capital), which provides mid-market private equity investments for media, technology, healthcare and specialist manufacturing firms. ‘By execution I’m not just referring to the integration of the bought business into the acquiring company, I also mean negotiation of the purchasing deal in the first place.’

‘Most of the mistakes made during acquisitions are so basic, it’s amazing,’ says Pip Peel from project management consultancy PIPC, who is an expert in the M&A field. ‘The first and most obvious error is buying the wrong business.’ Blunders in this area generally fall into two camps: misdirected strategy or poor targeting.

Flawed strategy

Before identifying a prospective target, the management of an acquiring business should define the strategic goals of the acquisition. Typical motivations for a strategic corporate buyer include increasing market share, diversifying product or service, accessing new customers or integrating vertically, such as by purchasing a supplier or distributor. However, Green contends that ‘private equity houses are primarily motivated by a desire to make a good return on their investment. ‘Of course, both types of acquirers are influenced by the nature of the companies involved and the marketplace.’

Failing to pin down considered and realistic reasoning for buying a business makes it much harder to identify a suitable target, which is when rushed and ill-advised decisions can be easily made. As Green elaborates, ‘Purchasing an incompatible business is often a decision based on flawed business logic.’

For example, buying your competitor isn’t necessarily a wise idea – many well-known brands have bitten off more than they can chew through such a bold move, including dealing with repercussions relating to anti-competition laws.

And, contrary to received wisdom, companies experiencing difficulties with market conditions aren’t usually bailed out by acquisitions. Take Compaq and Digital Equipment Corporation, for example. Faced with increasing competition in their core IT markets, Compaq’s acquisition of Digital seemed like an ideal solution but the combined business failed to meet expectations and struggled to overcome existing commercial pressures. Digital had to sell off most of its assets and Compaq eventually succumbed to a takeover by long-term rival Hewlett-Packard.

Poor targeting

Failed acquisitions are frequently blamed on a flawed understanding of the nature of the acquired organisation. Acquisitions should obviously add value, so it’s vital that companies on the hunt for a suitable target define their search criteria. Having a benchmark against which businesses can be measured for suitability is particularly useful during the long, drawn-out acquisition process, where management can easily lose sight of their original aims.

‘Your search criteria should be determined by your motivations for acquiring,’ argues Richard Green. ‘Are you looking to expand your existing market share? Then make sure the business you buy has strong customer relationship management and sizeable clientele that differ from yours. If you want to bolt on expertise or enhance your product technology, make sure you purchase an enterprise with intellectual property.’

Buying businesses in unfamiliar sectors is another classic exploit that trips up unsuspecting owners. Branching out into new markets is undeniably a quick and easy route to more customers, as illustrated by ITV’s acquisition of FriendsReunited and countless other high-profile examples. In reality, particularly for inexperienced acquirers, buying a business in an unfamiliar sector can spell disaster, particularly when it comes to price negotiations. Acquirers must look beyond the numbers and truly understand the target company’s market, why the business makes money and where it’s heading. ‘Dotcom boom investors got this seriously wrong, of course,’ reminds Peel.

Nasty surprises

Buying the wrong business is an error often avoided by undertaking extensive due diligence. ‘You should understand exactly what you’re buying,’ says Green. ‘It sounds obvious but many get it wrong and base crucial strategic decisions on incomplete information.’ Business owners who are not experts in the target company’s field need to acknowledge that and seek help from someone who is, usually by employing the skills of a corporate finance adviser, M&A consultant or specialist due diligence provider.

Some acquirers believe that looking at the target’s books and business plan is enough, but experts say it’s essential to scrutinise all areas of the vendor’s operation. Green says, ‘We investigate a host of aspects before investing: financial, commercial, intellectual property, environmental, insurance, pensions, management… it’s a long list.

‘The emphasis of any due diligence depends on the nature of the business,’ he adds. ‘If it’s a food company, you should focus on health and safety; if it’s a software firm, evaluate its product technology; if it’s a media business, examine content and delivery. These checks will uncover the strengths and weaknesses, helping you to assess the risk of purchasing it and decide if you’re getting value for money.’

Financial due diligence should uncover critical success criteria, key performance indicators and taxation risks, while commercial due diligence picks up on industry trends and customer research that will have a direct impact on the vendor’s projected profits, as well as any cost savings from potential synergies between the two businesses. Commercial due diligence, once sniffed at as superfluous by some acquisitive companies and their advisers, has become more relevant as a way of unlocking the value of acquisition synergies.

According to research by Asset Alternatives, for a typical private equity transaction, the value creation attributed to changing the operational direction of a company through acquisition has increased from 17 per cent to 38 per cent over the past 20 years.

There are added areas to consider (and risks to mitigate) if you’re a UK company expanding through overseas acquisitions. Green adds, ‘Companies undertaking cross-border acquisitions often fall foul of failing to address exchange rate risks, capital transfer risk, country-specific legal differences, pensions transfer, and so on.’

With so much to consider, how can you know if you’ve done enough due diligence and uncovered all the skeletons in the vendor’s closet? ‘In any deal there is going to be risk involved, but you can minimise this by being thorough,’ says Frederic Court from technology venture capital firm Advent Venture Partners. ‘Your advisers should be experienced enough to know when all areas have been investigated, though I’ve been involved in a couple of deals where we discovered something we didn’t know after a thorough due diligence process. It’s bound to happen sometimes. The trick is to make sure you’re protected, wording the contract so that investors and shareholders have disclosure obligations or provide some financial guarantees. Then at least you have some comeback if they fail to fulfil their duties. This is common practice in major deals between large corporations and it’s wise for smaller acquisitive companies to adopt this approach.’

The wrong price

Acquisitions throw up the age-old problem of how to fix a price for a private business. Valuations should not just be based on sales or profit generated by the target company, they must also consider factors such as market position and intellectual property. ‘Acquirers often make the mistake of paying a price that’s not related to their risk/return appetite,’ says Green.

Buying a business for a pound is not uncommon in the world of M&A, but a full appreciation of assets and liabilities is a must for any well-advised acquirer. ‘It’s tempting to buy a business because it seems like a bargain,’ cautions Court, ‘but that’s probably an indicator that the vendor knows something you don’t.’

However, ‘private equity firms sometimes buy an asset just because it’s cheap and the timing is right,’ says Peel. ‘A lot of US energy companies were snapped up for that reason, at a time when there were low energy costs that were sure to rise. They were happy to sit on the asset until the time was right to sell. Some situations do warrant that, but I would challenge that decision and ask the question, “Surely there must be some changes you can make to add value?”’

Due diligence can also prevent you from diluting the value of your core business, but, says Court, ‘I’ve seen many companies buy a business and not get £1 of value for every £1 they spend. That’s a huge problem. It’s normally a result of inadequate due diligence or poor contract negotiation.’

Inevitably, there’s a gap between how much a buyer is willing to pay for the business and the vendor’s price expectations. That’s when negotiation plays a vital role.

An inappropriate deal structure can destroy value for the purchaser, who will endeavour to mitigate risks from the deal at the same time as the vendor wants to maximise initial consideration. But remember, the objective is to reach a conclusion where both parties are satisfied. ‘There’s no point trying to screw over the vendor on price because they’re unlikely to be amenable during the rest of the acquisition process,’ advises Peel.

Deal-makers ought to take into account cost-savings identified during due diligence as this may influence the amount you can borrow to fund an acquisition. ‘We’ve been assisting the Barclay brothers in negotiations between Littlewoods and ShopDirect,’ explains Peel, ‘and have identified huge savings on supply chain, marketing and so forth, because they’re in the same market.’

‘Acquisitions should optimise, not maximise, your return on capital invested,’ agrees Green. ‘Much of this optimisation arises from how successfully you implement the acquisition and handle the post-deal integration of the two businesses.’

Mismanaging integration

There’s plenty of statistical and anecdotal evidence to suggest that the biggest destroyer of an acquisition is poor integration of the two businesses involved. ‘We’ve carried out some research in this area and found that 57 per cent fail at the integration stage,’ reports Peel. ‘It’s such an obvious consideration, so why aren’t more people making it a priority?’

Many mergers and acquisitions treat pre-deal and post-deal processes as discrete, often using entirely different teams of advisers before and after the transaction has been completed. This results in vague accountability, unnecessary confusion, and a lack of connection between valuation and financial goals of the merger. ‘We devise a 100-day plan for integration early on, at the start of negotiations,’ says Green. ‘The first stage of your 100-day plan should not be to make your 100-day plan! That’s leaving it too late.’

‘At the due diligence and negotiation stage, you have to be thinking about how you’ll assimilate that business into your own,’ agrees Peel, ‘as this may throw up issues you hadn’t considered.’

He continues: ‘Perhaps you discover that the vendor’s systems are more outdated than they first seemed, for example, and that will make the integration more expensive than imagined, so you should factor that into what you pay for the business.’

Too many acquisitions fail because parties involved are focusing on getting a deal done, usually as quickly as possible, not on long-term value creation. ‘If you’re not careful, you’ll end up with nobody focused on making all the motivations behind the deal actually bear fruit. I remember being involved in a cross-border acquisition and it dawned on me halfway through the due diligence process that there were only a handful of us thinking about the integration of these two businesses. The CEO hadn’t once considered the reality of how he was going to realise his dream of a combined entity.’

One reason for this transaction focus, at the expense of integration, is that management and advisers tend to be incentivised to get the deal done, not on making it work going forward. ‘CEOs on both sides of the deal often make a huge pile from the acquisition itself and are therefore not encouraged to look forward to future success for the enlarged entity,’ believes Peel. ‘And often, key personnel leave soon after an acquisition, which can obviously be disastrous when you’re trying to stabilise a business and optimise value.

‘Don’t underestimate the pain of integration,’ he warns. ‘Everyone’s day jobs are going to change, from the upper echelons to the lower rungs. Even a minor change to ways of working can be traumatic for some employees. The real value of acquisitions comes from harnessing the skills of your team and making staff in both businesses feel they’re all working for one company with one, unified goal. In practice it’s tricky, but that’s where remuneration and reward schemes play a role. It sounds touchy-feely, but cultural integration is absolutely imperative if you want the two firms to work seamlessly together.’

Underestimating the risks

Acquisitions take time and a lot of work to be successful, and there is a risk that management caught up in a whirl of deal-making neglect their core business.

‘Entrepreneurs are drawn to the excitement and growth potential of acquisitions, but many firms then go bust because management took their eye off the ball,’ counsels Court.

‘Don’t underestimate the time it takes to complete a deal,’ warns Green. If management are tied up negotiating an acquisition, someone needs to be left steering the ship. Airfix, the plastic toy kit-maker, learned this to its cost when it focused entirely on acquisitions and allowed competitors to steal its market and destroy the company.

Don’t be afraid to walk away if the deal isn’t going according to plan, advises Peel. ‘We once undertook an M&A investigation process with German media conglomerate Bertelsmann AG and set about identifying suitable acquisition targets, whittling the field down to two potential prospects. In the end, Bertelsmann decided not to proceed, having identified that the acquisitions were unlikely to meet the corporation’s needs and generate the desired results. It was the right decision, and the company has since gone down the route of doing joint ventures with the likes of Sony instead, holding a 50-per-cent stake in Sony BMG Music Entertainment.’

Deal dos and don’ts

  • Be clear on what you want the outcome to be and don’t lose sight of that during the deal-making process
  • Don’t make assumptions – check and double-check everything you think you know about the company you are buying
  • Set out your stall at the start – identify the points on which you’re willing to negotiate and those which are deal-breakers and stick to them
  • Don’t leave integration planning until you’ve bought the business – design your strategy while putting together the acquisition, as your plans for integration should influence your negotiations
  • Be prepared to walk away – if the deal isn’t working out, don’t flog a dead horse

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.