The words in the term ‘mergers and acquisitions’ are often used together, but they actually mean very different things.
‘Acquisitions’ often peak when stock market prices reach highs, as canny sellers recognise the window of attractive pricing and buyers are driven by optimistic share ratings to build even bigger businesses and enter new markets aggressively to drive further growth. From a small company perspective, this mostly results in attractive exits for founders and VCs. Some of these acquisitions deliver a lot of value to their acquirer; Symantec has built a significant integrated business around the email archiving company, KVS, which they acquired a few years ago, as has Autonomy through the acquisition of KVS competitor Zantaz. Sometimes it is more difficult to generate success from an acquisition; my Draper Fisher Jurvetson partners in California sold Skype to eBay for over $3 billion, and while Skype is a great stand-alone company, eBay has not achieved the synergies it hoped for.
In downturns, ‘mergers’ are often driven by the need to survive as markets contract and margins are recovered through economies of scale. Occasionally a bargain appears, or what appears to be a bargain. The circumstances of the owners and the need for liquidity or financing can result in businesses being available, which normally would not be without a premium price. But is it the right time to look at M&A? The current dilemma at Lloyds following its merger with HBOS suggests that what at first appears to be a bargain can turn out to be a huge error. The short-term costs may be significantly higher than initially thought, but only time will tell whether the enlarged bank with a significant dominance in many areas of consumer banking will ultimately deliver a return on the merger.
Private-to-private mergers are starting to become more common as entrepreneurs and their VC backers identify companies and look to create value this way, given the reduction in outright exits and tougher times in raising new cash. Recent announced mergers include Stardoll and Piczo, Imagine and Irish Broadband, Snell & Wilcox and Pro-Bel and the merger of Amazon’s DVD rental business with Lovefilm. These private mergers should not be seen as weaker players picking off troubled companies, or two drunks propping each other up. Rarely is it worth buying a troubled company, as the effort that goes into fixing the problems outweighs any advance that a cheap price can deliver.
In my experience, private-to-private mergers can be very successful and a great way of complementing strong organic growth with further ‘oomph’. The secret to making these mergers a success is for the management team to have a clear understanding of the critical metrics in the businesses, knowing what could be improved through best practice and where problems lie. Once merged, people from both sides work together in close integration teams to successfully combine the different businesses into one culture. This is vital not only for internal cohesion, but to make sure there isn’t any disparity in the quality of service to customers and clients.
As Lloyds and HBOS show, it is vital to conduct proper diligence in any merger. Fortunately, most small businesses aren’t hiding ‘toxic’ problems on their balance sheets and the hidden nasties, if any, can be identified quickly. The focus can then be on how to combine the separate teams to get the best out of each side, and to create a common culture to grow the combined business over the long term.
Pricing in a private-to-private merger can be tricky, but in essence it comes down to a relative discussion of what each side brings; it is not necessarily about bargains, although sometimes one side is more driven to merge than the other. Proceeds are usually in the form of shared equity in the enlarged company and that way, the interests of both sides are aligned for long-term success. The complex structures of preference shares that VCs are notorious for constructing over time are best swept away and a simple common currency of ordinary shares adopted.
Expect to see many more private-to-private mergers, and from these, exciting large new companies emerging. To reiterate: these deals are not signs of weakness, but strong teams recognising that now is the time to build and invest together for the future, when the cycle will turn once again to acquisition-mania.