We are often asked by business owners if the commonly quoted figure is true that 80% of mergers fail to meet expectations after closing. There is a fair amount of research on large ($1 billion+), public deals that suggests that the 80% post-closing failure rate may be true. However, I suspect that for smaller public or private deals, the percent of success is much higher. We polled a wide range of experienced acquirers in the electronics sector, and most believe that over half their deals are successful after closing.
Private equity firms seem to have a pretty good batting average for both platform and add-on deals because they tend to be long-term, experienced investors who are careful buyers. PE firms tend to monitor their acquisitions closely, and they enlist industry experts to help them analyze and manage their portfolio companies. Corporate/strategic buyers tend to do well if there is a good fit and they do not rush to pay too much for a deal.
On the other hand, venture capital firms expect a high percentage of investments to not succeed, but the 20−30% that do succeed more than make up for the others. For small, private deals, I believe that many do not meet original expectations, but that buyers are satisfied with more than half of their acquisitions. While the statistics may or may not be true, the more interesting question is, why do some deals fail while others succeed?
I believe the main reason why deals fail to meet expectations after closing is that the buyers overpaid. That sounds simple, but we see deals that appear to be way overpriced all the time. Of course, the sellers may be very satisfied with the deal, so at least half of those involved are happy at closing. Many times, terms of the deal include earnouts or other types of deferred compensation, so the headlines may not accurately reflect the true value of the deal.
Why do buyers overpay? There are a variety of reasons, including buyers’ egos, use of public company stock instead of cash, unrealistic growth expectations, lack of industry knowledge, unrealistic sales or cost synergies, etc. Buyers of small companies should talk to outside advisors to get a sanity check on the deal value.
Crazy or Just Plain Wrong Expectations
Almost every seller shows sales projections that climb to the sky in the future. Sometimes these expectations are realized, but in many cases those projections are over-hyped. In deals that fail to meet expectations, often the growth projections were much too optimistic, or the buyers’ assumptions were incorrect. Sellers should make sure that their projections are realistic, otherwise, they may lose the trust of potential buyers. Buyers should carefully review projections to make sure there is a basis for those assumptions, and should create A, B, and C scenarios to make sure they can still make money on the deal.
Focus on the Deal, but Not on Integration
Many buyers are so focused on closing the deal that they fail to prepare for the integration of the acquired company. It is important that buyers think about what happens after closing before they put in a bid. It is understandable that buyers forget about integration, as corporate buyers usually already have a day job, and closing deals is very difficult and time-consuming. If any part of the deal is in the form of deferred compensation, sellers should also be careful that the buyer has a good integration plan.
Missing the Boat on Culture, People
Buyers often misjudge the cultural fit between the two companies or ignore key employees. Culture is very difficult to define, and many sellers of small companies don’t understand their own culture. Buyers also tend to focus on the deal and ignore key employees until just before closing or even after closing. Sometimes, the culture of the smaller company is more dynamic than the buyer’s, and the last thing the buyer should do is change anything. Buyers tend to believe that their culture and systems are better than the seller’s and, whether that’s true or not, buyers should be careful not to change too much too quickly.
Force-Feeding of Changes
Buyers often say prior to closing that they will not change anything, and then afterwards change everything. Sales policies change, distributors and/or reps are terminated, suppliers are consolidated, employee benefits are cut, employees are let go, etc. It is best to make it clear up front that changes will come, rather than surprise the acquired company with sudden changes.
Often, the buyer of a business has a good integration plan, but then the plan is passed off on already over-worked executives who are left to make their own decisions. Either the acquired company is ignored, or the integration is sloppy. The CEO and executives of the buyer need to monitor the integration process, otherwise, much of the value of the deal can be lost. If the two entities need to work together to make the deal successful, those employees should be incentivized to work together.
Sometimes, deals fail to meet expectations due to outside factors, such as a recession, new competition, or a change in regulations. While it is difficult to predict these factors, buyers should be careful to put ‘circuit breakers’ into their expectations to make sure they do not wildly overpay. It would be great if the seller's projected sales will climb 25% a year for 10 years, however, there is at least some chance of a recession during that period.
Based on the statistics on failed deals, it begs the question: If so many deals fail, why do companies keep making acquisitions? Acquisitions have a higher batting average than starting a new business or division from zero. Also, larger companies usually have more cash, borrowing power, or stock value than smaller companies, so acquisitions can be a great way to grow or expand product lines. Larger companies can leverage the power of their organizations to take advantage of various synergies, such as purchasing power, sales/marketing structure, international opportunities, service capabilities, etc., which allows them to obtain a better ROI than smaller companies. While large, failed deals tend to grab headlines, the reality is that most small, private deals are at least somewhat successful. Experienced, knowledgeable, and practical acquirers do not succeed every time, but by following a disciplined acquisition strategy and skillful integration plan they can bat well above .500.
Tom Kastner is the President of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. Securities transactions are conducted through StillPoint Capital, LLC, Tampa, Florida, member FINRA and SIPC. To read past columns or to contact Kastner, click here.