A key step in the M&A process is often neglected, leading to suboptimal outcomes.
Merger & Acquisition outcomes often disappoint
It is a truism that many M&A transactions fail to live up to expectations. While there are often execution issues, we believe that many of these suboptimal outcomes occur because of a lack of focus on the detailed upfront analysis of how two businesses will mesh to make a combined company that is more valuable than the sum of the parts. Here are two examples.
Sellers: “Strategic valuation” is elusive
When an emerging growth venture is acquired, there is typically a big increase in valuation if the acquirer sees the target as having significant strategic value — rather than being a simple financial acquisition, with a value related to an industry-standard earnings multiple.
Unfortunately, many emerging ventures fail to take full advantage of this potential strategic value premium — either because they fail to identify companies for whom they represent a truly strategic acquisition; or because they articulate poorly the true strategic impact that they can have on the future of the acquirer’s business.
Buyers: Finding the “gems” is hard
Essential analysis is often neglected
In our view, there are three steps to a successful, value-creating M&A transaction.
On the flip-side of the transaction, large businesses often have trouble separating the wheat from the chaff among the many similar-sounding startups out there. All too often this leads to acquisitions that fail to live up to expectations. Or, to waking up one day and realizing your competitor has gained a huge advantage as a result of last-year’s acquisition of a startup that your company overlooked (or passed on).
- Identifying two companies with strategic overlap, and figuring out why (and how) combining them will create more value than if they had stayed independent;
- Doing the transaction; and
- Executing cleanly on an integration plan to put the two businesses together.
We have found that many M&A activities fail to live up to expectations, as in the examples of the prior section, because step 1 is done poorly.
The M&A ecosystem has a “gap”
The blend of skills needed to complete step 1 is often not available inside companies. And even when it is, bandwidth tends to be a problem.
But the M&A ecosystem seems to have a “gap” when it comes to helping with step 1. While numerous investment bankers and lawyers focus on step 2 (transactions), and various “change management” experts help with step 3 (integration), it is much harder to get help with step 1 (target identification, & the value proposition). For small-cap or micro-cap deals, the services provided by transaction-oriented intermediaries, such as investment banks, rarely include doing a good job of step 1.
Our M&A Value Creation service is designed to fill this ecosystem gap.
Value creation requires deep digging
Step 1 starts with finding a group of companies with at least the potential for (that dreaded word) “synergy”.
Sometimes there are cost cutting possibilities that justify a merger. For example, going from two factories (or marketing departments) to one. While these can increase profits, they leave total revenues unaffected. Sometimes there are financial motivations for the merger. For example, one company has cash the other one needs. Or perhaps the combined revenues of the merged entity will cross the threshold for analyst coverage, leading to higher p/e ratios.
We get excited about M&A combinations that lead to combined revenues (and profits) that are greater than just the sum of the two original revenue (profit) streams. Examples of such combinations include:
- exciting new products in one company, and a strong distribution channel (to the right customers) in the other;
- two companies with complementary, non-overlapping products and/or customers; or
- deployment of company A’s technology into a parallel market served by company B.
Step 1 then involves painting a picture of what the combined company would look like. This needs to go well beyond summing together revenue projections, and looking for potential cost cutting synergies. Ideally it includes finding ways that product and customer overlaps can be leveraged to create incremental revenues that would otherwise not have been there.
This usually requires some pretty deep digging into each company’s products and customers, and sophisticated insight into the likely directions the industry will develop in the years ahead. The whole exercise needs to be repeated for each target company!
To take the next step
- Learn More: about our M&A Value Creation Service
- Resources: Articles & videos of talks illustrating our approach to problems.
- Contact Us: to discuss your company, or ask
questions about how we work.
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