M&A, From Concave To Convex Deal

Much ink has been spilled over mergers and acquisitions (M&A) given their attractiveness in today's economy where organic growth opportunities are more difficult to achieve than ever. There are many reasons behind M&A, from access to new markets and new investment vehicles to growth through scale and access to innovation.

Although this seems to be very appealing, the reality is more complex. In fact, M&A do not often generate value as planned. Some reports mention a failure rate between 70% and 90%. Although this is very much linked to the goal set in the first place, it comes as no surprise and the reason is threefold; first, when a company plans to acquire another company or merge with one another, objectives and plans are established along with financial projections and value creation initiatives. Executives define why and how the value resulting from the combination is greater than the sum of the two companies. This, in general, appears to be appealing as the combination would shorten the path towards growth and value generation. Well, this, of course, is good and beautiful in theory. In the real world, however, and as seen in anything that resembles short and long-term planning, what happens rarely fits what was planned, and that's a fact. Welcome to the world of complexity where second-order consequences are impossible to predict despite our willingness to control.

Second, according to mainstream M&A practice, due diligence has the following objectives: to identify risks and potential liabilities, to quantify items affecting the sale price, to ensure there are no "downstream surprises," to get data-based inputs into the negotiation process, and to facilitate a streamlined and effective launch of the integration planning process. As one can notice, most due diligence themes are related to financial, legal, and risk issues. In other words, it defines how much money a company should pay given a specific risk. While this is a good strategy from a financial transaction standpoint, it ignores the fact that two completely different organizations would need to come together to work out value creation in an uncertain future, and this is no easy task.

Third, the theory behind making M&A work resides in the fact that a whole strategy for integration is devised and formalized in its own goals, plans, and most importantly, an integration team that has the mandate to act quickly on things to prove the well-founded rationale set in the first place. This urge of integrating a company as if it is a simple cog to fit within the corporate machine is very problematic. Companies are not machines; they are social institutions, and this has far-reaching consequences from the integration standpoint. In other words, the integration urge has more downsides than upsides when two organizations come together, but it does not mean it's impossible.

Every merger or acquisition is unique, so is the related goal regardless of what was planned before. One can have a buy and build plan but end up leaving the newly acquired company autonomous, and the opposite is true as well, and the reasons can be numerous. These emerge out of a thorough due diligence. While this emerging M&A objective can be easy to adopt in small, fast-growing, and nimble organizations, it is difficult to materialize in well-established, big, and bureaucratic ones. In light of new findings during the due diligence phase who would want to question the first acquisition rationale along with its financial projections that had already gotten the green light from wider executives and the board, especially given a related formal offer through the LOI had already been issued?

So, how to make sure M&A deliver their promise in terms of value generation? There are some general rules of thumb that one can adopt:

1: Be open to change the objective and the subsequent plan in light of new due diligence findings, and sometimes even call the deal off when the downside is bigger than the upside. This flexibility in decision-making allows pattern formation and leads to new ways of doing things. The financial projections should also reflect this change.

2: Do no harm. Do not rush to integrate as the exercise is concave (has more downsides than upsides) and the odds speak for themselves. In today's world, there are much more opportunities in having an autonomous business belonging to a network centered around an issue than one integrated company. This makes the network agile through a short-decision-making process and local agility that eventually favors innovation. The network would represent a decentralized corporation which would focus on capital allocation and function as a tail-risk hedge for those businesses and leave the operating companies to do their things. We do also acknowledge that in some instances, certain forms of integration are necessary.

3: Beware of optimization and efficiencies. These have generated lots of value for large businesses in the 20th century. They, however, produce fragile, rigid, and bureaucratic organizations. In today's complex and uncertain world, efficiency and optimization pushed too far have diminishing returns and can be very detrimental to a business, especially in a situation where two companies are coming together.

4: During the due diligence phase, evaluate the type of culture and internal social network, and search and find the levers that have an upside potential. These are very important as it helps uncover other reasons for M&A. Diversity, willingness to connect, and innovation are key here. The best example is the ability to find areas where computation can add value through the adoption of digital technologies.

5: Given the above, bring people together to work out future opportunities and find sweet spots. No plans can, however, provide this. It's a pattern formation favored through facilitating the right environment. It's this pattern formation that "the integration team" should be working on.