- Synergies may be hard to achieve
- Sometimes buying isn’t the best option
- Proceed with caution when you hire an investment banker
I’ve spent 15 years working with distressed companies, so I’ve seen just about everything. From executives who commit fraud but are somehow able to look you in the eye and claim they didn’t, to bankers persuading their clients to pay more to close a deal, to physical fights breaking out between owners in front of me due to stress.
I’ve seen private equity portfolio companies go from the brink of bankruptcy to recover and earn $400 million or a 10 times return on the original investment that was almost wiped out. Yes, I’ve seen this.
Business is a full-contact sport. Most executives charge in to problems but, just as in football, the best athletes are the ones who realize that the hole they see may not be open when they get there. They are ready to react accordingly. Relying on plans made before an acquisition begins may doom an investment as soon as it starts. On the other hand, having a dedicated team, including insiders and outsiders whose sole job is to focus on the daily issues and play devil’s advocate, can save owners money, years of pain and possibly their business.
There is no excuse for not studying why companies have failed in the past and avoid repeating the same mistakes. Remember, the people who tried acquisition and synergy strategies before you and failed weren’t idiots. Even though it makes sense on paper, it doesn’t mean you won’t join the list of failures.
Here are five of the most common mistakes in acquiring a company and how you can avoid them.
I. Financial engineering: Acquisitions usually require an investment banker or expanding current credit facilities to raise money. Advisers and bankers may be more interested in seeing the deal done than it getting done at the best terms for their client. By paying a premium, the company could become over-leveraged and heavily dependent on synergies to support the additional debt.
For example, I was recently hired after a construction contractor acquired an equal-sized competitor. The contractor overpaid because the investment banker pushed his client through extreme projections. In the two years that followed, rather than achieving the 30 percent revenue growth in the pitchbook, the contractor’s revenue declined 25 percent. The owner is currently worse off than if he had pulled out of the transaction.
Proceed with caution when you hire a professional whose incentives may not align with yours. To alleviate concerns, request that part of their compensation is paid through a “success fee” that is aligned with how the business performs after a transaction.
II. Overestimating synergies: Everyone wants synergies, but they can be hard to achieve. Even when businesses want to work together, generating anything close to the expected benefits can be difficult. The most commonly cited cost reduction is duplicative back-office personnel, but if some back-office operations cannot be consolidated, duplicative managers are required to maintain both locations.
Information systems are typically large obstacles when getting businesses to integrate. If these systems cannot be converged on one company-wide platform, the cost structures supporting the systems may not be eliminated. More often than not, several key executives and IT systems included in the original synergy plan cannot be consolidated, so the identified synergies cannot achieve their full potential.
III. Staying the course: When things get rough, many executives dig in. And when in doubt, they go back to what made them successful in the first place — they look at what worked in the past, follow their plan and rely on gut instinct. Two of my favorites quotes are: “Everyone has a plan until they get punched in the face” (Mike Tyson), and “No battle plan survives contact with the enemy” (war proverb).
Relying heavily on pre-acquisition plans often leads to failure. When a plan meets the real world, the real world will not yield to the plan. To achieve successful outcomes, having a fully dedicated team made up of insiders and outsiders working through the problem of the hour is critical. This enables day-to-day business managers to focus on the basic blocking-and-tackling strategy that is required to maintain the level of service customers require.
IV. Acquiring versus selling: When growth slows or margins decline, executives are forced to make hard decisions. One partner at a private equity group I work with said to his managing director, “You fix it or I will fix you.” Sometimes the best, but non-heroic, decision is to play defense by selling the business rather than trying to save a sinking ship by acquiring another company.
Most executives fail to admit that they are in a declining or commoditizing industry. Combining two poor performers with the hope of achieving improved long-term performance usually doesn’t work. In those situations, synergies will be acquired, executed and then lost as margins continue to erode. When owners should be selling, they often acquire to produce a temporary fix to a permanent problem — creating a worse situation at a later date.
V. Overestimating customer loyalty: I have never attended a meeting where executives have said, “We don’t have strong relationships” and “our customers aren’t loyal.” Executives often overplay customer loyalty and downplay customer reactions. The reality is that customers are “loyal” only if they need your company and currently don’t have a better option. When they find that better option, you won’t be their partner anymore.
Be honest. Realize that customers will leave and competitors will attack your customer base as your company focuses on integration issues. Competitors will use your integration issues, which will definitely occur, against you in the marketplace.
Paul Share is a managing director at Conway MacKenzie Inc. Paul has 15 years of experience in restructuring and interim financial management positions. He can be reached at +1 678-596-8545 or firstname.lastname@example.org.
Photo of Paul Share courtesy of Conway MacKenzie