“Happy families are all alike; every unhappy family is unhappy in its own way.”
Anna Karenina, Leo Tolstoy
Just as Leo Tolstoy’s famous opening line from Anna Karenina alludes to successful mergers and acquisitions are alike, while those that fail are all unsuccessful in their own way.
Even the most seasoned in-house acquisition teams experience occasional M&A failure. It goes with the territory.
Exactly how many deals can be deemed a failure is a moving target, but a recent article by the Harvard Business Review put the figure at somewhere between 70% and 90%.
Even if you halve those figures, the odds of success are not hugely favorable for most M&A participants.
We at DealRoom help dozens of companies organizing their M&A process and below, we outline 10 of the most common and up-to-date reasons why this is so.
This is probably the most common reason for the failure of transactions. Most attractive target companies operate under the assumption that ‘everything is for sale at the right price’.
This effectively translates to ‘the business is always for sale when a buyer is willing to overpay.’
In publicly listed companies, this usually means a premium over the share price. There’s little reason to doubt it’s any different in small, privately-held companies.
It’s important for buyers to set a limit before negotiations start and stick to it to minimize the chances of overpaying.
2. Overestimating synergies
Overestimating synergies goes hand-in-hand with overpaying in a transaction.
Overestimating the synergies inherent in a transaction is often the first step in overpaying.
While the idea that many costs will largely stay the same as two companies combined is alluring, it’s also far more difficult to achieve in practice than most managers are willing to admit. And revenue synergies are no less complicated to achieve.
For this reason, practitioners of M&A would be well advised to look at potential synergies from a transaction through a highly conservative lens.
3. Insufficient due diligence
The importance of due diligence can never be emphasized enough, partly because so many firms are evidently keen to get it over with as soon as possible.
One of the major problems that arises during the process is that the acquirer is depending on the target company to provide information that isn’t always complimentary to their management. This creates obvious agency problems.
By extension, the more uncomplimentary the information, the more the target company team is likely to withhold it and/or explain it away.
In extreme cases, this can lead to the failure of the transaction in the long-run.
4. Misunderstanding the target company
Even due diligence doesn’t guarantee that you’ll fully understand the target company.
It gives you the best opportunity to do so, but there are plenty of cases where even a lengthy period of due diligence doesn’t let you know what makes a company tick.
The example of British grocery retailer Morrisson’s acquiring rival company Safeway in 2003 is testament to this.
What looked on paper like a great deal for Morrisson’s – expanding their footprint all over the UK – turned into a nightmare, essentially because the two firms served completely different types of customers.
5. Lack of a strategic plan
A good ‘why’ is an essential component of all successful M&A transactions. That is, without a good motive for a transaction, it’s doomed to failure from the outset.
Academic literature on M&A is replete with studies of managers engaging in ‘empire building’ through M&A, and research into how hubris is a common trend in M&A.
A good rule of thumb here is that the less simply the motive for the transaction can be explained, the more likely it is to be a failure.
‘Market share’ is a good motive; ‘become a visionary in the industry’ is not.
6. Lack of cultural fit
Perhaps ‘inability to acknowledge cultural differences’ might be a better title.
Because cultural difference in itself isn’t a problem – rather, it’s the inability (or unwillingness) to acknowledge them and look to bridge the gap.
It’s vital that any two companies engaging in a transaction use a change manager to oversee the process.
Underestimating this element of mergers and acquisitions as merely a ‘soft area’ of the transaction has led to billions of dollars being destroyed over the years.
7. Overextending resources
‘Bolt on’ mergers and acquisitions – that is, target companies which are small in size relative to the acquiring company – are usually considered to be the best type of transactions.
One of the main strands of thought behind this is that they don’t require as many resources to be acquired or to be integrated.
At the other side of this equation, are those transactions that require significant resources on the part of the acquiring firm.
Loading up on debt to acquire any firm creates a pressure from day one to cut costs – never a good start for a deal, and often the beginning of the end.
8. Wrong time in industry cycle
For the myriad of reasons cited for the failure of the notorious AOL/Time Warner deal, one is seldom given: The year 2000 was not a good time for media firms to merge.
The media industry was about to undergo the biggest shake-up in its history, from which it is only now beginning to show signs of recovery.
The inability to see long-term shifts is a human trait (we overestimate change in the short-term and underestimate it in the long-term) and one that catches out many managers in M&A, ultimately leading to the downfall of many transactions.
9. External factors
External factors (sometimes called ‘exogenous factors’ or just ‘risk’), refers to everything that’s out of the manager’s control. 2020 provides us with a readily available example.
Suppose the managers of two hotel chains are considering a merger. It makes sense on almost every level – financial, cultural and strategic.
There is no overlap in geography, meaning regional hotel chains are joining to create a national chain.
On paper, it is perfect. As soon as the deal closes, a pandemic sweeps the world, tourism stops and money dries up.
The deal has been a failure because of external factors that few could have foreseen.
10. Lack of management involvement
The most obvious reason for failure is left till last. Management involvement is something of a catch-all answer and often incorporates many of the other reasons on this list.
No stage of the M&A process will manage itself, be that the search for a suitable target firm to the integration of the two firms into the newly formed entity.
When managers deem other tasks in their company to be more important than the successful implementation of M&A, they shouldn’t be surprised when their deal is eventually deemed a failure.
The number of transactions that fail every year, even among experienced practitioners, is testament to the difficulty of getting everything absolutely right in M&A.
A list like the one we have just outlined serves as a warning to managers that things can go wrong, even after they have seemingly taken all the right precautionary steps.
Our previous article on due diligence is an excellent place for any manager looking to maximize their chances of a successful transaction and avoiding these pitfalls.