Some risks are difficult to detect even with the most careful preparation. You can’t account for everything.
The long tail of issues that can arise is too long. And even if you could devote more time to going deeper into those issues, you’d probably be destroying value elsewhere by delaying the deal’s closing time.
The important part is to take steps that minimize the chances of unpleasant surprises arising.
At DealRoom we help our customers reduce the number of those surprises.
So, let’s take a look at M&A deal risks more closely.
Let’s take a look at M&A transaction risks and how to mitigate each of them
1. M&A Risk 1: Overpaying for the target company
According to Forbes, overpaying for a company destroys shareholder value. This is an especially scary fact given Forbes, as well as other similar studies, notes that most
“acquisitions fail to create value for shareholders between 70-90% of the time.”
With these staggering stats in mind, overpaying for a company is clearly one of the major M&A risk factors of our time.
This points to the root problem of poor valuation practices since there are many companies who have recently overpaid when purchasing other companies.
How to avoid overpaying for the target company:
First, focusing on your company’s overall strategy and overarching goals behind the deal is essential in building a foundation based on avoiding overpayment.
There are several key questions that will help direct this effort.
- Why do you want to complete this deal?
- What are your main goals?
- Are there other ways besides acquisitions that will allow you to reach these goals?
Next, producing a comprehensive valuation report is wise whether your company completes its own valuation or hires someone else to complete it.
Either way, collecting key business information related to the target yields a more realistic and appropriate price point.
More specifically, collecting information such as tax returns, key financials for the last three to five years, an overview of the target’s organizational structure and number of employees, and shareholder agreements tends to be most beneficial.
When considering the above information and/or valuation report, it is important, as previously suggested, to view the determined appropriate price as a limit, versus a starting point; this creates a powerful shift in mindset that results in paying the appropriate amount for a target.
Finally, it should go without saying, but checking your ego at the door is key when determining appropriate deal pricing – egos often run high during deals or when battling over a target, which can sabotage wise economic decisions concerning deals
2. M&A Risk 2: Overestimating synergies
Synergies do exist. It’s just that they’re not the silver bullet that many managers at acquiring firms believe them to be.
Synergies in themselves are too often given as the reason for an acquisition, when they should be just one of several factors.
A survey by management consulting firm McKinsey (link) shows that a quarter of all managers overestimate post-deal synergies by over 25%.
These managers tend to see the synergies that they can gain right across the board if the transaction closes: scale and scope, best practice, shared distribution, intellectual property and opportunities, and even of course, the “streamlined” workforce.
The problem with this lack of focus, is that if you’re trying to generate synergies everywhere, you risk not synergies money at all.
How to avoid overestimating synergies:
Being conservative when estimating synergies is perhaps the single most important step you can take when considering deal synergies. Given this, M&A project management platforms and valuation spreadsheets are helpful tools when determining synergies.
Once you have worked out what you believe the synergies are, you should reduce that number – common practice is dividing by two – this will allow you to maintain a conservative stance regarding deal synergies.
3. M&A Risk 3: Weak due diligence practices
Poor due diligence practices simply go against the nature and definition of due diligence, but time and again, deals are negatively affected by teams failing to be prepared for legal due diligence and lacking diligence experience and expertise.
In fact, weak due diligence preparation and practice can result in poor valuation, increased risks, and overall mis-directed decision making.
How to avoid weak due diligence practices:
Beginning diligence early, and with the right team in place, cannot be underestimated as due diligence is the necessary practice that can make or break deals.
When assembling your diligence team be sure it includes a broad range of knowledge and experience for the deal at hand. While general traits will be common to all teams – expertise in business, legal and financial matters – the best assembled diligence teams are those that are more specific to the deal and the company’s industry.
The importance of assembling a team with specific knowledge and experience is reflected in the growing popularity of expert networks in due diligence for larger deals. Bringing in an expert may cost more in the short-term, but invariably ends up generating value.
For example, in many cases, a company’s in-house legal team is unlikely to possess adequate knowledge of intellectual property management to provide an informed valuation of the target’s IP.
The diligence team has an important role to play both before and during the due diligence phase. As previously alluded to, before due diligence has even begun, the due diligence team’s role is to generate the due diligence request list.
This is where the diligence team can bring its expertise to bear – knowing the right questions to ask; not only does this minimize the risk of surprises arising, it also gets to the relevant issues faster.
4. M&A Risk 4: Integration shortfalls (M&A integration risk)
M&A practitioners are generally in agreement that post-merger integration is the most complex part of any transaction.
Involving everything from internal management audits to the integration of sales forces, there are a multitude of issues that have to be dealt with, creating significant risks, the threat of employee disenchantment, failure to capture synergies, and ultimately, loss of value.
Furthermore, the scale of difference between each integration process can be enormous, multiplying the risks involved.
And what makes integrations even more difficult is that the factor that is most important of all to integrate – culture – isn’t necessarily easy to identify straight away.
Taking all of these points together, it’s not difficult to see why the integration process represents such a large risk.
How to avoid common M&A integration shortfalls:
The first logical step toward improving integration practices is to have members of the due diligence team become part of the integration team. This creates continuity and streamlines information thus reducing redundant work and tasks.
In addition to bringing members of the diligence team onboard, your integration team should include individuals who understand, and have a strong background in, value creation.
Furthermore, the team should include players with robust IMO and project management skills. Finally, you will want someone from HR on your integration team – ideally, someone from the organizational developmental side of HR.
With an experienced and skillful integration team in place at the commencement of the deal, a keen eye toward integration planning can take place during diligence as new information and a better understanding of the target company are uncovered.
5. M&A Risk 5: Little attention to culture and change management
Related to integration practices is the importance of taking into account company culture and equipping your new employees with the skills to be successful and acknowledging them as vital and welcomed members of the new company.
As change management expert Dawn White reminds us:
What the most successful acquirers realize is people are their biggest assets because it is people who help companies reach goals, sell products, capture synergies, and drive innovation.
Failure to take into account culture can be catastrophic for an acquirer. This is equally true for poor change management practices.
For instance, we have all seen good employees leave during M&A transactions; in fact, industry recruiters are often waiting in the wings to pluck unhappy, scared, or unsure employees from the new company.
Culture and change management are also closely linked to company morale, which can drive success if it is positive and supportive of company goals and strategies.
How to avoid the negative cultural effects of M&A:
Just as integration planning should begin early, the buy-side should collect information on the target’s culture as soon as possible.
Sometimes, in the earliest stages of a deal when the buyer is not privy to certain information, this can be done through observations during onsite visits, or analysis of how the target speaks about management styles and workflows, or through one-on-one conversations.
Ideally, the buy-side would have a change management expert or team in place to be responsible for the gathering of this intelligence.
As the deal progresses and more information related to culture is learned, the change management team can examine the differences between the buy-side and the sell-side that could weaken or even kill the deal.
With this information, the change management team can be used to combat these pitfalls.
6. M&A Risk 6: Overall lack of communication and transparency
To the best of our knowledge, no deal has ever been a failure because of too much communication. Communication is the grease in the wheels of most mergers, both before and after the transaction has occurred.
Polite and forthright communication begins at the negotiation stage and should only increase after the transaction has concluded.
The lack of communication and transparency, often due to teams working in silos, will serve to hinder deals of all sizes.
In a survey of global managers that had conducted M&A by AT Kearney, lack of communication was cited as the biggest problem identified by managers at the PMI stage.
Those findings remain just as relevant in 2021 as they were nearly two decades ago when the research was conducted.
How to avoid poor communication and lack of transparency during a deal:
Undoubtedly, technology is one of the greatest tools that can be leveraged to assure robust communication and transparency during deals.
Specifically, the introduction and popularity of the virtual data room for M&A have made the secure sharing of information easier and more efficient.
In particular, project management platforms built for M&A activity, such as DealRoom, allow for real-time communication and transparency.
7. M&A Risk 7: Failure to capture synergies
Once expected deal synergies are identified and their values are conservatively estimated, it is critical to develop specific strategies and timelines to make certain the synergies provide the estimated value to the new company.
How to avoid failing to capture synergies:
Tying back to our #2 M&A risk, being conservative when estimating synergies is key.
Furthermore, following best practices (many of which have been previously touched upon) can be employed to realize your predicted synergies:
- Capture low-hanging fruit. This means focusing early on capturing the “easiest” synergies that will yield the highest return. This low-hanging fruit strategy should also align with your overarching goal and have a high probability of success.
- Focus on your overarching goal. As previously noted, aligning all stakeholders and team members around your overarching goal/objective can help you capture synergies that will support this goal.
- Adopt an Agile workflow / practice. Since Agile preaches focusing on your overarching goal and regrouping and redirecting when you get off course, this approach supports successful realization of identified synergies by maintaining focus on synergy implementation. Agile M&A can help you to dive deeper how to adjust Agile methodology to M&A process.
- Work on retaining key employees from the target company. Again, going back to the importance of culture and change management and the notion that people make a company successful, retaining key personnel is essential.
- Analyze your customer base to capture revenue synergies. This means analyzing both the current relationships with your customers, as well as the other services and products your customer needs that you do not currently supply.
8. M&A Risk 8: Threats to security
Data is, of course, essential when working through a deal, but the data you gather is not only valuable to you – unfortunately, hackers and thieves find it valuable as well. Threats to security hurt both the buy-side and the sell-side, and, consequently, the overall value of the deal.
How to avoid security threats:
Utilizing virtual data rooms is one way to avoid security threats when sharing and reviewing confidential information. Moreover, you will want a virtual data room that:
- is ISO compliant
- has digital watermarking
- boasts strong encryption methods
- possesses various document permission and restriction settings
- requires two-factor authentication
9. M&A Risk 9: Unexpected costs associated with the deal
While the cost of a deal is specific to the type of deal itself, the multiple types of fees can easily overwhelm a deal, and sometimes a seemingly small increase in costs can greatly impact the value of the deal.
Advisor, investment banking, and legal fees are often expected and calculated for, but the scope of what a deal costs reaches far into due diligence (for example, per page pricing models some practitioners still follow) and integration practices (for example, employee training, rebranding, and new salaries).
How to avoid unexpected costs associated with the deal:
Again, early planning and estimating for each type of fee is critical. Furthermore, all team members must embrace the mindset that working to minimize cost at each step of the deal is critical.
What are some practical ways to reduce costs?
One easy way is moving away from per page pricing during diligence and moving towards a flat rate model; with this approach, data and information are not compromised and large fees related to due diligence can be easily planned for.
Leveraging technology is one way to move away from per page pricing.
Similarly, utilizing M&A project management platforms can help teams be more efficient and avoid wasted time and redundant work – all of which equates to saved time and money.
In truth though, perhaps nothing avoids unexpected costs more than having a strong team in place; specifically, a group of experienced practitioners that can keep the deal progressing forward and can identify and plan for integration and transitioning.
10. M&A Risk 10: Unforeseen market disruptions and/or “acts of God”
While educating yourself on potential risks associated with M&A, learning from expert practitioners and studying current trends are all valuable tools to mitigate M&A risks. However, there are certain risks that cannot be predicted – these “acts of God” are in reality virtually uncontrollable.
Our current pandemic proves this – it has caused significant and unforeseen shifts and delays in the M&A landscape and will undoubtedly have ripple effects throughout the market (and overall economy) for years to come.
While there is no way to avoid unforeseen market disruption or acts of God…..
Continuous M&A study, professional development, and discussions with other practitioners can help you navigate unforeseen market disruptions and the impacts they can cause, which will, hopefully, mitigate their overall negative impact on your business.
Furthermore, analyzing the impacts of past market disruptions (i.e. 2008 economic crash) can provide valuable insights and lessons learned during new challenging times.
While not a panacea, knowledge and professional study can improve your odds of sound decision making during challenging times.
What is M&A risk management and how to deal with risks in M&A
Acquisitions are often the largest investment that a company makes over the course of its lifetime and that alone, makes them a significant risk.
The primary risk is financial – mergers and acquisitions can place a huge cash burden on companies if not executed properly. Many of the mergers that end badly are the ones that take on too much of a financial burden, dooming the deal to failure from the start.
But financial risks are just one of many that have to be mitigated.
For example, are operational risks (staff underperforming owing to uncertainty about their positions), commercial risks (major clients going bankrupt) and even political risks (governments unilaterally deciding that the target is of ‘strategic national importance’).
Thus, the whole mergers and acquisitions process requires risk management.
For M&A risk management, read due diligence. If any of the risks mentioned in the above paragraph are not on the due diligence agenda, the chances are that you haven’t adequately conducted M&A risk management.
There is a tendency to view due diligence as an inspection of the target company; this is only part of its role. In a wider context, your due diligence process is your M&A risk management.
Even experienced top companies make mistakes in deals that hurt their value. The list of companies that have overpaid, failed to integrate properly, and failed to capture synergies is all too long.
As with many things in life, being keenly aware of potential risks implied by M&A activity can help you avoid them, or,at the very least, can help minimize their impact on the success of your business.