As the economy picks up, so does mid-market merger and acquisition activity. Yet successful deals remain elusive. According to a wide array of respected industry studies, the failure rate of M&A deals ranges between 70 and 90 percent. Even the most upbeat research shows M&A success as a 50/50 proposition at best — daunting odds for such a high-stakes venture.
The good news is that buyers and sellers can dramatically improve those odds and control their respective destinies by approaching due diligence in a spirit of partnership. Think of it as enlightened self-interest: Ultimately, both the buyer and the seller want to feel they got a good deal. Even when the going gets tough — maybe especially when it does — both parties will benefit from understanding each other’s interests and remembering they’re in this together.
Due diligence is a critical time for buyers who want to know what they’re getting into so they can confirm the value they see in the opportunity and make the right decisions to achieve it. As buyers plan for integration, they value the seller’s insights and participation in the process.
Sellers want the best possible price for the business they’ve built. Most care about creating a positive outcome for their employees who will be making the move. During due diligence, the seller can influence both the value of the deal and a soft landing for employees by demonstrating the value of those people and their willingness to contribute to a smooth transition.
In many transactions, buyers and sellers remain connected for a period of time through a Transition Service Agreement. This critical phase in a merger can be contentious or cooperative. Either way, it will impact the ultimate success and the realized value of the transaction for both parties.
For all of these reasons and more, buyers and sellers will get their deal off to the right start by putting themselves in each other’s shoes. It pays to know and respect what makes a deal attractive to the other party.
What Buyers Are Looking for, and Why
From the buyer’s point of view, due diligence is not only about legal risk and financial modeling. It also sets the stage for integrating the business to capture value as quickly and cost-effectively as possible. Buyers can improve the chances of getting the information they need by making clear, direct information requests that give sellers ample time to respond. Sellers can show good faith by being timely, thorough and straightforward in recognizing the buyer’s needs to:
Assess the challenge and cost of achieving synergies. Synergies are often the initial drawing card for a deal. An acquisition may lead to new buying power and economies of scale. Right now, many M&As are taking place in healthcare to achieve such synergies. Buyers may also gain operational synergies, such as the ability to combine two Enterprise Resource Planning systems (enterprise systems that generally support core functions that include financials, procurement, human resources and asset management) into one. Revenue synergies can be substantial due to new customers and cross-selling opportunities. Most synergies are not automatic. In addition to assessing their value, buyers need to determine what it will take to achieve them.
Get a handle on all integration costs. Because the costs of integration can affect the economics of the deal, buyers need these numbers as early as possible. All one-time costs related to the integration should be identified, including costs to achieve synergies, reduce dis-synergies and mitigate integration risks. What will it cost to integrate IT systems? Will marketing or travel budgets need to be increased to achieve some of the market-facing synergies? Will dis-synergies cause some operational costs to increase, or revenue to decrease? This analysis should include the costs of mandatory integration tasks, such as integrating financial reporting. It should also cover the legal, accounting and other consulting services related to integration.
Get integration risks out on the table. In order to determine integration costs, buyers need a clear-eyed appraisal of integration risks. What could go wrong? Risks may range from business disruption to loss of customers and key employees, culture clash, productivity declines and delays in realizing synergies. Now’s the time to identify the risks, quantify them as much as possible, and develop mitigation plans.
Consider the impact of culture. M&A deals create one company from two cultures, each with its own strengths, weaknesses and idiosyncrasies. Buyers need to assess the culture gap between the two companies and incorporate their findings into their integration strategy and change management plans.
Buyers can learn a lot about culture during due diligence. For instance, knowing how people are compensated gives meaningful insight into incentives and behavior. Consider the value of cultural similarities and differences. Is there value in the differences? Or is it all downside? Cultural misalignments may be difficult to quantify, but they can be just as important to consider as the latest P&L statement.
What Smart Sellers Do to Maximize Value
Sellers can command the best price by seeing the deal through their buyers’ eyes. For a buyer, uncertainties mean higher risk. And higher risk requires higher returns, which take the form of a reduced purchase price.
Sellers can reduce risk and maximize the value of their enterprise by being a good due diligence partner by planning to:
Anticipate and prepare operational information and metrics. First impressions matter. The simple act of showing up with the readiness to address the buyer’s wants and needs can increase the value of the business. If the seller is a “small fish” being acquired by a larger company, a high level of professional preparedness can elevate the profile of the business in the buyer’s eyes.
Sellers should put themselves in the buyer’s shoes. Consider what they would want to know about how efficiently and effectively the operation runs. Anticipating the buyer’s needs will give the seller time to prepare and provide this information before it’s requested.
Carve out the business to be sold early on. If only part of the business is being sold, the seller will profit from developing the stand-alone business model and cost structure well in advance of the sale. This added clarity during due diligence can lead to a better price by reducing buyer uncertainties, making the deal more attractive and simplifying the transition at the time of sale.
The seller can take early steps to separate product lines, financials, vendors and even physical business spaces so the entity can be uncoupled more easily later on. The more the seller does to separate the business in advance, the clearer its value to the buyer. The seller can attract a premium price when the buyer gets a modular piece of business that is a straightforward “plug and play.”
Be forthcoming; get any bad news out early. Bad news is worse for everyone when it comes at the eleventh hour. If a lawsuit is pending or some other unsavory issue is going to come out sooner or later, make it sooner. The seller should be the one to bring it up and outline what’s being done to mitigate the risk. By being candid, transparent and thorough, the seller earns the buyer’s trust that there won’t be any unpleasant surprises later on.
Beat the Odds
At the end of the day, M&A deals are negotiations, and negotiations can be tough. Of course, each party is expected to put its own interests first. But those interests are often more entwined than companies might think. When buyers and sellers enter due diligence in a spirit of partnership, they serve their own best interests, too. Life is long, and the aftermath of the deal can be dramatically affected by what’s gone on in the weeks and months leading up to it. Keeping the other party’s concerns and interests in mind throughout the due diligence process will increase the odds of success.
Otta Ramos and Dan Avery are both senior associates with Phoenix-based Point B and specialize in leading buyers and sellers through a strategic process to maximize the value of their transactions. Point B is a management consulting and venture investment firm that combines industry and functional expertise with an ability to execute, and its capital group’s deep venture advisory expertise leverages the company’s broad network to drive portfolio companies’ growth and success.