The motivation behind a business merger, whether you're the buyer or the seller, is to create synergy between two firms, forming value that is greater than what the individual businesses brought to the table on their own. A well-executed merger can be a great idea for both companies because it should result in enhanced capabilities, increased shareholder value, better operational efficiency, and cost reductions. Yet there's a cautionary fact for all middle market leaders to consider, whether they're the target company or the acquiring one: more than half of all mergers fail, for a number of different reasons we'll go into later.
The last few years have seen an upswing in Merger and Acquisition (M&A) activity focused on the middle market, especially the low end of the middle market. In 2013, for example, 81 percent of all M&A activity in the middle market centered on companies generating less than $250 million per year (recall that the middle market is defined as companies generating between $10 million and $1 billion). According to a survey conducted by consultant KPMG and "Mergers & Acquisitions" magazine, that trend will continue in 2014, with some 77 percent of all middle market M&A deals expected to involve companies making less than $250 million annually. There can be multiple M&A scenarios, from middle market companies at the high end (between $750 million to $1 billion) acquiring smaller middle market companies at the low end (say, at $75 million or so), to larger enterprises buying middle market companies of different sizes.
Unfortunately, the desired benefits from mergers aren't always realized. As a middle market executive considering a business merger (whether as the acquirer or the target), there are signs of trouble to be aware of.
- Every business merger needs to be aligned with a strategic plan. For example, an acquiring company looking to focus on premium customers would be foolish to buy a target that's serving the low end of the same market. On the other hand, say that there are two middle market companies in the same premium market segment. The target company might offer a product portfolio that complements that of the acquiring company, or maybe the target has better access to a certain customer base than the acquirer. This sort of relationship creates a good foundation for successful synergy.
- Like any buyer, the acquiring company must perform due diligence in order to understand exactly what it's buying. Assigning a proper value to the target company may be the most difficult (especially at the low end of the middle market, where financial reporting structures may be less mature/sophisticated) and important step in the entire M&A process. Overvaluing the target can lead to an instant loss of shareholder value.
- Oftentimes, high achievers in the target company fear for their jobs and leave before a merger is complete. Since the acquiring company often buys the target because of its talent, losing that talent up front can destroy synergistic potential. When the best people quit, added value goes out the door along with them. When dealing with middle market companies, especially those at the low end (many of which are family businesses), engaging with the key people from the beginning is important in order to retain them within the post-merger entity.
- The two companies involved in a merger will likely not have compatible IT systems, making the process of system integration expensive and slow. This can lead to a lot of frustration among employees and customers. Again, understanding the level of compatibility between each company's IT infrastructure is critically important and directly relates to potential value creation.
- A big conglomerate that buys a target company known for a culture of innovation and flexibility should leave that culture alone if it wants the target to work for them successfully. Imposing a bureaucratic, top-down structure onto, say, a smaller middle market target company that's used to operating with more flexibility is one of the fastest ways to kill synergistic potential. When two cultures don't fit, it becomes very difficult to make any merger or acquisition work.
With so many chances for a merger to go wrong, what steps should middle market companies (whether the target or the acquirer) be taking to ensure success?
- Identify potential synergies early on and map them out carefully. Also, consider areas that could be streamlined or reduced due to overlap between the two merging companies. Understand as best you can how the merger will create value and plan out how you can capture that value. Both companies should be on the same page so they can be in lockstep as they start to execute that vision.
- Develop a talent retention plan to keep your highest achievers engaged during the merger process. Much of this work involves communicating with your top talent about the specifics of their roles in the new structure and how the merger will enhance their range of career opportunities. Doing everything you can to retain talent is every merger's first priority (and often is a merger's first failure, as well).
- Plan integration of IT systems and any new structure beforehand. A key step to integrating two companies is knowing their differences and deciding how to manage them. A detailed integration plan should be drawn out ahead of time to try to make the melding of technological systems as seamless as possible. This can be one of the most challenging parts of any merger. Having it all mapped out will let you know where issues may come about.
- Navigate and make determinations on cultural issues. Be extremely careful when approaching cultural differences. Sometimes they can be so large (like when a strict, authoritative managerial team takes over a set of employees that is used to a more casual, flexible working environment) that they set off alarm bells. In this case, the best decision is either to plan out major adjustments or not move forward with the merger at all.
- Both companies should re-examine projects in light of potential financial synergy. It's likely that merging companies will have different cash-flow situations, and oftentimes it's the target company that benefits from a new relationship. If a middle market target company had, for example, shelved projects based on prior financial constraints, the newly merged company may be able to remove those money constraints and give these shelved projects the green light.
- Keep lines of communication open. If the leadership team does not develop a clear and consistent communication plan, the grapevine will start communicating for you. You'll need to reassure people about their new roles and the overall plan. Nothing helps a merger succeed like open and consistent communication. If you're not transparent, you'll have an exodus on your hands that may destroy value.
- Make necessary layoffs early in the process. Letting go of employees is tough no matter the circumstances. Get it out of the way early and as bunched together as possible. A slow drip of terminations, especially when coupled with a landscape of insufficient communication, will erode morale and diminish value. Rip the Band-Aid off quickly, so to speak, and move on to more positive things.
There are no guarantees when navigating through this tricky endeavor. By identifying potential areas of value and the likely problems that you'll run into, you can plan out the entire merger as thoroughly as possible and be ready to deal with the inevitable difficulties surrounding the transition.
Have you ever been involved in a merger? Is there anything else to consider? Let us know by commenting about it below.
Boston-based Chuck Leddy is an NCMM contributor and a freelance reporter who contributes regularly to The Boston Globe and Harvard Gazette. He also trains Fortune 500 executives in business-communication skills as an instructor for EF Education.