Far too many acquisitions across industries, geographies and sizes fail to meet their post-acquisition targets. According to a commonly cited Harvard Business Review metric, 70-90% of acquisitions fail, in part, as a result of poor integration execution. We often hear of a high-priced acquisition within the Digital Marketing, Analytics, Content or Media sectors struggling and then being unceremoniously absorbed into the parent company. Clearly, if you’re in the industry, you know of many poorly managed transactions that resulted in significant challenges. The reasons undoubtedly vary, but poor integration execution is always a good bet.
Recently, S4 Capital (owner of Media.Monks and 20+ other firms) announced that they will miss their profitability targets for 1H 2022 citing costs increasing faster than revenues in non- like-for-like units, the unspoken conclusion here is that the integration of their recent acquisitions did not proceed as smoothly as envisioned.
Imperative vs Opportunistic Integration
Broadly speaking, M&A valuations are based on two components. First is the stand-alone business and second is the value of the synergies that arise from combining the two businesses. (Examples of the latter may be new sales channels or client relationships that one of the companies introduces to the other or cost savings by having a single accounting system / department). Regardless of whether the valuation is on the stand-alone business or justified via layers of synergies, integration execution will always improve the outcome of an acquisition.
However, an integration effort is costly, and there are certain buyers whose strategy is to acquire firms at below-market valuations, loosely integrate them into their “network” of acquired businesses and then eventually exit the combined businesses for an at-market valuation. To these buyers, integration (and resulting synergies) is an opportunistic but not essential part of their strategy (despite protestations to the contrary). For buyers demanding the maximum strategic value of the combination, integration is imperative, and they are largely the subject of this article. (This idea may well become a later article expanding on why sellers struggle to realize their value with the loosely integrated approach).
Everyone Wants to Go to the Party…
“Doing an M&A deal” holds a certain amount of prestige to businesspeople. Buying a company (with yours or even better, someone else’s money) is a significant accomplishment, but for all the talked-about synergies that are discussed at length and modeled to the nth degree, they aren’t magically unlocked upon closing. Someone must follow through on implementing the vision to ensure that the increased revenues or efficiencies that were used to justify the valuation are actually realized.
It’s a lot harder to integrate a business than it is to buy it. Overpaying to acquire a target takes no great skill but coming up with a list of synergies to justify a valuation when these synergies may never be realized is just a disguised form of overpaying.
And yet, many buyers (M&A and Corporate Development teams) see their job as “done” at closing which means they are taking their deal-specific knowledge with them and leaving the hard, and value-generating work for someone else to do.
… But Nobody Wants to Clean-up the Mess
Frequently, the M&A team invoking the synergies have little / no responsibility to see them realized. A Corporate Development group may make a wonderfully strategic acquisition that lacks an owner(s), or they may acquire a company that has no clear role within the acquirer, so it limps along as a stand-alone without ever becoming part of that larger organization. In both cases, the lack of a clear plan or ability to unlock the synergies reduces much of the envisioned value that a combination was intended to bring.
Granted, the skills needed to negotiate a deal are different from those needed to see the goals realized, but there should be continuity of thinking relating to the value and process needed to achieve the targeted benefits. When it works out well, it is the BU Owner who is taking the acquired firm into their P&L and so is the principal on the deal and the integration.
Earnouts Limit Integration
An Earnout on an acquisition allows the Buyer to mitigate some of the acquisition risk and the Seller to be better valued on growth potential – but at a cost of limiting the practical level of integration. Most earnouts will be based on the acquired business successfully delivering a pre-defined target of profit, revenue, etc. This means that the acquired business must be measurable – which is contrary to the point of a tight integration. Earnouts typically invoke a compromise of cross-charges, foregone synergies or other workarounds that prioritize valuation mitigation over integration synergies.
Buyers with confidence in their ability to identify and realize all practical synergies tend to buy companies outright (with no earnouts) and begin to tightly integrate them into their existing organization so that by the end of the first year, it’s impossible to pinpoint the value derived specifically by the acquired business.
Merger Integration: A Simplified View
Merger Integration can be simplified into two streams:
Infrastructure Integration: This is the “plumbing” that makes the acquired business function as part of the larger organization. Often, cost savings in this area form part of the deal synergies, but we feel that the goal should be a quick and effective migration to the target environment(s), and any savings that may arise are a bonus. This is more of a philosophical viewpoint, but relying on savings from the consolidation of systems probably means the valuation is on the edge, and so this is venturing into overpaying territory.
Infrastructure Integration related items would include:
- Accounting and Finance: Software, invoicing, payroll, chart of accounts, policies, reporting, budgeting, etc.
- Human Resources: Benefits & Compensation, hiring / firing, policies, retention
- IT: SaaS Platforms, equipment, security
- Marketing and Communications: Digital channels, collateral, Day 1 announcement(s)
- Sales and CRM: Systems, processes, and platforms
Infrastructure Integration is not where the deal’s value will be created but is definitely where it will be lost with lack of or poor integration. We have all heard of high-growth acquirees not being able to hire desperately needed resources because the HR policies are misaligned, but a common destroyer of value is the lack of an integrated financial / reporting system. Dozens of spreadsheets to be consolidated by the parent company is a disaster for useful reporting, and the lack of transparency into the forward-looking business may result in missed earnings surprises of the kind S4 Capital just experienced.
Whether the acquired firm is renamed or ostensibly left as a stand-alone business, Infrastructure Integration should happen immediately. As a rule of thumb for smaller acquisitions, the close of the second full month after acquisition should be under the parent company’s structure. As much as this is aggressive, it is doable if the planning begins during Due Diligence. In practice, this usually means that the Financial Lead on the deal team is responsible for seeing the integration happen and remains with the acquisition until it is completed.
Strategic Integration: This is where the deal value is created and hopefully why the business was acquired in the first place. Notice we said the deal value is created here, not in negotiating the deal itself – a critically important distinction.
Strategic Integration is much harder than Infrastructure Integration. It is a lot more abstract and is a product of the Buyer and Seller’s attributes plus the strategic vision of the deal participants – the latter of which requires a deep understanding of the wider industry and sales / operational processes to maximize the opportunity. This uniqueness explains why any Google search for merger integration predominantly returns Infrastructure related processes or blandly suggests you schedule a meeting with “Sales Executives” without actually saying what synergies should be targeted.
A few Strategic Integration items that we try to target quickly include:
Cross-Selling: Identify value proposition and clients and who may benefit from the capabilities that the combination offers. Similarly, identify RFP’s and create offerings that open up due to the combined capabilities.
Business Development: Ensure that sales teams understand the newly available offerings and that compensation plans are duly aligned.
Partner Ecosystem: Evaluate whether existing / potential software partnerships or sub-contractor arrangements will benefit some part of the combined business.
Resource Sharing: Incentivize the sharing of resources internally rather than seeking external assistance.
IP, Automation & Methods: Evaluation and wide access to the defined best-of-breed apps, tools, scripts, processes, methods etc.
The combination-specific considerations are also why so many deals fail to realize their potential – to be successful, it requires a deep business understanding rather than a deal mindset.
Great Idea and all…
For mature firms, acquisitions exceeding $100M typically include a full-fledged merger-integration team whose sole purpose is to see the targeted synergies realized. Their skills, methodologies and incentives are built around understanding exactly what has been acquired, how it best fits into the target organization, and the quickest way to accomplish the deal’s goals. Smaller acquisitions typically don’t get the benefit of a full integration team, and this is where value creation begins to fall apart.
Many contemporary firms make acquisitions because they see the strategic value of a combination, while lacking the institutional M&A experience to capitalize on the potential of the acquired business. Integration is weak, so at best, there is a significant pause between closing and integration. At worst, the acquired business flounders, and the excitement and momentum that was part of the acquisition process is replaced by a malaise and resentment within the acquired business. Often newly acquired founders are so frustrated that they have no idea who to talk in the new organization, their new boss has no time for the new direct reports, and the earnouts that were so intrinsic to the valuation are suddenly looking far away.
The disconnect between the team buying the company and the team owning it post-close causes an incredible amount of potential value to be lost, and the momentum from the deal, once lost, is incredibly difficult to re-establish.
If You Buy It, You Integrate It
This was the philosophy of Platinum Technology – a software company that acquired some 50 companies in the late 90’s and were themselves acquired in 1999 by Computer Associates in what was, at the time, the largest-ever software acquisition. One of us was an M&A Analyst on the Services side of the business and with a deal closing every other month, the integration of the acquired business had to be efficient.
Rather than separate the pre- and post-close teams on an acquisition, each deal team was fully responsible for the execution of the deal’s promise. In the Services business, the owner of the P&L, where the acquired company would eventually sit was the “deal owner”; however, they were required to have a Finance (M&A) sponsor for each deal to ensure the deal’s parameters made sense. This deal owner would take on the financial targets commiserate with the deal in their own P&L and therefore into their bonus plan. This created a strong incentive to capture as much of the synergies as early as possible and pushed the integration planning well into the due diligence process.
To avoid spending time post-close trying to work through the infrastructure integration items, the Finance Lead would typically have payroll, benefits, accounting and finance, and policies migrated over by the first month – with a substantial integration package available at deal closing. The expectation with the selling company was always that, where practical, these items were non-negotiable and were being moved over quickly. The standardization of the migration processes certainly streamlined the efforts, while it was the active involvement of the deal team that enabled the infrastructure to be quickly moved to the “To-Be” environment. This approach was devised precisely to address the issue of integration ownership and was a successful solution that we have used many times since.
Be in the 10-30% of Deals That Succeed
To give oneself the best chance of avoiding the 70-90% of deals that HBR says fail, the deal needs to be looked at in its entirety – that is all the way through to a fully integrated acquisition. Responsibilities need to be assigned and met for the full deal duration.
After all, it’s a lot easier when the guests help to tidy up after the party rather than leave everything in shambles for someone else to resolve.