Seven- and nine-figure mergers and acquisitions (M&A) deals bring two or more companies together and require meticulous due diligence before closing. Despite that effort, half of such deals fail.
The primary purpose of M&A is to grow a business by acquiring new products, markets, and customers and increasing profitability. So, what goes wrong?
1. Insufficient Management Capacity
When companies begin the M&A process, they need to carefully analyze their capability to integrate and build upon the more significant combined business. If the target company is already overextended, the acquiring company must dedicate resources to fill those gaps. Doing so requires investors to identify those deficiencies and calculate the time, effort, and resources needed to overcome current and future challenges.
Failure to perform thorough groundwork dooms an M&A deal. These deals may result in the acquiring company needing significant resources and becoming overwhelmed by debt to integrate the target company. That debt creates pressure to cut costs immediately and is not a good start to the deal.
Sears and Kmart, two of the most iconic names in US retailing, merged in March 2005. The combination of two fading rivals attempted to create a stronger, combined company. However, they failed to reinvest in the company when it probably needed investment more than ever and sold its assets over time. The lack of reinvestment resulted in declining sales and net worth.
The best type of M&A transaction is when a company acquires a comparatively smaller firm in size and is easier to integrate. In this way, the acquiring company does not have to employ considerable resources for smooth expansion.
In 2011, a $35 million trucking firm based in Oakland, California, GSC Logistics, gained a footprint in the Pacific Northwest by acquiring Best-Way Trucking in Seattle, Washington. The deal proved to be successful and produced excellent results for the company, which could expand without detracting from its existing team and infrastructure.
2. Issues with Cultural Integration
At times, companies neglect to assess the target company’s culture thoroughly. When companies underestimate cultural compatibility, they lose money in the long run. Executives must examine whether the two companies have a cultural fit. If not, they need to acknowledge the cultural differences and devise a plan to bridge the gap.
For example, CPP, the personality assessments publisher, acquired its master distributor in Australia after a 25-year relationship in 2007. As expected, the deal and the integration went smoothly, as they had already established the compatibility of both cultures, and there was a close relationship.
In contrast, the Daimler-Chrysler merger was one of the most famous M&A disasters in history, highlighting the challenges inherent in cultural and integration issues. In the Daimler-Chrysler debacle, the acquiring company betrayed the target company’s expectations, resulting in a deadlock on critical operational and integration points for the acquiring company, a cultural war between the two organizations, and the failure to retain top talent. Ultimately, in 2007, Daimler paid Cerberus Capital Management to take Chrysler off its hands.
The key learning from the Daimler Chrysler case study is that cultural integration issues are essential. The acquiring company needs to have a proper strategy to either allow the regional businesses to run their units with well-defined targets and profit-making systems or go for forceful integration by setting aside cultural differences.
3. Lack of or Diversion from a Key Strategy
Most M&A transactions are backed by a motive essential to their success. A deal without a strategic plan is doomed to failure from the outset.
While improving the company’s market share is a good motive for an M&A deal, seeking to become a visionary in your specific industry is not. Every acquiring company must have a key corporate strategy and pay attention to whether the target company aligns with it. A deal straying from the core corporate mission could turn out to be very expensive.
The acquiring company is in a position to recover the costs of a problematic integration if the target company fits well with its key corporate strategy.
For example, United Site Services and its CEO, Ken Ansin, bought Handy House, a $15 million portable toilet firm. They executed a well-disciplined, region-by-region acquisition strategy adding many similar companies in 23 states. The company grew into a $120 million portable toilet business.
At times, an acquiring company fails to understand that the price they pay for the target company is not the only cost of an M&A deal. M&A costs also include, but are not limited to, resources for smooth integration to leverage the target company’s advantages and still get a return on investment that passes the hurdle rate.
The acquiring company should set a spending limit before entering negotiations.
For example, in the early 2000s, in the series of technology and talent acquisitions, the internet search engine Ask Jeeves looked at over a hundred companies. They were aware that the price they paid for the target company would double their cost while leveraging and integrating it. Hence, they refused to overpay.
5. Incorrect Valuation of the Target Company
The history of M&A deals shows that factors or assets that look good on paper don’t always be the same after the deal.
With a $2.5 billion deal in 2008, Bank of America attempted to cement its place at the top of the commercial banking business by acquiring the country’s largest lender, Countrywide. However, it did not turn out the way they had expected. They lost $40 billion and are still counting.
Even though Countrywide had grown immensely by offering subprime mortgages to people with credit problems, it was losing money at that time due to the collapse of the housing market. The deal could have gone through at a much lower price had this critical factor been considered.
After the deal went through and Bank of America began poring over Countrywide’s books, they realized they had purchased a mess. Several states had sued Countrywide for mortgage abuses. Also, with the housing market in turmoil and many loans extended to people who could not afford them, Bank of America faced a flood of foreclosures.
If they renegotiated the deal at the right time, they could have saved themselves from the debacle, suggesting experts.
6. External Factors
The failure of Bank of America’s acquisition of Countrywide also contributed to the overall collapse of the nation’s financial sector, which hit mortgage companies disproportionately. The risk of external factors like natural calamities, pandemics, and economic slowdowns is out of the control of M&A managers.
Likewise, the year 2020 is an excellent example. Suppose, just before the COVID-19 pandemic, two travel companies considered a merger, and everything about the deal from financial, cultural, and strategic to price looked practically perfect on paper. Then, just as the deal closed, the global effects of the pandemic became evident: the travel and tourism industry stopped, and the money dried up. This hypothetical deal failed due to an external factor that no one could foresee.
7. Poor or Delayed Integration Process
Post-merger integration plays a critical role in the success of an M&A deal. Companies need to be extra careful in identifying key employees, crucial projects, essential products, sensitive processes, critical matters, bottlenecks, and much more. Based on the identified critical areas, they need to design efficient processes for clear integration by exploring automation, consulting, and even outsourcing and executing them without delay.
When Bank of America and Merrill Lynch merged, the two companies took an excessively long to integrate their assets and announce critical executive decisions. Even months after the merger announcement, they had no clarity on which executives would run which critical groups within the firms and which management models would prevail.
The indecision and resultant uncertainty led many Merrill Lynch bankers to leave the company shortly after the merger announcement, which ultimately destroyed the rationale for the merger and led to the failure of the M&A strategy.
Related: HR and M&A – The Relationship.
Get Expert Help for the Right M&A Deal
Statistics showing a large number of M&A deal failures prove that many factors affect the merger of companies. All cannot be good at all times. The reasons for failed deals also serve as warning indicators that even after businesses take all the seemingly correct steps, things can still go wrong.
Scrupulous examination of M&A deals before closing them serves the best interests of all parties involved and increases the odds of success. However, nothing can fix a deal that was not supposed to go through in the first place. Not all deals can be salvaged. Recovery from such a deal costs as much time, money, and resources as would go in cracking two other good deals.
Getting assistance from experienced, knowledgeable advisors, analysts, and industry experts, conducting thorough due diligence, timing the deal right, and staying vigilant against pitfalls maximize an M&A deal’s chances of success.