Why so many M&A transactions fail, and how not to be one of them
In 2021, many companies and funds were flush with cash and looking for opportunities to spend their cash productively; some invested in improving performance, others invested in mergers and acquisitions (M&A). As a result, 2021 was a banner year for performance improvement advisory (top line growth, cost optimization, leadership effectiveness, digital, and extracting value from M&A) which took advantage of a record-breaking year in M&A activity. According to Refinitiv, there was over $5.9 trillion in deals transacted globally, including $2.6 trillion of U.S. deals, making up approximately 63,000 transactions. While transaction flow may be slowing slightly as we come to the end of the first quarter, Morgan Stanley anticipates that 2022 will continue to provide a strong environment for M&A activity due to robust economic factors and significant dry powder to be used.
Even with interest rate hikes, inflation, supply chain issues, a war in Europe, energy uncertainty, additional COVID-19 challenges, and other economic issues existing or looming, Citizens Bank found that 58% of survey responders from U.S. middle market companies still believe their companies will improve in 2022 with 62% predicting that M&A will be the “primary growth driver.” And as transactions continue to close, the performance improvement initiatives necessary to derive planned value from existing and newly acquired businesses will continue to be critically important for the reasons outlined below.
Why 90% of transactions fail
For many businesses, mergers and acquisitions are a key tool to accelerate revenue growth through quick expansion into new markets and products as well as accelerated production and service capabilities. However, with a record-breaking year last year, and similar activity expected for 2022, how many of these transactions are truly successful and create value for shareholders? Studies have shown that between 70% and 90% of transactions are not successful i.e. they don’t live up to their investment thesis.
A recent Harvard Business Review study reported that more than 60% of transactions actually destroy, rather than create, shareholder value and up to 90% fail to achieve their investment thesis. The reasons for failure are few in number but common in occurrence including:
1. Hubris and bias
2. Inadequate diligence and planning
3. Lack of integration strategy and priorities
4. Leadership and resource challenges
5. Poor communication
6. No end-state clarity
7. Slow or weak implementation
Countless articles have been written and are available to help the uninitiated navigate better than their predecessors. Capable and experienced guidance is available through partnership with various advisors and yet, over and over, the cycle of optimism, failure to plan, poor execution, and lost value repeats; never moreso than in a year of record transactions. Why does this happen repeatedly? Why hasn’t the problem been solved? Some of the answers below have been studied and proven with hard data. Some of the commentary, though, is the result of years of personal experience with, and observation of, transactions of all sizes and stripes with numerous clients and their advisors on both the buy and sell side. Sometimes, you don’t need a research study to draw a solid conclusion.
One reason this phenomenon repeats over and over again is, like the cause of many business missteps and failures, hubris. As expressed so eloquently by James Hollis, author of What Matters Most, “hubris, or the fantasy that we know enough to know enough, seduces us toward choices that lead to unintended consequences.” Many corporate executives and fund managers, particularly those who have been successful, are under the mistaken impression that they are too smart to fail, that they are more insightful than what the team, data, and advisors are telling them; that because they feel it, it must be so. As a result, the overconfidence in themselves and their optimism around the investment thesis biases the diligence (or causes flags to be ignored) ignores the need for (and often the pleas for) early integration planning and resourcing, leaves key team members out in the cold (which leads to poor morale, lack of support for the transaction, and unwanted departures), and brings everyone, unprepared, to a Day 1 post-close without the necessary foundation for integration and success. We all, at times, suffer from hubris. And, sometimes brazenly marching forward pays off. As Julius Caesar said, “It is only hubris if I fail.” But, more often than not, hubris is just hubris, not concealed genius. As Roger Lowenstein, author of “When Genius Failed” wrote, “Finance is often poetically just; it punishes the reckless with special furvor.” The same can be said of M&A and the data is there to prove it.
But not every executive or fund manager lacks humility or the willingness to listen or listens with a biased perspective. In fact, many do not. Yet a majority misstep and fail when pursuing a transaction. Why else, then, might smart people repeat the same destructive pattern over and over?
One core reason for this repeating debacle is the insatiable drive for growth and the fact that capital needs to be deployed to create a return. The old adage, “Money just sitting is being lost” drives a lot of bad behavior by smart people. This is true of lenders who are under pressure to lend, often doing bad deals rather than no deals. It’s also true of companies and funds under pressure to grow, often causing shrinkage rather than growth. If the goal is growth or the objective is putting capital to work, the outcome will likely miss because the starting point is wrong. The starting point for a good transaction needs to be that (a) there is an objective reason for the businesses to come together, (b) there are compelling synergies that can be achieved, (c) there is a workable cultural fit and, (d) the companies (or at least one of them) are healthy and have a solid foundation (too many buyers and sellers try to bolt crap onto crap to create gold and it never works). If any one of these reasons are missing, the transaction will be destined to fail no matter how great the opportunity seemed on paper. Desire is not a strategy. A good narrative doesn’t cause 1+1=3. The impression of growth is not growth. Real growth takes an open mind, hard work, planning, and outstanding execution whether done organically or via acquisition. A purchase is not the easy path, at least not in the long term.
Which brings us to the last reason successful executives continue doing bad deals despite all the lessons in plain sight to learn from (think Payless Shoes, Deadspin, Shopko, and RadioShack for private equity examples and AOL/Time Warner, eBay/Skype, Google/Motorola for corporate examples). It is difficult to grow a business organically and it is getting more difficult as time goes on. Price arbitrage and leverage have gotten harder to achieve in such a competitive market. Margins and efficiency have also gotten harder to realize with globalization and commoditization. Let’s face it, it is hard work to dream up new products and gain market acceptance. It is challenging to squeeze every last penny of efficiency out of a decent, but not great, organization.
As Jim Collins, author of Good to Great said so profoundly: “Good is the enemy of great.” So few achieve great because it is easier to settle for good. When the ease of settling for good crashes headlong into the pressure to grow, transactions get done as a way to grow that lack the requirements for success: a reason, synergies, cultural fit, a solid platform. In short, transactions appear to be an easier way to grow but, time and again, the destruction of shareholder value in a majority of transactions prove that appearances are deceiving.
Don't be one of the 90%
Let’s say you have your eye on an acquisition, you’ve checked yourself for hubris and desperation under pressure, and you believe the requirements for success are there. Since everyone starts out thinking they will succeed, how do you not become one of the 60-90% who, nonetheless, fail?
1. Fight against bias. We look at a deal. We like it. We have dreams of its success. We see our names in headlines. And, with that, have created a mental investment, a bias, that precludes us from seeing clearly. “We are all biased. Our brains were designed to be. We categorize information to store it, which means we have to make judgments. Those judgments rely on our past experiences, which, in turn shape our perspectives. They help us figure out what is safe (generally, what is known) versus where to be cautious (generally, what is unknown). So, bias always plays a role in decisions.” But, science has shown that our brains don’t work well when conditions for bias exist. Nowhere is the condition for bias stronger than in risk-reward situations under stress. To fight against bias, be curious, be willing to re-evaluate as new data comes in; listen, listen, listen. Do not be so invested that you aren’t willing to pull the plug.
2. Broaden diligence and plan early. Our best advice, though not to be self-serving: hire good advisors so that the people evaluating the deal aren’t you, don’t report to you, and don’t have a stake in the outcome. Don’t be pennywise and pound-foolish. Go broad when considering how to unearth issues and achieve success. Focus on not just the financials but the market, the customers, the products/services, the systems, the foundation of the entities, and, most of all, the people. If any of the information coming back about the combination, at any time, smells funny or feels off, do not ignore that feeling. And, if the diligence appears positive, begin planning immediately. To begin with, it will always take longer than expected. But, as importantly, the process of pre-planning is a form of diligence in and of itself. It is one thing to say, “Put these two things together.” It is another thing entirely to plan out the how of putting them together. In that process, it will either start to appear workable or it will start to feel like squeezing a square peg into a round hole. Synergies aren’t created without an early plan, a talented integration team, clear priorities and communication, and outstanding project management.
3. Formalize the integration strategy and priorities. Over the course of the merger or acquisition process, good company leadership focuses on managing a meticulous due diligence process, risk assessment review, marketing testing, and capital raises to achieve a successful closing. But the integration strategy and work needed to ensure the transaction is value-add in the long-term must be initiated in tandem with the due diligence process and implemented immediately upon closing. To extract value from any transaction, it is critical that (a) an integration team be appointed, (b) a comprehensive integration map and checklist be developed and planned for during the deal process, and (c) once the transaction closes, outstanding project management to integrate the newly married entities. Often times, we see leadership teams do all the right things up to prioritizing the long list of tasks required to be thought through and implemented. Drinking from a firehose is rarely a successful strategy for hydrating and, in the case of a transaction, the integration team needs vision, leadership, and a clear hierarchy of what is most important.
4. Clarify leadership and resources. Of the many transactions we’ve seen come off the rails, the most frequent roadblock involves people. From which company? From which departments? Who stays? Who goes? The two sets of leaders have to decide early on who is going to be part of the integration team, who will lead what (remember, there are two sets of leaders at the start who both have a vested interest in the outcome), who will stay and who will go (if there is to be consolidation), who will be privy to the planning (are you in the club and motivated or out of the club and demoralized), and who will make the tough calls when they arise. This is particularly challenging since (a) most people are conflict averse and (b) early in the process no one wants to give anything away lest it doesn’t work out. Yet, the paradox is this: If control is not taken and ceded, if trust is not created and relied on, the transaction that everyone wants to work stands a far greater likelihood of failing.
5. Communicate, communicate, communicate. Right behind leadership snafus in terms of why transactions fail comes communication lapses. Key people internally need to be in the loop. Full stop. See #4 regarding selecting key people. But, once the hard work of selection is done, no secrets. That team of key leaders can then work out a communication strategy for the market, for customers, for vendors, for employees. The human brain abhors a vacuum. Absent information, people make things up to fill the vacuum and it is almost worse than the worst of the truth. A lot of our clients fight us on this with fear that communication will make it impossible to retain customers, staff, etc. In fact, the reverse is true. Of course, there is a time and place for all communication. But, it is almost always earlier than your instincts advise you.
6. Begin at the end and be ready to go. In the same way that a transaction needs a reason to be, a clear path from here to there needs a “there” in clear sight. To borrow wisdom from Stephen Covey: “To begin with the end in mind means to start with a clear understanding of your destination. It means to know where you’re going so that you better understand where you are now and so that the steps you take are always in the right direction.” In any implementation, success depends on good people, correct and prioritized tasks, and speed. Implementing immediately post-close to prevent or solve for any integration plan gaps as quickly as possible. The leadership team and integration team must be prepared to act quickly and pivot as needed, which may include making difficult decisions regarding people and systems.
7. Finish strong. All the planning in the world accomplishes nothing if it doesn’t translate into strong integration and performance improvement implementation with an open mind, a solid plan, achievable priorities, the right leaders, transparent and inclusive communication, and strong project management. The performance improvement measures that are almost always baked into an investment thesis – grow the topline, optimize costs, create an effective workforce, and integrate and upgrade systems – must take place quickly and efficiently while also engaging the combined workforce for the benefit of the transaction to be realized. It is a daunting task, but it is doable. As numerous famous and wise individuals have said, in one way or another: “Good judgement is the result of experience and experience the result of bad judgement.” If experience has taught us anything it is this: learn from, and rely heavily on, those who have been through it before and succeeded.
While there is no guarantee that any transaction will ultimately be a successful value-add transaction, incorporating the recommendations above can help organizations develop a strong plan and foundation for integration and, if implemented properly, can provide a stronger likelihood of success limiting the possibility of becoming one of the large majority of M&A deals that aren’t successful.
1. James Hollis, PhD. What Matters Most: Living a More Considered Life (Avery, 2009)
2. Roger Lowenstein. When Genius Failed: The Rise and Fall of Long Term Capital Management (Random House, 2001)
3. James Collins. Good to Great: Why Some Companies Make the Leap…and Others Don’t (Harper Business, 2001)
4. Jackson, Jarret. “Three Ways to Avoid Bias in Decision-Making.” Forbes. Forbes Magazine, August 18, 2020. https://www.forbes.com/sites/jarretjackson/2020/08/26/three-ways-to-avoid-bias-in-decision-making/?sh=469fa831a715.
5. Stephen Covey, The 7 Habits of Highly Effective People: Powerful Lessons in Personal Change (Simon & Schuster, 1990).