A recent study on M&A turned up a surprising statistic. Between 1984 and 1994, some 80% of LBO firms reported that their fund investors had received a return that matched or exceeded their cost of capital, even though in many cases the prices paid for the companies those funds acquired were pushed up by competing bidders. That figure stands in stark contrast to the overall record of M&A investments, which from the corporate acquirer’s perspective has been dismal, at times disastrous.
The fact that financial acquirers are so much more successful than most corporate acquirers may come as a shock to some managers. After all, financial investors don’t bring synergies to their acquisitions, and they often have relatively little operational experience in the industries involved. Indeed, it’s highly likely that the target’s management team will initially view potential acquirers with substantial skepticism. 1
Why, then, are financial acquirers so successful? Based on our experience advising companies on both acquisitions and negotiation strategy, we believe the answer lies in their approach to the acquisition process. Most corporate managers treat acquisitions as a direct-march-up-the-hill kind of exercise: “I want to buy this company. Let’s find out what it’s worth, offer less, and see if we get it.” The actual deal-management process is often delegated to outside experts—to investment bankers and lawyers.
But senior managers at financial investors—and the more successful corporate acquirers—treat deal management as a core part of their business. They approach potential acquisitions with sensitivity and a well-established process. They adjust their negotiating postures and objectives as the deal evolves. And they take the trouble to carefully coordinate the different actors—senior managers, lawyers, investment bankers, and so on—throughout the process. It is this care and effort that enables successful acquirers to create the value they do.
In this article, we’ll describe how successful acquirers manage their deals. Our focus is primarily on friendly deals, but much of what we found is applicable in a hostile context as well because even a hostile bid has to end in an agreement to work together. All friendly M&A deals pass through five distinct stages: screening potential deals, reaching an initial agreement, conducting due diligence, setting the final agreement, and ultimately closing. We’ll walk you through that process, comparing good practice with bad, and then we’ll suggest ways companies can turn their deal-making experiences into organizational learning.
Screening Potential Deals
Acquisition possibilities can pop up without warning and usually need to be evaluated quickly. A core challenge in sizing up potential acquisitions, therefore, is to balance the need to think strategically with the need to react opportunistically. Experienced acquirers follow two simple rules in screening deals.
Look at everything.
Successful acquirers are always on the lookout for deals. An LBO shop such as the New York City-based Cypress Group might complete only two or three deals a year, but it will have explored as many as 500 possibilities and have closely examined perhaps 25 of them. Successful corporate acquirers do much the same, albeit on a smaller scale. Cisco Systems, for example, typically evaluates three potential markets for each one it decides to enter and then takes a hard look at five to ten candidates for each deal it does. Assessing a large volume of opportunities confers two main benefits. It gives Cisco an overall sense of what kinds of strategic acquisition opportunities exist and at what price, making the company better able to assess the value of each prospect relative to the others. On a more basic level, it forces managers to bring discipline and speed to the screening process.
Keep a strategic focus.
A common mistake for novice acquirers is to cast strategy aside in the face of an exciting opportunity. “The failure starts right at the beginning,” one senior financial professional explained to us.” Someone at the top falls in love, and the word comes down, ’We are going to do that deal.’ Once the decision gets made, the guys doing the deal just want to get it done. They start stretching the operating assumptions to make it work.” Senior executives at LBO firms, however, are strict about sticking to guidelines. Joe Nolan, a partner at GTCR Golder Rauner, is very clear about his firm’s focus: “We look for businesses where acquisition will be a core part of the growth strategy. We back people who know how to both operate and acquire companies, which is a rare combination. We invest in service companies and not manufacturing.”
From Talking to Planning
Initial negotiations can take place in a variety of ways. Some cases occur through a structured process, such as an auction; others happen less formally through conversations between senior executives. Either way, the challenge at this second stage is for the senior management of both companies to agree that the potential for a deal is sufficient to justify investing resources in further exploration. Successful friendly acquirers follow much the same rules of thumb in nursing potential transactions through this phase.
Don’t get bogged down over price.
It is usually unwise to try to establish a firm agreement on price this early. The parties simply don’t have enough information. As Bob End, one of the founding partners at Stonington Partners, puts it: “You have to do some preliminary feeling out, but if you focus on price at the beginning, you are setting yourself up for failure. People start staking out positions and end up souring on the deal. I’d rather get some momentum around the business possibilities, to get people nodding their heads.”
Identify must-haves.
Although acquirers cannot afford to get tied up with too much detail at this stage, it is essential to pin down certain issues. Many of these are driven by the acquisition’s strategic rationale. GTCR Golder Rauner, for example, focuses on the management team’s experience and its incentive structure. Cisco insists that the management of target companies believes in employee ownership. It’s also important to clarify the roles that the target’s top executives will play in the combined organization: who will be retained, and what will they do? American Home Products’ merger with Monsanto foundered, for example, because the two CEOs could not agree on which of them would be number one. Finally, it is essential that the acquirer be comfortable at this stage with any potential liabilities—such as environmental exposures, retiree health-care liabilities, or class action suits—that could materially affect the price of the transaction.
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