Acquisitions can deliver instant diversification for companies that are dangerously reliant on a tenuous or highly competitive core business. Just ask
While that story no doubt warms many an investment banker’s heart, it isn’t typical. According to Booz & Company research, the most successful acquisitions are not for diversification. In analyzing the 2011 deals in three industries, the consulting firm found that purchases of like companies were much more likely to be winners than losers. Depending on the industry, acquisitions that added capabilities to the current business were from 38% to three times more apt to be successful than acquisitions for diversification.
Acquisitions of dissimilar businesses carry outsized risks for mid-sized companies. I’ve asked many a mid-market CEO to think through the implications of having little domain expertise in a business they’re about to buy. If R&D begins to stumble, will you know which new products to protect or jettison? Will anyone in your company be able to quickly troubleshoot a production problem after key factory manager’s exit? If the CEO of the acquired firm leaves earlier than you planned, can you give his employees a compelling vision of the future so they don’t follow him?
Most acquirers hope that the seller’s management team stays in place. However, the risk of defection is high, especially if much of the knowledge of how to make the business really work resides in the owner or CEO. The less that the buyer understands about the business, the more critical it is for the seller’s team be competent and trustworthy, and that they remain in place and engaged after the close. The other major source of risk is the learning curve: how fast the buyer’s management can learn and run the business. Of course, if the seller’s team proves problematic, the pressure to learn is immense.
Losing the team of an acquisition that is a substantial diversification can be catastrophic. Crucial decisions can’t be made or made well. Customer needs often are ignored. Key support people flee since their bosses have left. Morale plummets.
This is an all-out emergency, and all general management hands must do what they can—even if it is only marginally effective. They must bring in industry-savvy consultants immediately at high cost. They must find a new leader for the acquired business must be found, and that leader must be allowed to hire his own team. This could cost hundreds of thousands of dollars in consulting and recruiting fees, plus a massive loss in revenues, profits and time to market from the indecision in the business. If this happens soon after the deal is signed, it will prolong integration for 6-12 months.
So should mid-market companies avoid acquisitions of dissimilar businesses altogether? I think not because such purchases can be necessary – for example, those to offset a long-declining business in a declining market. Then how do mid-market companies greatly reduce the risk? Six moves can go a long way.
Size the risk
When asked how well they understand a target acquisition, many management teams of acquiring companies will profess to have great knowledge. Yet often this knowledge is cursory. A few pointed questions will reveal how much an acquirer knows about a coveted acquisition target:
• Do we know, and possess most of their core competencies? Look carefully for hidden core competencies in different technologies or business processes.
• Are their customers really our customers? Just because two companies both sell products to many of the same industries doesn’t mean their customers are the same. They may address very different decision makers or even companies in the same sectors.
• Do we understand their marketplace dynamics such as trends, industry maturity, and levels of rivalry? You don’t want to be the equivalent of the National Football League’s replacement referees – football reps indeed who were not at all used to pro football’s rules, speed and pressures to make the right calls.
• Do we understand their competitive set? Do we really know who to look out for and who to ignore? And do we fairly well know the strengths and weaknesses of competitors that matter?
• Are we familiar with the geographies that an acquisition will take us into? In some industries, regional variations are large and critical. And being a long distance away makes management more difficult.
Understanding the risk is a first step, but there are also some opportunities to reduce that risk.
Hire an industry “river guide” in advance
Any move to diversify should be planned, and be a part of the strategic plan. Consider hiring or bringing onto the board someone with strong domain knowledge long before the acquisition process starts.
Get buy in from the seller’s team.
Especially in cases where you’re counting on the seller’s team, your team should interact extensively with the seller’s team before closing. This will help you determine if you like and trust them, and if they like and trust you. In addition, share your ideas about future for the business and listen to their ideas. Before closing, share the final post-acquisition plan, and see if they truly buy into it. They need to be eager to drive that plan.
Between 2008 and 2012, Rambus (NASDAQ: RMBS), a $300 million technology development & licensing firm, has been diversifying its business lines, adding two business units (lighting and security) to its core memory group. Altogether it has made about 20 acquisitions in the past four years, with five of them being operating businesses (as opposed to asset acquisitions). . They learned early on that a critical success factor for the successful integration of a new business is alignment with the seller’s management team on the go-forward business plan. Today Rambus works with the seller’s management team before closing, to develop an acquisition plan to be approved by the board to insure quick implementation and alignment from day one.
Prepare and attach golden handcuffs
Change is hard for everyone, and being acquired is a big change. As a part of the acquisition, retention packages are essential. They should include significant rewards not only for staying but also for achieving critical milestones. When the buyer is dependent on key players, the packages should be especially generous.
Minimize or delay antagonistic aspects of integration
To retain the seller’s team in the short term, it may make sense to postpone aspects of merger integration that they will view poorly. For example, while you could cut costs by merging the R&D labs, the irritation factor would be high.
Budget for learning-curve accelerators
Not having expertise about a business you are acquiring is always dangerous. If you haven’t added the “river guide” you need in the new domain before acquiring, do so as soon as you close. These industry “tutors” can help the core management team learn the business much more quickly—even if the seller’s team is committed to staying.
Think twice about buying a company in which you have little domain experience. If you do (and there are many good reasons why you should), be certain about the team you’re relying on and that they are enthusiastic about your vision for their company. Either way, learn your new industry as quickly as you can.
Having little domain experience is just one of a dozen identified acquisition risks. To read about the others, or to take an acquisition assessment, click here.
Subscribe to my quarterly newsletter, and check out my book, The Feel Of The Deal; How I Built A Company Through Acquisitions.
