Why Do Acquisitions Fail? Part 4 – Price Negotiation & Deal Structure

The success of an acquisition is rarely down to the price you pay according to the research. First the research: Cass Business School, concluded from detailed research covering 12,339 deals including 2917 acquisitions of distressed companies from 1984 to 2008 that price was not the determining factor for success but that post acquisition integration was the key. So, the research is really clear – post acquisition planning is critical. However, we see unnecessary mistakes being made at the crucial stage of negotiating the deal which feed into a flawed integration strategy. We call this Phase 4 in our playbook. It’s a dangerous phase because by the end of this phase you will have agreed a Letter of Intent (LOI) and be driving into due diligence.

Common Mistakes

1. Instead of remaining curious about the current performance of the target and auditing the signals, acquirers become lazy and miss signals.
2. Valuation models are constructed based purely on extrapolation of historical performance of the sellers.
3. Poor empathy is displayed in these advanced meetings leading to a lack of trust. For example, there is little appreciation of the workload on the seller to continue to supply information.
4. Meetings are poorly structured with loose agendas leading to mystery around next steps.
5. Instead of less stress as the process continues, all parties are feeling more stress and uncomfortable as the deal continues.
6. The roles of each acquisition team member are unclear leading to confusion on the seller side on who to deal with.
7. The acquirer has failed to establish the key shareholder objectives including price aspiration, leaving way too much mystery on the table heading into the LOI meetings.
8. The deal structure being considered does not reflect the reality of the post-acquisition plan. For example, in an extreme case, we’ve seen an the earn-out structure based on profits, despite the fact that the post-acquisition plan involves a complete integration of the target into the acquirer.
9. The acquirer fails to use questions to uncover the seller’s belief system on key emotional issues.
10. important details are not covered in the LOI meeting, relegating key commercial issues to the Sale & Purchase contract negotiations. Examples include, net asset adjustment process, definitions of debt, definitions of excess cash beyond the day to day needs of the business, worked examples of earn-out scenarios.

This a crucial stage of the M&A process. Don’t let the momentum of the deal push you into a decision you will regret later. You need to be constantly validating your investment thesis.

Better Way

1. 1. Continue to build a comprehensive picture of the target under your ownership. Are you stress testing your assumed go-to market plans, pricing policy, customer fit, cultural fit, customer assumptions, quality of the seller’s management team? Is this the target you thought it was when you first prioritized it?
   2. Buyers perceive value. Sellers aspire to price. Do you understand that aspiration? Is it possible that the sellers are hanging onto that crazy price paid for their competitor which was 10 times bigger and done two years ago?
      As the acquirer, does your valuation model forecast the profit and loss and cash flow of the seller covering the next three years under your ownership including the costs of rationalizing factories, investing in new product development, losing some customers, etc. etc. Acquisition success is measured not at closing but at least three years later when you have integrated the business (whatever level of integration made sense).
   3. Specifically, if you are acquiring a private company the key word for us is respect. This phase of the process should show to the sellers the type of people you are. Sellers are observing how you act under pressure. Are you staying relaxed, professional and courteous? The sellers are trying to run their business with limited bandwidth to deal with your numerous requests for answers. Sometimes a respite is required to allow the target to catch up with requests.
   4. Always maintain momentum at this stage. Clarify clear next steps on both sides. End meetings on a positive note. Confirm the achievements and set out where we are at in the overall process. Over communicate to the target’s deal team. On a little point of detail, be careful that the seller has a mandate in place to represent all shareholders (you don’t want Uncle Bill who owns 75% of the business to be unrepresented in key meetings)!
   5. An acquisition process should feel like a successful sales process, trying to close a large customer deal. Both sides should progressively feel better and better about the marriage.
   6. Introduce your acquisition team to the seller to ensure the other side understand roles. Who is the deal lead, who is the technical guru that needs to understand the technology, who is responsible for pulling together the financials.
   7. Every meeting is an opportunity to understand the seller’s motivation. Price is important but also aspirations for their employees, expectations on product roadmaps, ERP systems, expansion plans.
   8. We believe post-acquisition strategies should be considered as early as possible. By the final negotiation stage an acquirer should have a clear picture of how the target will operate under their ownership. This must inform value and deal structure.
   9. We are a huge fan of using questions to understand the other sides position on key points. What’s behind your belief that the business is worth $20m? Why is it so important to partner with Smith as a distributor? What promises have you made to staff if this deal proceeds? Why do you believe there is $2m of excess cash in the business that is not needed on Day1 post-acquisition?
   10. Ensure a comprehensive LOI agenda. It’s not fair to kick the can down the road on crucial commercial aspects of the T&Cs. We have 14 items on our agenda covering much more than just price. consider; updates since last meeting, assets covered, IP, key employees, bank guarantees, warranties, price & structure, earn-out examples, post-acquisition plan, due diligence process, exclusivity, strategy, timetable, NDAs.

In summary, it is essential to have a clear and well-defined negotiation strategy in place. Acquirers must price deals and structure them to account for the potential risks, but also the long-term value of the target company.

TPP is buy-side investment banking reimagined. We seamlessly become an extension of your team and integrate at all levels to add deep mergers & acquisitions into your business.

Ian@TPPBoston to arrange a conversation.