10 Things in M&A that are too good to be true

One of the things I love about M&A is the incredible complexity and diversity of issues and challenges you face in a very short and accelerated time frame. So it’s not surprising that dealmakers often encounter issues and subjects where you can’t get to certainty and need to make educated estimates, guesstimates and projections. However, in my experience there are simplifying assumptions that are almost always wrong. Whenever I see one, it’s a red flag that someone is being optimistic or unrealistic about the likely outcome. Here are a few…..

1. The entrepreneurial founder will stay. There are certainly exceptions but as a general matter, when you had a lifelong (and successful) entrepreneur, life-changing amounts of money, the last thing they want to do is join a large corporate (or a PE-backed pressure cooker) and fill out TPS cover sheets. The universe has just told them that they’re good at starting and growing businesses and the most likely outcome is that they will tire of your bureaucracy and either leave to start a new company or head to Montana to perfect their fly fishing. Sometimes they know they’re not staying long (but tell you what you want to hear) and sometimes they’ve deluded themselves into believing they’ll be happy as a cog when they’re used to being the machine. Either way, if you don’t have a clear succession plan for them, you’re likely to face a rough road.
2. Synergies will roll out on time and at plan. Setting aside the adverse incentive on almost everyone’s part to overstate synergies to drive deal approval, integration plans and the embedded synergies never roll out as you expect. To paraphrase Helmuth von Moltke (don’t we all quote Prussian military commanders?) no integration plan survives first contact with the acquired business. Whether it’s undiscovered facts from diligence, or unexpected human behavior (see the quitting of the founder above) synergies never roll out as expected, and usually unforeseen delays versus benefits. I’m not saying you need to sandbag your projections, although I would, but that you should at least plan for speed bumps and have resources available, and expectations set to deal with them.
3. Pro Forma EBITDA accurately strips costs. I have never seen a seller who under-adjusted EBITDA. This is not to say that adjustments are all fraudulent but certainly many are disingenuous. Look carefully at any adjustment that isn’t absolutely clearly not related to the operation of the business and reverse it in your own model. Sure, if the founder has been running her house rental and country club membership through the company that’s a reasonable adjustment. But on the other hand, has the founder been paying herself a market rate or are you going to have to pay her successor more?
4. The buyer GM is prepared for integration. This one has a notable exception. There are a few business GMs who are veterans of a number of integrations – most likely in companies whose core long term strategy is to grow through acquisition. But unless your GM has done deals repeatedly and recently, you can count on them to underestimate their level of effort and commitment to integrate. Integrating a business is both more complex and different from running a business. You have to drive a whole bunch of change in both the acquired and receiving business very rapidly. Few GMs internalize the effort until they are on the field of battle.
5. Your diligence is thorough. The information asymmetry between buyer and seller is massive and the seller has lots of adverse incentives to either not share, or sugar coat, facts about their business. There are tools to help minimize your information gap as a buyer including pre-existing ecosystem relationships with the seller, outside vendors, a well-staffed diligence team and a well-run diligence process. But even the best acquiror will miss things in diligence and needs to plan for those surprises both in terms of resourcing the ‘absorbing business’ and building some leeway (another sandbag – they’re adding up) into the financial projections.
6. NDAs are a source of critical protection. As an ex-lawyer I find this one particularly frustrating. Non-lawyers tend to radically over-value the protection afforded by an NDA. First, they generally don’t read them so assume that identifying and then prosecuting breaches of an NDA is easily done. Not the case. They also assume that NDAs provide strong protection against someone simply knowing things (ie. not sharing but internalizing the information which then informs their own actions). They don’t. I’m not saying don’t get an NDA but weigh the real benefit of one against the cost (many large buyers hesitate to sign them early and may rather walk away from your deal).
7. Corporate development officers are in-house I-bankers. There’s a radical difference between the roles and skills of CD and investment bankers. Investment bankers are selling a service and have a natural (and obvious) adverse incentive toward making a deal happen. They only get paid if the deal happens, and if it fails to deliver on it’s promise they are not directly impacted (maybe only in brand and only if the client blames them). The corporate development officer is a fiduciary and lives with the deal post-closing. They are generally not incentivized based on deal flow and so are at least somewhat more likely to be risk averse about bad deals. While investment bankers might advise on issues like integration and diligence, they are at best chickens (engaged but not committed) to those processes while corporate development officers are usually pigs (committed). For those that don’t know the reference – chickens are engaged in breakfast; pigs are committed.
8. We can make this move quickly. M&A is a lot like house renovation. Many people involved with interlocking responsibilities and interdependent workflows and timeframes. Unexpected delays and challenges always loom once you pull back the drywall. In both cases there is a lot of pressure to accelerate the timeframe and the vendors have an incentive to over-promise and then deliver the bad news about delays in the midst of the process once the owners are pot-committed. This doesn’t mean you should heavily sandbag your timelines and take the pressure off. But as the owner you’d be wise to have contingency plans in place for inevitable delays.
9. We will just activate our sales organization to accelerate revenue. As my friends in sales leadership will attest to, there’s often a tendency to assume that sales is a ‘coin operated’ funnel that can be turned on and off. When you assume your sales organization will seamlessly, instantly and painlessly adopt a new offering, you are bound to be disappointed. While sales organizations can and do sell multiple offerings, it’s not an infinite capacity machine. Every new offering both requires training of the sales team and by definition dilutes focus on other offerings. There’s no magic ‘breaking point’ but every new acquisition brings greater pressure if it’s dumped into the same sales funnel. This doesn’t mean you can’t add to your sales portfolio but expect you will need to invest in training and maybe even capacity expansion. Also recognize the greater the differences between the new and existing offerings (problem solved, pricing model, implementation process, etc.) the greater these investments will need to be. Sales friends…. you’re welcome.
10. Highest price wins the auction. I guess this is true if you’re buying a Matisse at Christies or a Led Zepplin vinyl on eBay. But particularly for non-financial sellers, there are a myriad of other variables that impact who wins an auction. Many sellers care about things like the fate of their brand, the care of their employees, their own role post-close and even the way the sale is presented publicly. Failure to recognize those non-price values can lead you to lose an auction (or win but overpay).

What did I miss? Add to my list in the comments.