.jpg)
Engaging in M&A activities just for the sake of doing them is one of the biggest reasons for failed deals. Without a well-defined purpose, these transactions can distract the business and waste massive amounts of resources. In this article, Baljit Singh, Corporate Development Leader, discusses the importance of strategic alignment between M&A and corporate strategy.
“M&A is not something that is done artificially. It has to be tied back to the corporate strategy and not the business unit strategy.” - Baljit Singh
Corporate strategy vs M&A strategy
Corporate strategy is the top-level strategy which sets the direction for the company as to where it wants to be in the long term. It could be price or cost-centric, or it could be product differentiation-centric. M&A strategy is simply finding the gaps that the company has in its capabilities, and executing on those. The thing of most importance in M&A strategy is they should always support the top-level strategy. If the strategy starts with the M&A team, that is not true corporate strategy. It has to start from the CEO, CFO, and business units.
Capital allocation
For any company to grow, they need capital injection, whether it is for R&D, sales, or anything in between. At the beginning of the year, each business unit gets their own revenue target and is told how much they can spend to achieve that target revenue. There are instances where business unit leaders might look at M&A as a way to spend their budget.
However, there must be no clear-cut budget for M&A. Companies must rationalize it as opportunities come up. If there are four business units, it doesn't mean that each one gets to do one transaction every year. It could be forcing those business units to think that they need to do one transaction in their space because they have some budget for it. And that's not the best way to do it. The best way to manage capital allocation is to look at them collectively.
Measuring business unit’s success
There are different metrics to measure performance, especially when evaluating a company, projecting its financials, and considering methods like DCF and multiples.
IRR (Internal rate of return) is a good way to do it. From a pure finance perspective, IRR is the discount rate at which the future value becomes zero. An IRR clearly has to be significantly higher than the cost of capital for the company. Otherwise, it doesn't make sense and will be dilutive.
The easiest way to hold a company or a business unit, with a P&L, accountable is to focus on the things they have direct control over, such as revenue and direct costs. If there are two business units, one with a stable line of business and the other with high fluctuation, the high fluctuation business should account for the higher IRR.