How to Overcome M&A Hurdles

Secrets to overcoming hurdles

There’s no secret. I often think about a slogan that says “Keep calm and carry on.” M&A is hard, but it's also fun and exciting because every single deal is extremely different. You have to expect the unexpected and things never go as planned.

You have to be flexible and agile as the deal moves forward. Having a playbook and looking at a formula or strategy that might have worked in a prior deal is a good way to kind of think about what might work in the next deal. But it's not often that easy. It does require a lot of thinking and improving and reassessing throughout the deal process. 

Staying focused and agile is really helpful. Also try not to be too emotional. Sometimes when a deal is dragging on or it's been going on for several months and you're in the heat of negotiations, it's hard not to get emotional.

But taking a step back and really assessing why you're doing the deal, what are your non-negotiables, thinking a little more about the deal thesis and the outcome you want really helps. 

As you get more deals under your belt, you start learning about what's a really big issue versus what's not. So it's all about experience. But keeping calm and carrying on is the slogan we use. 

Challenges in M&A

Most people think that large deals are the ones that are the hardest to do, but that’s not always the case. Because often, in larger deals, you do have more governance and processes and people with clear functional GNA roles that make it way easier. 

It’s often the smaller deals where there's so much more complexity. You have startups who have messy corporate histories and you often uncover a lot of landmines. And so when we're thinking about challenges, it really just depends on the company and their life cycle.

I often see a lot of issues on the tax side, especially when you have operations in several countries or states. Their sales tax and transfer taxes and things of that nature that often get overlooked by startups or companies that are still non public. Those issues tend to get compounded and there's often nine out of 10 times exposure on the tax side.

The other key area that we often see issues is on the HR side, especially in this current hybrid world where you have employees who might say that they stay in one state, but actually are traveling all over the world. It does create a lot of payroll regulation and exposure. 

We have also seen areas where there's not been clear employment agreements nor clear IP assignments. There might not even be an entity that has been formulated to hire those employees. So there's a lot that goes into just HR and tax. These are the two areas that we try to streamline earlier on in the process so we can see if there’s any potential red flags. 

Sometimes, there’s also contract issues. It’s where the company is very dependent on a couple of key vendors, understanding change of control mechanisms or any other interdependencies. But generally HR, tax, accounting, and often the GNA functions that are outsourced or there might not be someone that's truly dedicated within the startup, ends up being issues when you're doing diligence. And so we try to prioritize that. 

On the product side, I would say we spend a lot of time doing that diligence upfront as we approach LOI. And once we're comfortable, we enter into formal diligence where we spend more time on these GNA functions. But usually it's within these GNA roles that we often see issues now.

Timeline of challenges

Sometimes it's a surprise across the board, depending on what gets disclosed and at what period. We try to really prioritize our list because we have a sense of where there might be more work to be done or diligence that will take time for us to uncover. 

For example, on the tax side, there's a lot that goes into tax diligence. And so we often have a very detailed list that we would provide the target earlier on in the process, but it will take them several weeks to populate a data room with that material.

So even though the ask is not there, it takes them many weeks. And by the time we've had a chance to look through it and come up with our potential view on any exposures, it’s towards the tail end or middle of the diligence period. 

So some of these just diligence processes just take a long time, given they're pretty intricate. But oftentimes you try to front load as much as possible, but there's always things that come up throughout the process. 

We try to frontload where it matters and again, where we have less confidence in or where we've seen some of the initial diligence materials and we figure there's gonna be some potential issue. 

Complexities of smaller deals

Smaller companies are harder to get information from. Even just the way they do accounting, whether they're actually accounting for revenue correctly, and whether you can actually recognize that revenue once you acquire them. Those are basic things that you would want to check for when doing diligence. 

It comes up earlier on in the process, but it does take some time to think through and get all the materials from the target in order for you to assess that. But we do something called quality of earnings check just to make sure the way the company's thinking about revenue, the way they're accounting for it, the way the cash flows, all those things are vetted before we actually complete diligence. That process requires a lot of input from the target. 

Sometimes we do that in-house, depending on the size of the deal. If we have an accounting team that has the bandwidth and the experience, we would try to do it in-house for smaller acquisitions. For larger acquisitions it does make sense to include that as part of outsourcing to third party consultants, especially if you need proforma financial.  

The people-side is also often haphazardly done. They might not have mature HR policies in place. They might not be properly hiring an individual. They might be a contractor, but they're not really a contractor under law. And so we often find those types of challenges when we actually dig a little deeper to understand why folks are employed a certain way within a startup.

And I think a lot of times startups don't realize that they're actually creating exposure because of the way they're actually accounted for that employment of that individual. But when we actually dig into it a little deeper, we start uncovering a lot of these things and then we start putting together ways that we can potentially mitigate this.

• Is it exposure that we expect that’s gonna happen? 
• Do we need to move this contractor to a full-time equivalent? Because from a legal perspective, they're not really contractors. 

These are all things that get overlooked because from a startups perspective they just want the best talent and they want the best talent in fast. But they're not thinking about the proper processes and the rules when it comes to employment.

And it's compounding. It's very nuanced because it's per state. The longer the exposure is, the more it compounds. And some of these can be mitigated by going to the state and revealing that you’ve made a mistake and you need to change your employment. Other things are penalties that might be incurred. 

Handling people in a smaller company

This depends on the company and the culture of the company. There's definitely instances where there's a cultural gap and that creates an issue. We implemented something called a culture survey. 

Earlier on in the deal process, we really do an assessment of the culture of both companies. So we can just at least be mindful of where we think there might be cultural gaps. And we try to address that in the first 90 days post-acquisition. 

But I would say culture is a big part of that and as well as the founders and how much they believe in the business and the thesis of the combined business going forward. It also comes down to whether they see this as a successful exit or the company is losing money and they need it to exit and therefore hard to retain all the individuals at that point. It just depends on the overall ROI of that investment. 

Cultural assessment

Pre-close, we do a cultural assessment where we have a list of questions that we would want to get answered between the target and the acquirer so we can understand:

• What do they think about their employees?
• What matters most to them? p
• What's really important in terms of their day to day. 
• What events do they like to have? 
• How does a team communicate? 
• How does a team bond? 

Those types of things are really important to make sure we hone in and, and don't lose. But at the same time, you are bringing this target company to a new company altogether, so there is a mixing of cultures. 

We have to make sure there’s not a cultural gap that is so way off that it will be hard to achieve alignment. It's something that we try to focus on. If you don't have that, if they feel like it's a totally different company than they would wanna be a part of then it's really hard to retain that team. 

There's often surveys that we do post-close as well, the first 30, 60, 90 days to see how people are feeling about the deal. If they are seeing any conflict or any confusion so we can help remedy any of that stuff as soon as we see it. But it's often a delicate balance.

You have to enlist the founders and the key executives who are a part of the deal to help motivate their employees. Because at the end of the day, they're the most trusted folks within that company for that subset and that team. 

And so we really need to make sure they're on board and excited about joining and use that as the key to communicate and create that excitement for the rest of the team.

Culture ends up killing the deal

Culture can kill a deal. Sometimes you still would do the deal if everything else is positive. But understanding that culture is going to be a struggle. There are always challenges, especially when it's two very different companies with very different mindsets of how they wanna operate, different countries, languages, et cetera.

It just makes it very difficult. You need to find that middle ground between both sides early on so you can understand each other and communicate with each other. When you can't find that, or give the target company that level of attention earlier on, you will see them become detached. And often, the target company won't be as successful within the company going forward. 

And it’s also very different in tech. A lot of tech companies still operate like startups in some ways. They have a very tech-centric culture, A lot of perks, a lot of transparency. That makes it exciting for a lot of startups because they have that within their own business today.  

When you join a non-tech company, that's when it becomes a lot more difficult because there are more processes from the very top. There's a lot more layers, less transparency. It just makes it way more difficult to digest for a startup to come in.

Tax Issues

Issues are often not paying taxes or you are not profitable today so you feel like you don't need to  apply for any taxes, but you actually still do. You do have to pay payroll taxes or disclose your tax situation to those states. 

One of the biggest issues is that startups don't take taxes as seriously until they are profitable and not hiring the right folks to manage their taxes. But it is a big deal especially when they don't have the resources necessary to outsource third-parties. 

On the accounting side, most companies, especially small startups, are not audited. It always becomes more difficult because you need to vet through the numbers to make sure it's legit. And that takes a lot of time in diligence for us, especially when it might be a different business model, might be a different type of SaaS or, or hardware business or licensing business or whatever it might be.

You really need to absorb it and see where and how revenue should be accounted and whether it’s accounted for appropriately. You also need to review the cost.

• What's included in cost
• What's not? 
• Is it appropriate? 
• Is it in the right categories within the P&L? 

So there's a lot of work that goes into that and startups are not really focused on those nuances. Whereas for large companies it matters especially for a public company as we get audited and we need to consolidate our financials. It becomes more of an issue for us.

And then obviously being a public company, you have to have these SOCs compliant so there are other compliance related aspects to accounting that goes on to doing a deal that creates a lot more scrutiny than a typical startup might be used to.

But there's always a challenge regardless of the size, it's just the level of challenge that changes. 

HR issues

With larger deals it really comes down to making sure there's a clear transition. You might have a product team in a take team and all the GNA functions and they are all used to reporting straight up into their same organization structure. But that's not necessarily how it will work on your acquired business. So understanding why things will have to be spread out and reporting into different functions is something that the people will have to get used to.

Oftentimes in M&A, we might keep the team together for a period of time, but over time we would want them to report into their functional areas. So that's often a hard conversation to have when it comes to thinking about org structure and how all of that will work together. 

The other thing is compensation and ensuring people understand retention. Retaining talent is hard to do for any M&A deal. So making sure you have the right mechanisms in place to keep  the most relevant and most crucial folks in the company retained for a period of time is super important for us. So we would negotiate terms that would make sure we get those key employees. And usually, if we get the key employees, we can get the rest of the people. 

Besides employment related, the other challenges that we come across are classifications and culture.  That's where we spent the bulk of our time. Since Covid, we've been also dealing with hybrid versus not hybrid and coming into work or the culture of working at home. 

That's come up more and more and dealing with that and figuring out what makes the most sense for that startup is something that we've been assessing. But before that, we never really had too much of a challenge beyond those issues. 

Contractual Issues

We do legal reviews of key contracts as part of the deal process to see if there’s any that would need to get remediated or signed over prior to deal closing. A lot of times a company cannot function unless those key vendors or contracts are in place. 

And you never wanna be in a position where you're not sure whether that contract is something that could be handed over to the acquirer post deal. So we do spend a lot of time trying to understand that and getting comfortable with the risk. 

We really hone in on change in control provisions or assignments. That type of stuff gets done earlier on in the deal process. so we can figure out which ones to address between which period. Sometimes you might have a period between sign and close in order to address that as well. But those are the usual key issues in contracts. 

Sometimes there's also provisions and terms that might have agreed upon that as a public company, we would never have agreed to. So sometimes, it’s unwinding some of those contracts, which becomes tricky cuz those are lengthy and take time. 

And especially when you're coming in and trying to renegotiate something with a third party. It doesn't necessarily run on deal time. It runs on on their schedule and that can sometimes prolong a deal from closing.  

I had an incident like this many years ago. I was working on a deal involving a small startup that didn't invest enough in legal resources – a lesson for most startups. They signed a customer contract with a large commerce company, believing it to be a proof point for their business and platform. However, they didn't realize that the contract stated any work they did for this commerce company would essentially become the commerce company's intellectual property (IP) and not their own.

As a result, all the work they had done for the last year and a half was no longer their IP, and they hadn't understood the implications of what they had signed. They thought it meant something different but failed to read the language closely enough to understand that they were actually assigning over their IP and business.

During due diligence, we discovered this issue early on and had to find a way to renegotiate the contract on behalf of the target company anonymously. This was to ensure that we could reassign and change some of the provisions, allowing us to feel comfortable proceeding with the deal.

It was a very tricky process and took two months to renegotiate the contract, making the entire deal longer than anticipated. However, we ultimately had a favorable outcome, as we were able to renegotiate the terms and complete the deal.

Change of control and assignment

In most contracts that companies sign, particularly the larger ones, there might be a provision for change of control. This refers to what would happen to the contract if the company was acquired or changed owners.

• Would it supersede?
• Would it continue? 
• Would there need to be authorization to continue the contract?
• Do we need to strike a new one?
• Could it just be assigned without any type of change of control, allowing it to immediately transfer to the acquirer?

So those are the types of things we look for because if there is a change of control mechanism,

1. It might mean we might not have that key contract if we need to renegotiate it. 
2. We might not get the same terms either, especially when a third party vendor might see a larger company is acquiring a smaller company, and thinks they can ask for more money.

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That often becomes problematic because at the end of the day, no one wants to pay more for the same service. But oftentimes we have to get into a process of renegotiating those relationships and that becomes really time consuming and painful as part of the deal process.

Change of control is a crucial aspect of contracts, including other vendor agreements and even employment agreements. There are specific contracts that really matter when it comes to change of control, and you want to make sure you account for all of those things. For example, there might be provisions in employment agreements for accelerated vesting in a change of control scenario. This can be problematic if key executives get accelerated vesting and are no longer incentivized to continue working.

Therefore, it is essential to thoroughly review and understand contracts on both the people front and any critical contracts the company has regarding how they operate their business. This ensures that you can continue with business as usual going forward.

Risks Mitigation

There are a lot of different ways to mitigate risks. For startups, the best thing they can do is hire good lawyers and advisors. Having competent legal and tax professionals, and if possible, HR management is essential. Often, the CEO or founder wears many different hats but is not an expert in HR, taxes, payroll, or accounting. When they try to manage all these areas themselves, errors can occur.

For the acquirer, it's essential to focus on these key areas early in the deal process. Identifying potential issues early allows time to address them and develop solutions. Understanding these concerns early in the deal process also helps with integration planning.

Another helpful strategy is to establish a set of non-negotiables or principles agreed upon at the beginning of the deal. Referring to these principles during negotiations can clarify whether something is a deal-breaker or only perceived as such due to the ongoing process. A concern might be a deal-breaker for one cross-functional team, but not for the deal sponsor who wants to find a solution if the overall thesis still holds for the target company and deal. In such cases, it's crucial to navigate and find a solution or determine if the parties are willing to take on the risk.

There is usually a solution to most problems encountered. It's just a matter of deciding who bears the risk. Options can include increasing indemnity, extending the timeline for indemnity, or adjusting the purchase price. The key is to determine who is willing to bear the risk and proceed with the deal under the new terms.

Finding good lawyers

Referrals are a great way to find a good lawyer or advisor. I would always prefer a referral over a simple Google search. Startups should discuss with their board members and ask for recommendations. It's important to find someone with experience working with startups, dealing with contracts, and managing cap tables.

When filtering, I would want to know about their deal flow. Understand their deal sheet, who they've worked with, and the outcomes of those deals to see the companies they've represented and whether those companies have faced any issues or had successful exits. 

I would also consider the caliber of their talent – which law firms they come from. There are many independent advisors and law firms formed by professionals from larger law companies, and they are often more cost-effective.

Additionally, it's helpful to understand their current customer set. Are they advising a similar company in your space? Knowing that they understand your industry and how legal terms are negotiated within it provides more confidence. When negotiating cap tables or terms for your deal or fundraising, having someone experienced in your key segment is extremely important.

Integration planning

Integration is likely one of the most underrated functions within Corp Dev. It sometimes gets overlooked because it's the challenging part. It takes a lot of effort to integrate a business. However, it's a crucial component of M&A. At Toast, Square, and Yahoo, integration was part of our Corp Dev team and played an integral role in our deal process very early on.

We would involve the integration team from the very beginning, even before signing a term sheet. We would inform them about the deal, the important aspects, and the reasons behind it. They would then start shadowing us as we got into the deal process. 

Once we began due diligence, the integration team would join all our cross-functional diligence sessions, allowing them to hear and understand potential issues related to integration or areas where we would need an integration plan.

It's essential to have a dedicated person or team for post-close integration rather than assigning it as a side task. Having dedicated individuals handling integration can make or break a deal.

Integration planning vs hypothesis 

A lot of integration planning is done in collaboration with cross-functional teams. We use a method called blueprinting, where we outline the current state of the target for each function. 

• What would be the 30-day post-close? 
• Where do we want to be?
• Where do we need to be?
• How do we know what needs to get done by day-one readiness?
• What’s the long-term plan?
• Do we want to migrate ERP systems?
• Do we wanna migrate them into Workday?
• Do we want to move our salesforce entrance together?

All of these tasks cannot be completed on day one, but we'll have a viewpoint on where the company is currently, what is feasible within the first 30 days post-close, and where we want to end up.

We work closely with cross-functional teams post-close to hold them accountable for the first 30-day plan. After those 30 days, we start planning when the rest of the integration can be completed. 

Integration is a dynamic process, and not everything gets done on day one. As you acquire a business, you uncover new information, priorities change, and viewpoints shift. There might be ongoing processes within the company that no longer make sense for integration.

You have to be willing to adjust as new information arises. While you can have a clear idea of the current state and the first 30 days with the cross-functional teams prior to closing, the 60-90 and 180-day plans usually take more time and often get moved around quite a bit.

Integration planning goes beyond corporate development. We’re lucky enough we're at a bigger company where you can have cross-functional teams who are experienced that could come in and help out with diligence, but they are very much involved throughout the deal process as well as post-integration. They're the ones that make the integration happen.

And this continues to happen for many different quarters post acquisition. It’s not just something that happens for the first 30 days. 

No dedicated integration lead

Usually, when we do acquisitions, the acquirer side takes the lead in terms of integration, and we find a representative within each cross-functional role. For example, there might be someone responsible for accounting and tax. That person will be the liaison with our accounting and tax individuals. The same thing applies to the HR side.

We usually find the individual currently handling a specific function at the company to help us make decisions. Sometimes, however, there might not be anyone available to fill that role, and they are fully reliant on us to determine the best plan. In such cases, we usually work with the founder to decide the best approach, but we would take more responsibility in determining the best end state.

You have to get into the details. A really good integration leader is someone who can delve into the details, has seen integrations happen before and knows where they've failed, but can also help keep the teams motivated and accountable. If we say we will do something post-close and then get busy and don't prioritize it, the integration doesn't happen. Oftentimes, that can hinder the business and the deal's success.

We spend a lot of time making sure we are meeting regularly with our cross-functional leads and also using tools like scorecards, where we measure the success of the deal. We have clear KPIs that we're tracking and reporting upwards. So when something falls through the cracks, we quickly address it and make sure we try to keep things on track going forward.

You have to set KPIs which you will be accountable for the deal pre-closed. And by the time we close the deal, we start tracking that. 

Principles of doing deals

So there are different principles we use. And if one of these principles is no longer is true, we will reconsider the deal.

First is the deal thesis. The deal thesis and why you're doing the acquisition. If during diligence something changes and that deal thesis no longer holds true, then we reassess whether it makes sense to continue. 

Next is the financial profile of the business or the health of the business. If we uncover that the business is not as healthy as we had expected, they're losing customers or churn is higher than we expected, or we don't think we can cross-sell or there might not be synergies, then we reassess whether it makes sense to do the deal or maybe it makes sense to do the deal, but at a lower valuation. 

Finally, there's the team. Without the team, you cannot do the deal. At the end of the day, you need continuity post-acquisition, at least for a period of time. And so if you acquire a business and the majority of the team leaves, you're going to have a really unsuccessful deal. 

Ensuring the founders are on board or the CEO, and then a good portion of the team is willing to sign offer letters and join the company post-close is really important. Getting ahead of this is something that we like to ensure as well. 

If for whatever reason we cannot get the team on board, we probably wouldn't proceed with the deal because it will basically mean that we're going to have to inherit a company, the infrastructure, and then rehire and retrain folks to start working and inheriting that business and P&L, which is often hard and impossible to do.

Non-negotiables

Those are our non-negotiables or principles that we end up using for the deal thesis. So, these are things that we don't want to bend on. I think writing them down earlier on in the process is really helpful and healthy.

Because oftentimes, if the deal prolongs, you forget about the non-negotiables.  You're just trying to get the deal done at some point and willing to knock down an issue and then move things forward. 

But when you actually look back at the things that we said we would not negotiate, yet we're at the table negotiating that, you need to reassess whether we should be doing that or not. Having it written down and having clarity with the deal sponsor about what is really important and what we can't bend on really helps bring a little light into the negotiations and helps you figure out a path forward.

Sometimes there's no path forward. And you just decide this deal's not worth doing. Other times, you're willing to bend even though it's a non-negotiable because, at the end of the day, you still think the business is a great business to acquire. And we might have to find a different way to remediate the risk, but it helps us at least alleviate some of the concerns and also enables us to be a little accountable when we're thinking about acquisitions.

Non-negotiables could include things like whether acquiring the business would harm our current operations, such as putting us in harm's way from a regulatory aspect, or impacting our accounting structure or the way the rest of the company operates. We have to be really detailed and consider anything that could be really impactful to our current business. This often comes up in larger deals, where there might be more significant consequences.

Another example is a principle, such as if the company engaged in fraudulent activities. We don't want to associate ourselves with a company involved in fraud, as it would reflect poorly on our business. We also don't want to associate with companies that have been negligent or engaged in other unethical behavior.

From the people side, if we feel someone is not behaving ethically, that's a non-negotiable for us too. If they lied about something in the diligence process and we uncovered it, that's something we would likely address with the founder or the CEO. If we can't reach a resolution, we would not proceed with the deal. So, non-negotiables are things that are really impactful and can hinder the company post-acquisition.

If it’s a small deal and its more straightforward, it’s a lot easier to think about your non-negotiables. If it's something where it's a larger deal for which we got comfortable, then we would align with it with the deal sponsor and make sure we're in agreement.

Because it enables us to be in a position where we can negotiate where it matters. If we are willing to bend on certain areas, it enables us to negotiate better versus other areas that we know are non-negotiable, that we're not willing to trade on.

Dealing with issues

It’s more of an art than a science on how you deal with these issues. You have to remember, at the end of the day, the founder or the CEO might have been building this company for many years, and this is their life's work.

When you find issues and need to address them, you should be empathetic. You can't just go in and list out a bunch of issues and then leave them to think about it for days on end. You need to be tactical, direct, and often rip the band-aid off at the very beginning, but also be transparent about it. Be collaborative and help them find a solution. Letting the CEO or the founders dwell on problems is often a recipe for disaster.

Additionally, you want to make sure you're fully bulletproof when you actually present an issue to the target company. Sometimes it might be our misunderstanding, or it might just be a mistake in how we comprehended something. 

When we discuss issues with the company, we want to make sure we have bulletproof evidence that the issue exists. Then, present it in a way that helps them understand there are options. It just means that we're going to have to think about the risk a little more and potentially consider ways to mitigate it, whether it be through indemnity, purchase price reduction, or something else altogether.

We'll consult with our sponsors and executives to make sure we're all on the same page. Ultimately, we often find a solution. It's really about risk balancing: who bears the risk? How much are you paying for this company? If you're paying top dollar and a high premium, then your expectation is to acquire a very clean company.

However, if the company ends up being messy with a lot of exposure, then you're not willing to pay the same price. In this case, you need to have those conversations but be collaborative about it. Explain why, help them understand, and work together to figure out a solution.

Interestingly enough, when you're deep into the deal process, a company is usually quite invested in the deal at that point and is willing to work with you to resolve the issues.

Surprise Issues

I've encountered various issues in deals, such as intellectual property assignments where the IP is not owned by the company. Understanding that and working with the company to untangle the issue was something I dealt with in a deal a couple of years back. 

In another acquisition I was working on, the company had publicly stated something about their platform, which was key to their marketing strategy. After conducting due diligence, we realized their claims were absolutely false.

When we approached the CEO about it, they twisted the language in their favor and tried to sweep it under the rug. It became very clear that this was an issue of ethics rather than a simple misunderstanding. We ultimately decided to walk away from the deal, partly because of the company's ethics.

In other deals, we discovered significant tax exposure, which led to complex indemnity negotiations. The tax exposure was 50% of the purchase price. It was crazy. I've also worked on a deal where the target company didn't have signed contracts with their top three vendors. Everything was done through handshakes, which is risky because those agreements may not hold up after the acquisition. We had to renegotiate all of their key contracts before closing the deal, which was a challenging task.

These situations often arise when a company has been growing rapidly, and their paperwork becomes messy. Unfortunately, that messy paperwork gets inherited by the acquirer, so it's crucial to do thorough due diligence and remedy these issues either before or after closing the deal.