How to Validate the Deal Thesis To Ensure M&A Success

The Yahoo! acquisition

That deal was a rollercoaster, probably one of the most memorable and high-profile deals I've worked on. It started as the first project I was thrown into when I joined Verizon's Corp Dev team, as they were making a big push into digital media and ad tech. 

Inclusive of Yahoo, they spent nearly $10 billion to enter this space. With the acquisition of Yahoo, they effectively became the third-largest online ad network, behind Google and Facebook at the time, reaching about a billion consumers.

That deal was their way to monetize and capture some of the value flowing through their network. It was a competitive auction process initiated by one of their activist investors, Starboard, which pushed to separate Yahoo's core operating business from its equity investments in Alibaba and Yahoo Japan.

At that time, Yahoo owned about 15 percent of Alibaba and 35 percent of Yahoo Japan. It was a unique situation because the value of the company's core operations was less than the value of its equity holdings. 

The acquisition ultimately came in at a $5 billion purchase price, roughly $4.5 billion, while the equity stakes were worth $40 billion. You could think of Yahoo, before it was sold, as a tracking stock for these public equities.

It was a complex, global business with many different product lines—advertising, subscription, commerce, first-party, and third-party media—completely different from what Verizon had been operating in. 

The business was doing about $5 billion in top-line revenue, declining in low single digits but still profitable, with a lot of potential operating leverage. During the auction, aside from a few strategics, several other financial sponsors were involved, seeing the potential to increase cash flow and generate a return.

It was a very high-profile deal, as you mentioned. It felt like, at each step, details were being leaked. We'd work on something, and the next day, it would appear on Bloomberg. Ultimately, after a few rounds, Verizon came out on top due to the strategic value they saw in the business.

There were several curveballs that made it notable. For instance, between signing and closing, the deal was going through antitrust review, and then it was announced that Yahoo had experienced the largest data breach of all time, affecting over a billion accounts from hacks back in 2013 and 2014, which was only revealed much later. 

The SEC even investigated why it took so long to disclose. There was also a planned reset of 500 million accounts. We had concerns about whether to move forward with the deal, ran the analysis on what it might mean for the business, and eventually negotiated a $350 million discount. Still, we proceeded, believing the thesis remained valid.

Once the deal went through, a lot happened. The world changed dramatically, especially in advertising, with more regulation and competition. GDPR came in, and this was before TikTok, which further changed the ad landscape. Amazon ads were just starting, and it became more difficult to hold consumer attention, which the business was contingent on. 

There were delays in integration, which affected capturing synergies, but we managed to achieve significant cost synergies, though less so on the revenue side. It was a really dynamic situation.

This was one of two case studies at the time. AT&T, another telecom company, also made a big foray into media, acquiring Time Warner for $80 billion. We all know how it ended a few years later, with both Verizon and AT&T spinning off their media assets for roughly half of what they paid. 

So, that's the long and short of what happened. It was definitely a rollercoaster of a deal.

The importance of validating the deal thesis

Validating the deal thesis is incredibly important. It's helpful to have clarity on what you're looking for in an acquisition going into it. But before discussing the deal thesis, there are two key ingredients that I see as foundational: your strategy and your alternatives.

First, regarding strategy, it's about where to play and how to win. 

• Where are you deciding to focus? 
• How do you plan to execute against it? 
• Who's your target market? 
• What are your capabilities and customers? 

Understanding these factors helps determine how to use M&A as a tool. It's one of many alternatives, fitting into the traditional "build, buy, or partner" framework.

Once you have a clear strategy, you can pursue specific targets and think about validating the deal thesis itself. 

That may seem obvious, but M&A can sometimes be opportunistic and occur when you're not fully prepared, or the target isn't perfect. Sometimes, the ideal target may not even exist, so it's crucial to be clear on what you're aiming to acquire and why before starting.

I'd emphasize that it's important to validate the deal thesis to avoid problems where the rationale behind the acquisition is only half-formed. You don't want to try to fit a square peg into a round hole, so to speak, when the acquisition doesn't tick all the necessary boxes.

It comes down to whether this is the right path among all other options. Are we doing this because we can't build it ourselves? Or because we couldn't find a suitable partner? When you think about the other options, it often boils down to speed, capability, and the ability to build.

In companies I've worked at, there's sometimes a bias toward believing we can build everything, leading to not doing M&A. Or, you might realize you can't build it, but you've already passed on other targets that are now too expensive, forcing you to build it yourself anyway.

Understanding the strategy and alternatives early on positions you to validate the deal thesis effectively and determine if it makes sense in the current context.

The timing aspect matters too, because sometimes you're asked, "Hey, we're trying to fill a capability gap. Let's go and acquire something." But sometimes that specific capability doesn't exist in the form of a target available at the right price, for various reasons. Making those things align doesn't always happen. 

So, when opportunistic deals come up, you need a clear framework to determine why this makes sense versus trying to force it to make sense.

We'd use a framework like this because if an opportunity arises at any time, you can evaluate it and decide if it's the right time or if there are reasons why it isn't a good strategic fit.

When we think about validating the deal thesis, it's really about targeted diligence and clearly understanding the value drivers of a deal. There are usually three to five key factors that matter in a deal. If you're clear about what those are, you can validate whether the target makes sense or not.

It varies depending on the deal. Even at places like PayPal and others where I've worked, it depends on the business unit you're working for and the specific capability you're looking to acquire. The value drivers are different for each case.

The risks of rushing M&A deals without proper alignment

What happens when you don't focus on validating the deal thesis and just push deals through? It goes back to two things. One is understanding the role of corporate development. Often, people equate corporate development with M&A, but more broadly, we should be seen as one of many alternatives for achieving strategic outcomes. 

M&A might be one answer, but it's not the only one, and we shouldn't push for M&A to always be the solution. When deals go wrong, it's often because there's no clear accountability for who will own the business post-close. It shouldn't be corporate development; it's not going to be us. 

Even if we want to do a deal, whether it succeeds or fails is not just in corporate development's hands—it's in partnership with the rest of the organization. 

Problems arise when you do a deal just for the sake of it, trying to fix a gap or solve short-term issues without long-term ownership.

We shouldn't sign term sheets or move forward with a deal without that internal alignment. That's a critical part of the job.

I can point to several examples from my career where companies pushed deals through without proper consideration—without naming names, of course—but when that happens, you face issues post-close. There are often questions about how much continued investment the deal will receive. You can't just acquire something and then starve it of resources.

There's also the issue of prioritization and ownership. Whose business unit does it fall under? Were they a willing participant? Now that it’s part of their P&L, the business unit owner will be accountable for it. 

Do they have control over it? Do they even understand what they’ve taken on and where it fits within their overall strategy, or was it just a pet project? All these factors determine post-close success or failure, even if you push a deal through.

How to effectively validate a deal thesis

Once you have identified the three to five value drivers—the reasons why you're doing the deal and what is core to making it successful—that's where you should focus 90 percent of your diligence. 

For example, typical value drivers for a deal might include people, product, technology, sales team, user base, regulatory considerations, licenses, etc.

Depending on the value drivers, you need to involve the right internal people who are experts in the space and who will own the process, including what the future integration might look like. You need a hypothesis on how the acquisition will fit into the business. 

If the people are a key value driver, then you have to consider how you will retain them. Are they a fit? For example, if you're looking at engineers, do they code in the same language? Did they build in the same way? What does their architecture look like? 

You need to bring in your technical team to assess this and look into factors like historical retention and attrition to understand how they might fit in.

On the product and technology side, a big value driver might be acquiring a business for its product. If you're a large corporation considering buying a small, subscale startup to cross-sell its products into your user base. That sounds great in theory, but you should validate that. 

You can often do this early on without an M&A process. You might partner with them first to see if the thesis holds—if your user base picks up the product on a white-label basis, for example.

Then consider how difficult integration will be. You need to dig into their tech stack and architecture to understand the integration effort compared to your systems. You must have a clear idea of what you're looking for and dig into these aspects to see if they make sense and hold up.

Also, consider the alternatives. In a large company, if something is important enough, capital can be allocated to build it internally. The reason to acquire instead is usually unique domain expertise and faster market entry, which you wouldn't achieve otherwise. 

You want to validate whether it is truly faster and whether the benefits will hold up. You should do as much upfront work as possible to validate the deal thesis.

To me, they're one and the same as diligence. There are parts of diligence that are more operational, figuring out how the company will integrate into yours—what systems they use, benefits, compensation, and onboarding processes. 

That can also be part of the key value drivers. But the question goes back to what you're diligencing for and what the objective is. When you have a short timeframe to perform diligence, say four to eight weeks, you need to prioritize. 

You have to focus your internal resources as well as those of the target company, which is often a smaller startup that can be overwhelmed by the large company’s many questions. You need to determine where to focus your resources and what will move the needle, how you can plan for integration, and validate these aspects.

Example

Let's say you're acquiring a company because they have interesting technology and good people. Simple enough. For the technology, even upfront, before you have a letter of intent (LOI) or anything, you should figure out if the tech stack is compatible with yours. 

• Are they even writing in the same code? 
• How easy is it to port over? 
• Are they using the same cloud services? 

All these questions are crucial when evaluating tech. You need to assess upfront how automated their processes are compared to yours and what kind of effort it would take to integrate their systems into yours. 

Typically, they might have more lax information security protocols than you do. You also have to ensure their products haven't been breached or compromised.

There are several things you need to check to determine if the tech is viable, and a lot of that can be done upfront. If it passes initial scrutiny, then you can go deeper after the LOI is signed.

On the people's side, you can interview a few key individuals to gauge the quality of talent. Ideally, the leaders should represent the overall quality of the organization. By interviewing a few people, you can get a sense of whether they would fit in, if they have reasonable compensation expectations, and if you can make a compelling offer that they would accept.

You can do much of this pre-LOI to set the stage for the next phase of diligence, where you go deeper to validate these key value drivers and also check everything else: Is it a clean company? Do the financials make sense? And so on.

It then goes back to the value drivers. If the main value drivers are technology and talent, and we've validated that both are strong, then we need to determine what it's worth to us and how much we're willing to pay. This involves a financial analysis to assess their worth to us, any synergies, and ultimately, to put a value on this deal that could lead to an LOI.

Once you have alignment with the other side—that this is compelling enough to move forward—you then begin the diligence process to understand more deeply all the aspects beyond what was initially assessed. This includes planning for integration and addressing any additional functions necessary to make the deal a reality.

Before the LOI, you're doing a sanity check to ensure there's alignment on the key value drivers and the value you'd be willing to pay. If those two things align, you move to the next stage. 

The goal of the pre-LOI phase is to do as little work as possible to validate the hypothesis and then enter into a more exclusive process with the other party, where you can invest more resources to cover everything needed.

For engineers to evaluate effectively, they need to have discussions with the other side. There will be back and forth and various requests. So, we’re less concerned about whether they use Google Docs or Microsoft Teams. 

What really matters is the core product itself—whether it does what they claim, if it's scalable, and if it fits within our systems. That’s what we care about. It might take one conversation or several, depending on the depth required and whether we're asking the right questions from the start.

And it also depends on the other side. Sometimes, in a targeted process, they might only want to talk to us and not open up their entire management team, which can make diligence more challenging. If it's a more open process, allowing us to talk to many people, it makes it easier.

Risks of not validating the deal thesis

Kison: I remember talking to someone at a company who mentioned that their business acquired several different tech products, but they weren't integrated into a single platform as planned. They were on completely different tech stacks, which resulted in a terrible experience for the customer. Is that an example of not validating the deal thesis?

Jann Lau: Yes, possibly. It might have been the intention from the beginning, but it comes down to where it stood in post-close prioritization. Were resources dedicated to it? Did it make it up the priority list?

Every year, companies have to prioritize their limited engineering resources and teams to keep the business running, work on new products and innovation, and integrate any acquisitions. 

Sometimes, integration doesn't get prioritized above these other things and is left on the sidelines until someone realizes a few years later, "Hey, what are we doing with those acquisitions? They're not providing the value we expected." That's when companies consider divestitures and other actions.

In your example, they intended to integrate but didn't. In other cases, companies acquire a business and intentionally leave it alone until they decide to do something with it.

Typically, you want to bring on the customers, but you also have to consider what's required to enable and monetize those customers. A simple example would be Facebook acquiring Instagram. 

Instagram had a unique technology, but its real uniqueness was in the virality and network it built. The technology itself wasn't hard to replicate—others have done it—but the "lightning in a bottle" effect was what Facebook wanted. They put all their advertising and monetization efforts behind Instagram to make money from it. 

That's a familiar example where the customer base is valuable, but it's captured within the app and its technology.

Crafting a deal thesis

The deal thesis is essentially a succinct explanation of why we should pursue the deal. It should also include reasons why we might not want to proceed and what the plan is for the deal. This needs to be articulated at various stages, and formally presented.

Right from the start, before even engaging, you should have a rough idea of the deal thesis. This should remain consistent but can be updated based on what you find during diligence. 

Sometimes, you may start with five key points, but after some diligence, you realize only two are really critical, and the others aren't as relevant for the target company. 

The thesis evolves, and you need to get approvals at each step of the way, potentially all the way up to the board, depending on the deal's size and scope.

It's a simple articulation of why to proceed with the deal, balanced with reasons against it. The recommendation is to move forward if the pros outweigh the cons.

It should be short. If it's a memo, it shouldn't be more than five to ten pages. If it's a presentation, up to twenty slides, max. Keep it concise.

You would start with, "Here's our investment thesis. This is why we want to buy this company. They have unique technology that would accelerate our roadmap and allow us to bring new product Z to market faster, thereby generating revenue sooner."

You would provide context, share what was found during diligence, outline key next steps, and detail your integration plan—all of that should be clearly laid out. 

You include details about their technology, how it fits into our ecosystem, the integration approach, and timelines, and potentially even details on where people will sit after the merger and how you plan to integrate the companies. 

You should outline as much as possible in detail, ideally before signing, to the extent you can. 

If we plan to eliminate all their sales and marketing because it's a small company with only $1 million in revenue and we're really after their technology, we'd be transparent about that. It’s important to be transparent, not only internally but also with the other side. A lack of transparency can cause issues post-close if there's a misunderstanding about the future of the business.

Being on the same page with the target is beneficial. You can say, "Here's what we'll do with your company post-close. As the CEO, management team, and board, you're agreeing to this plan. If we're aligned with this vision, all deal economics, incentives, and plans will be aligned because we've agreed upfront."

If relevant, we reference compensation there. Valuation is a key component, and a crucial question is why we are paying what we think we’re paying. How much of the synergies are we giving away versus keeping for ourselves? All of this should be part of the deal thesis.

We have to formally present this. The CEO often presents to the board, or sometimes there's an M&A committee, which is a subset of the board, depending on the deal size.

Pitching the deal thesis

Validating the deal thesis is so important. The reasons for doing the deal shouldn't be in isolation. They should connect to the overall strategy and alternatives considered. 

You have to set the context: here's the situation with this deal, why we're doing it, and the other options we considered that led us to decide this is the best path forward to achieve our goals.

That's the general storyline around why this makes sense, and the validation work we've done to prove it. If the story is compelling and all the boxes are checked, then ideally, the deal accelerates your business, advances your roadmap, and builds shareholder value.

The "bad guy" is the counterargument to why we should do the deal. It's essential to outline both why we should and shouldn't do a deal. The bad guy is the opposing side, highlighting potential downsides or risks. 

You need to frame the story by saying, "For all these reasons, this is a great move, but for these reasons, it might not be." Looking at the whole picture, if we still believe it's a good move, we proceed with eyes wide open.

We acknowledge there could be risks, but we also present how we've thought about those risks and what mitigations we can implement. If we can't explain or justify the risks, then that's a problem—an unsolvable bad guy in the story.

From a distance, we see the promised land, and we have a vision of getting there by building a giant boat and crossing a massive sea. But there will be challenges—the boat may fall apart, or we might run out of food, but we believe we can grow a sustainable farm on the boat to keep everyone alive until we reach the promised land. 

There are always ways to address the challenges and manage the risks to reach the endpoint. It's not just about identifying risks; it's about having a plan to manage them to succeed.

Integration as a deal driver

At the end of the day, Corporate Development is really one team between the deal side and the integration side, because that's what's needed to make a deal successful. But execution is where it gets tricky.

It comes down to recognizing the handoff between the deal side and the integration side, making it seamless, and ensuring everyone understands that value is created after the deal closes, not just when it's signed. You need to understand the steps to capture and realize all the value drivers we've discussed.

For example, if a value driver is technology, you want to acquire that technology to unlock a market or accelerate development. You measure your success by your ability to meet those milestones. 

If you could have built a product in 24 months but acquiring it allows you to launch in 12 months, you're capturing that acceleration. Whether the deal is successful hinges on fulfilling that promise.

As part of integration planning, you must determine what is needed to hit that 12-month timeline after the deal closes. You need the right people in the room and ensure it's prioritized and adequately invested in. A common issue I've seen is not having the right people involved or failing to include everyone needed post-close.

You have to bring everyone in early, help them understand the deal, and ensure there are investments to support it. If you need additional headcount beyond the current team to execute post-close, your sales team should be involved. It comes down to the tactics. 

If you're bringing in new technology and plan to cross-sell it, your sales team needs the right collateral and training to hit the ground running. They need to understand the gaps the acquired company fills and how to sell it effectively.

All these details need to be meticulously planned and executed. Integration planning is about getting down to the details and ensuring flawless execution.

Celebrating the integration is a company to company basis. You don’t hear it as much. Corp dev tracks the success of it. There’s a window within which we track the deal. And then after a certain point, it becomes BAU part of the business. You’re probably not hearing it because at that point, we’re not tracking it anymore, and track what happens within a few year window after it closes.

Who takes the blame in corporate development for a bad deal?

In Corporate Development, personally, not specifically, I've been in that role where there were repercussions for doing a bad deal. That's mainly because making a deal successful involves so many people. It wouldn't be fair to pin it all on Corporate Development alone. 

However, depending on the aspects of the deal, particularly around deal point negotiations, there could be some validity in assigning responsibility.

If it's a significant deal point, it usually isn't just Corporate Development making that decision unilaterally. 

It's typically part of a deal sponsor's role to agree and say, "That sounds good, let's do that," rather than Corporate Development acting in isolation and making up terms just to get the deal done. 

That's when you run into trouble, and that's when it might be more fair to blame Corporate Development or a specific person involved.

Key questions to nail down your deal thesis

It helps to be aligned with the eventual deal sponsor on what exactly they're looking for in a target or capability. It's up to you to source and identify the right target, but you need a clear understanding of whether you have the right filters in place. 

Are you clear on what you're looking for? This allows you to validate the deal thesis effectively, rather than bringing in targets that only vaguely meet the criteria for a deal.

Having a solid understanding upfront of what the ideal deal looks like is crucial. Get that filter right from the beginning.

But nothing ever fits perfectly. So, you get as close as you can. That's where the decision-making comes in. If a target fits 90 percent of what you're looking for, or even 50 percent, is that enough? Is the value you place on the 50 percent sufficient to justify acquiring the company?

Balancing gut instinct and stakeholder buy-in in M&A decisions

That's the psychological part of the deal thesis. Many executives and corporate development professionals have developed their own preconceived notions about what works and what doesn't over the years. 

Some executives won't consider acqui-hires because they don't think the talent is worth it or they don't believe the talent will stick around, and that might be based on their past experiences. Others believe that, despite the risks, acquiring a team wholesale—even if only to retain a few key engineers—is worth it.

It depends on the company you're with and the executives you're working with. That's the environment or "deal environment" you're navigating. You'll have to manage these biases to decide whether a deal makes sense.

It sounds like it varies from company to company based on their culture, their appetite for M&A, and how well a deal fits their strategy. 

That's why this job has been different at every place I've worked. Different companies are at different points in their lifecycle and have varying levels of interest in inorganic growth and how they want to execute it. That keeps the job fresh, interesting, and exciting. 

I have worked for CEOs who make bets on deals based on their gut feelings, that happens. And there are times when we're not as active because we're being more selective about what we want to bring in.

Lessons from deal surprises

Another example that happened, one was a deal we were doing about two years ago. We were evaluating a company based in Eastern Europe, but most of their operations were in the U.S., and many of their engineers were in Eastern Europe. 

We didn't have any entities or employees there, so understanding local employment laws and regulations for bringing those folks on board was a challenge. We had to navigate what kind of offer letters they would need, how we would pay them, and make it all make sense.

While dealing with these issues—working with employment counsel and HR to see if there was even sufficient talent there—the Ukraine war broke out. The country where we were looking to acquire was right next to Ukraine. 

At the time, nobody knew what was going to happen. We had to bring in our trust and safety team to figure out what would happen if the war spilled over into the neighboring country where the target company's employees were located.

The question became, do we even pursue this deal? Is it worth the potential headaches? If we signed, we'd likely have to close, and those employees would become our responsibility. How would we get them laptops in a potential war zone? 

These were questions we didn't expect to consider when we first looked at the deal. Initially, it seemed like a great opportunity—lower cost of operations and great engineers—but then all these other considerations came up.

We didn't have operations there, so we had to consider if there was enough talent density and what that would look like, especially with the potential war throwing a wrench into things.

Definitely a big curveball. Then there are other surprises, like dealing with management and specific requests. For instance, during my time at Compass, dealing with folks in real estate, there were very particular needs—specific titles, whether their car should be paid off by the company, or if a specific team should be kept. 

Sometimes it's family-owned businesses, so you have to navigate those dynamics. For example, if the father owns the business and the son runs it, is the son qualified? Should we keep him or not? It's a political thing. There have been many interesting situations over the years, and I'm happy to share more.

When to walk away from a deal

I haven't often encountered any showstoppers post-LOI where we couldn't continue with a deal because of a major surprise. 

The reason is that purchase agreements are written in such a way that, once you sign, there aren't many ways to back out unless there’s an explicit termination clause that the target doesn't meet, such as a closing condition. You need to be very sure that once you sign, you're willing to close.

At the LOI stage, it’s usually non-binding, so you can still pull out for various reasons before closing. Generally, roughly 90 percent of deals close after signing an LOI. We try not to put out an LOI unless we genuinely believe we'll close, barring any major showstoppers.

The biggest and most typical reason we decide not to proceed with the deal is if the deal no longer becomes a priority. This can happen if we're in the middle of planning cycles or if there’s management turnover on our side. If it’s no longer a priority, we walk away.

Another reason could be if one of the key value drivers we identified isn't what we thought. For example, if a key person we needed for the deal leaves, that could disrupt everything. Ideally, you've done enough work pre-LOI to validate the value drivers to avoid these issues later on. It would need to be a significant material change.

Other ways to streamline the M&A process

It comes down to focus and prioritization. You're usually trying to balance doing the deal as quickly as possible to stay within the exclusivity window signed during the LOI. You want to be thorough but also fast. That's within your control.

Setting up the right cadence and managing the deal with all your internal stakeholders and the target is key. It's about continuously pushing forward and making progress on all fronts. 

For example, don't just send a diligence request and wait a week for a response. Have regular touchpoints to check for any issues and keep things moving back and forth. These tactical steps can help streamline the process.

In terms of how we streamline things process-wise, at the places I've worked, we still rely on pretty old-school methods. We mainly use spreadsheets to manage deals, sometimes shared documents, but it's still quite traditional. We try to ensure that everyone is working from the same documents to stay aligned.

It’s definitely more work because most places have a standard list of diligence questions that you have to go through. But if you really think about what needs to be answered when, and how you present that to the other side and make sure they're focused, that helps streamline it.

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