M&A from a Business Consultant's Point of View

Here is more on Joseph’s background.

For the last 10 years, I’ve had my own consulting business, Joseph Feldman Associates, and my primary activity is working with middle-market companies on acquisitions.

I help companies that don’t have a  corporate development executive as part of their team to help them develop an acquisition strategy, identify potential targets and move ahead to close those transactions that are most attractive to them. 

I know you published a lot of stuff around diligence surprises. What do you think is the best due diligence checklist in your experience?

On one hand, I have seen a lot of different checklists that I think are really terrific as prompts for legal questions, accounting questions, environmental questions, and like. I’ve seen a checklist published online by Grant Thornton that has almost 500 bullet points with ideas of questions that might be asked as part of an acquisition process.

None of these questions, however, relate to places where surprises are most prominent, such as those related to organizational fit, culture, or potential changes that might occur with customers or suppliers. I believe checklists can be useful as starting points, but they can also give you a false sense of security.

I think, at some point, the goal is to encourage a team to start thinking outside the checklist. How would you go about doing that?

One of the things that I often advise clients is to start the integration process at the time that the acquisition campaign begins. By integration planning, I mean starting to involve the operating executives of the company, who are oftentimes excluded from the deal process in the thinking about how a particular company might fit with the firm that’s doing the buying. 

In terms of executing the diligence process, what would be the strategy to eliminate post-closing surprises?

I think the goal should be to prepare for post-closing surprises, not to eliminate them. What’s better for a company is to try to anticipate where surprises might come, what flavor they might take, and to prepare for a wide range of different possibilities that they might see.

Having multiple different scenarios in mind is one way to prepare for a potential surprise, as opposed to thinking that you can completely eliminate that risk. 

That seems like a big challenge because companies can be really large and complex. How would you think that through and map out what those different scenarios would be?

I think financial modeling is an area where scenario analysis is maybe easier to get your arms around and it might be useful as a jumping-off point. The idea is to identify key drivers in how value will be created from a mathematical standpoint, so you can identify the top three, four or five drivers of value and also potential risks of not achieving the results you have in mind.

Each of those different scenarios on a spreadsheet will correspond to different scenarios that might exist with people in the organization or people who are in key positions at customers, or suppliers. This can be a good jumping point to start looking for those surprises. 

Have you ever heard of anybody getting sideswiped out of something outside of those areas?

I can think of an example of a company, a specialty retail business where a friend of mine is  CEO, that had about 20 different locations in the market and they were regularly looking for opportunities to expand.

It was a very high touch business and they had identified a location that they thought was terrific, in a neighborhood that really suited their branding. 

What they found in the first 30 to 60 days after the deal was closed, was that the frontline staff was offering giveaways and discounts, the profitability at that store was low, and so was the satisfaction of the customers.

The location was, in a way, damaged goods, and the local community could never see this location as having a higher quality of service that was part of the brand. They ended up having to close the store entirely. 

Do you think that was just the culture of that management team for the location, or culture of the community?

I think it was the culture of the frontline staff. With retail, in this particular case, it was very hard to shake the reputation that this particular location had among its customers. 

When you are going through diligence, was there an opportunity to have a management meeting to understand what they were working with in terms of the management team over there in this particular case?

They probably had greater access to all the aspects of the business than you’d find in a more substantial acquisition. This was one retail location that was considered for addition to an existing retail chain, so it was a relatively modest size operation.

They were focused on financial statements, being in the store, looking at the assortment, understanding the demographics of the community, and getting a sense of whether the brand imagery from the buying company could be applied in this location, rather than management meetings. 

What other surprises have you seen outside of talent-related, people exiting and key hires exiting early. What other types of surprises have you seen post-closing?

I was working with a consumer products company and they have a stable of really well-known brands. They were looking for new brands that were up-and-comers who might be able to take advantage of their retail distribution, their expertise in consumer marketing, especially social media marketing. 

We also thought about international opportunities and the conclusion that we came to was that international opportunities are just not going to be very interesting for this particular brand.

Shipping costs would be very high, distribution in some of the key markets, particularly in Asia, that this company did business with were very competitive and so from a synergy and value capture standpoint, we really dismissed international expansion as an opportunity.

Within two or three years of the deal closing, the markets in Southeast Asia were a source of incredible growth for this purchase brand. So, from a synergy realization standpoint, my client ended up realizing a significant amount of value that was completely discounted when we went into the deal. That was a real upside. 

Why do you think so many acquisitions fail or are considered unsuccessful?

Executives can risk falling in love with the transaction and begin to look at it with rose-colored glasses, where everything looks good and the risks and potential downsides are easily dismissed. Expectations can sometimes be so high that realizing them can be extremely difficult. 

Another thing to consider is that the acquisitions are a multi-pronged growth strategy, where you are doing three, four, or five initiatives related to growth, all at the same time.

Any of those individual initiatives might have a 90 percent chance of success while achieving success with all four or five of them require success probabilities that mathematically move you way below 100 percent and pretty soon you’ll end up with a 50 percent probability of success.

What would be your consideration to counter that?

Bringing operating executives into the conversation as early as possible is a significant way to mitigate the potential risks of failure or disappointment with acquisitions. It's important to think about where the surprises that the company might encounter are, what they can do to prepare for them, and what are the different value-enhancing opportunities that are available?

Think about these as a portfolio. Don’t value that portfolio based on succeeding with each and every one of those initiatives, because only two out of five might end up being successful. This can help properly temper your expectations. 

How much transparency would you keep with the operational team?

I think there is an obvious tension between confidentiality associated with the deal on one hand and bringing the operating executives in on the other hand, which is even more sensitive in the case of public companies where discussion about potential deals is limited to a very small number of executives, none of whom might be responsible for the deal after it closes, apart from the CEO. 

Including the operating executives earlier is advisable and will pay dividends in terms of better planning of what the deal can deliver, greater assessment of what the risks might be and how to prepare for them, and finally, better identification of very high-risk possibilities that might be mitigated ahead of a deal closing.

What risks or surprises do you consider the easiest to uncover?

The easiest to uncover are those that are subject to check-the-box kind of diligence. An example would be companies that have a significant number of physical operations.

Accounting and tax diligence can also be relatively straightforward because the baseline that you are comparing against is well established and generally speaking not subject to much interpretation. It’s always the people side that gets to be more complex, subjective, and challenging.  

Are there things that require thinking out of the checkbox? How would you go about getting your team to think outside the checkbox to get a different view of potential hidden surprises that could come up?

I’ve seen a lot of companies focus on how the customers are going to react following an acquisition, and I think that’s appropriate.

Some of the most successful pre-closing activities that I have seen are role-playing activities on the part of the acquirer to try and foresee and play out different conversations and scenarios of how the customers might react. Those are sort of rehearsals for the live performance after the deal actually closes. 

During diligence, would you ever consider working with a third party to do more in-depth customer diligence?

I have seen different organizations that offer customer diligence services and can provide expertise by reaching out to former employees.

But, there are natural limitations to how much a customer is going to be willing to share with anyone ahead of an acquisition, and there is also going to be a lot of sensitivity on the part of the seller as to how much access they will permit ahead of the acquisition.

How about lawyers? Can they help mitigate risk or surprises?

There are two significant ways in which layers can be helpful. From a strictly legal standpoint, there are a lot of terms and conditions in a purchase agreement. These are things such as representations and warranties, holdbacks, earnouts, different terms and conditions that are contingent on certain truths being borne out or certain risks coming to pass.

Lawyers who are experienced with deals can be very helpful in identifying what the market trends for representations, warranties, and holdbacks are, and also distinguishing general deal terms. They can bring their expertise and knowledge of other deals to bear far beyond their narrow legal contributions. 

Are some types of acquisitions more susceptible to surprises than others?

One example is cross-border deals. If a company is acquiring a business in another country, that raises a number of issues which might be different than any they’ve encountered before, because of the different language, potentially different laws, and different contractual traditions or habits.

Another one that comes to mind, generally speaking, are companies that are very people-intensive, such as service businesses, which are more prone to surprises because there is more value tied up in the people.

A third example would be companies that have a very high degree of customer concentration or supplier concentration.

How about bankers? How can they help mitigate the risk of surprises?

They can certainly help with financial modeling that then serves as a basis for identifying operational areas that are going to be critical to the success of the acquisition. They can also bring in their experience related to other deals.

However, the thing to keep in mind is that investment bankers get paid for deals closing, and so their motivation is going to be to have a great client relationship, but first and foremost to have the deal closed.

They can make a very successful deal close, but they won’t necessarily be helpful to how that post-closing enterprise operates on a go-forward basis. 

You’ve done a lot of research and taken surveys focused on post-closing surprises. What are some of the interesting things you’ve seen from that?

One of the most interesting things I've seen is that members of boards of directors who I’ve spoken with have a relatively straightforward view about what makes acquisitions successful.

They try to keep it very simple as far as the preventing surprises go, so if there are red flags going off about a culture not fitting, or red flags about customer concentration issues, they would simply step away or look at the price or a structure that’s going to be satisfactory.

The most successful ones I’ve spoken with all highlight that it's important to be humble and take it one step at a time. 

What is the craziest thing you’ve seen for a post-closing surprise?

A friend of mine who ran a medical products company and his acquisition team brought forward an acquisition, they negotiated the deal, and a CEO, who was still a very significant owner of the company, had a tremendous payday, around tens of millions of dollars. They signed an employment agreement with him, so they thought they were all set there.

After the deal closed, they had planned the first session at the corporate headquarters to discuss the implementation of the integration plan, only to hear that the above-mentioned CEO was somewhere in the Caribbean. He just told them that he is done, he is not going to join the company and declared a victory for himself. 

Did that turn out to be the most costly surprise you’ve seen?

The most costly that I've seen were deals where the integration was deferred all the way through the closing of the deal.  One of the transactions that I worked on was a company that was making its first cross-border deal.

However, they didn’t have anyone in the home office who was prepared to move to that other market to run the business, the founder of the company that they were interested in announced leaving, and there was no game plan for who was going to run the business.

They ended up losing a lot of the business they had bought and it made it dramatically harder for them to transfer some of the existing business that they had with other collaborations into this new entity. 

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