Monday, February 1, 2016

Lesson #225: Potential Pitfalls With Mergers & Acquisitions

Posted By: George Deeb - 2/01/2016


& Comment

I have always been a fan of considering mergers & acquisitions as a viable way to more quickly scale your business.  But, this road is not foolproof by any means.  Below are some of things that can go wrong, so do your research and plan accordingly.


The skillsets it takes to grow a small stand-alone business are very different from the skillsets required to grow a larger business through M&A activity.  You want to make sure someone inside "Newco" has past experience in dealing with M&A related issues like merging businesses, teams, financials, etc. and someone that knows how to operate a much bigger company, typically with more procedures and controls for scalability.  Remember, the CEO's role must change as the company scales.


Let's face it, mergers are very much like marriages.  You are merging people, personalities and cultures.  And, marriages don't always go as planned, often ending in divorce.  But, "divorce" in the M&A sense is typically much harder to accomplish, meaning you are stuck with these issues, whether you like it or not. So, it is critical you do your homework and make sure the senior management has clear roles and can gel as a new team together.  And, that the employees in the trenches will aspire towards a shared collaborative culture of "we", instead of "us" vs. "them".


Oftentimes, entrepreneurs think selling to and working for a big company will solve all their problems, as big companies have bigger budgets, etc.  But, having lived through two sales to billion dollar companies, big companies bring as many headaches, as they do solutions.  Big companies move like a turtle, compared to the lightspeed of startups, with many layers of bureaucracy and decision makers.  And, the powers that be at the top, are typically focused on much bigger "fish to fry".  Which means your startup will most likely get "lost" inside a big company, unless you have a well-documented agreement detailing their guaranteed support ahead of time..


Yes, I am sure you tried to ask all the right questions during the due diligence process (as I have previously taught you how to do back in Lesson #66).  But, I guarantee you, even the best advisors and lawyers may miss something that can come back to bite you.  Not to mention, let's face facts, a seller is trying to sell, and is always going to present things from a rose-colored glasses perspective.  Which is why you need proper seller representations and warranties documented in your M&A agreement to protect you.


Let's say you have two $5MM businesses coming together.  It is reasonable to estimate that the combined business could do $10MM in revenues together, if not more from the cross-selling of the respective products.  But, the reality is, you have a higher chance that revenues are only $7-$8MM when the dust settles.  Why?  Because key employees may become disgruntled by the merger and leave the company.  Or, the target was overly optimistic on the health of their sales pipeline, etc.  So, build in a cushion for situations like these, and make sure the pro forma economics still work for you.


Earnouts are payments made to selling shareholders at some point down the road, well after closing the deal, after the selling company hits some agreed upon financial or performance target.  Earnouts can work great if you are a buyer, as most buyers know, earnouts very rarely pay out to sellers as much as the sellers hope for.  Sellers agree to terms thinking the earnout will be achieved, and then a grim reality sets in when it does not.  So, if you are a seller, regardless how well written you think your earnout is, things will most likely not pay out as you hope.  So, take more upfront cash in hand, where you can.  And, be happy with deal even if a zero earnout is achieved.


Getting M&A transactions properly documented for maximum protections in the event something goes wrong down the road is not easy.  It requires the skills of very experience lawyers.  And, it is most likely not your general counsel; it is a lawyer with deep M&A experience who has lived through the "negotiation wars" over time, and has battle scars to show for it.  Do not be cheap here, pay up for the best M&A lawyer you can afford, as it could end up saving you millions in capital and hours of heartache down the road.

This is not intended to be a catch-all list of potential pitfalls, but is simply some high level things to keep in mind to protect yourself when going down the M&A road.  Get a good advisor to help you with your negotiations and a good lawyer to make sure it is properly documented.

For future posts, please follow me on Twitter at: @georgedeeb.

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