Why M&A Deals Fail: The Key Factors and Strategies for Success
December 8, 2022 •Oak Street Funding
Business mergers and acquisitions are pursued to generate success for the companies involved, so it’s natural for observers to wonder why so many M&A deals fail. In an article for the Harvard Business Review, M&A consultants Alan Lewis and Dan McKone analyzed 2,500 M&A deals. They discovered that better than 60 percent resulted in lost shareholder value. The Feel of the Deal author Robert Sher says most research points to just half of M&A activity meeting its objectives, what he describes as “basically a coin toss.”
M&A's- not the same transactions
While mergers and acquisitions are often discussed as though the terms are interchangeable, there are significant differences between the two.
A true merger generally involves two companies similar in size and capabilities that believe combining operations will make them more competitive than they could be on their own. Essentially, the new whole becoming significantly larger than the sum of the parts. Motivations behind mergers may include reducing costs, enhancing efficiencies, gaining competitive strengths and advantages, and achieving a larger market share.
In contrast, acquisitions involve a situation in which one of the companies is larger or financially stronger than the other. The larger company will essentially consume the acquired company’s assets and other resources. Often, acquisitions are described as mergers to allow the acquired company’s leaders to save face or protect the company’s reputation in the marketplace.
Why enter an M&A transaction?
The reasons behind mergers and acquisitions are many, but most often, companies have one of two objectives. The first is a desire to leverage the transaction’s potential in a way that increases the profitability of the combined company. The second is growing revenue (and ideally profits) with more products and customers in larger marketplaces.
Regardless of the reason by the M&A deal, there’s often a great deal of enthusiasm when two company leaders shake hands on a proposed deal. Everyone involved is excited at the prospects, and on paper, the deal looks to be an excellent combination. All too often, unfortunately, great expectations become eclipsed by a reality that isn’t as positive. And, as Sher points out, a failed deal can be more damaging to smaller companies because they have fewer resources to help them recover from any negative consequences.
Is your deal a lemon?
Author Shobhit Seth likens the M&A deals process to purchasing a used car. No matter how carefully you inspect the car, you really won’t know if you made a good deal until after you’ve bought the car and used it.
Similarly, a company can study a potential merger or acquisition candidate’s financials and obtain assistance from professional advisors. But an honest verdict as to whether the transaction has been successful can’t happen until long after the deal has been completed and the combined company has been operating.
Common causes of M&A failure
According to Seth, several factors are common in M&A transactions that fail, including:
- absentee leaders who rely too heavily on outside advisors instead of taking the lead in the M&A process.
- inaccurate pre-deal valuations that fail to provide the true value of the transaction.
- lack of detailed planning for the integration of the two companies and their teams.
- insufficient strategies for contending with different cultures.
- limited resources to allow for growth after the transaction and to support the combined company through unexpected challenges.
- poor negotiations that lead the acquirer to overpay for the transaction and its related costs.
- external factors that weren’t considered or anticipated.
Often, a lack of discipline
In the excitement surrounding the M&A deal, it can be easy for company leaders to lose focus on what they hope to accomplish. They mustn't fail to create realistic plans for the many components of integrating their operations. In mergers and acquisitions, planning for integration is critical.
Consultants Lewis and McKone claim their research points to a failure on the part of company leaders to bring sufficient discipline to the deal-making process, essentially causing them to make bad transactions.
They note that M&A due diligence often produces an unrealistically optimistic view of the revenues the combined companies will be able to generate. When acquirers use those projections as the basis for the price of the transaction, they end up overpaying.
Lessons from large M&A deals
Your business may not be an industry giant, but corporate finance consultant Lawrence Pines believes you can find lessons from failed M&A deals among huge companies. For example, Pines attributes the failure of eBay’s purchase of Skype to a bad assumption on eBay’s part. The company assumed eBay® users would embrace Skype’s® technology as part of the auction process, but users did not see the benefits of communicating through the platform. Therefor, eBay's assumptions resulted in a failed acquisition. Are you making incorrect assumptions of your own?
Daimler and Chrysler’s merger looked like a promising combination of two automakers. They did not compete directly by product type or geography. Pines says it failed because Daimler’s highly structured business approach was incompatible with Chrysler’s entrepreneurial culture. Is your M&A target’s culture compatible with yours?
Pines adds that Bank of America and Merrill Lynch’s merger stumbled because the companies failed to identify how the combination would be managed and which executives would move into key roles. The uncertainty led valued team members to leave. It’s important that employees understand how the company will function after your transaction is complete. Does your M&A plan include employee placement details for key executives?
Best path to M&A success
Lewis and McKone say the most expedient plan for achieving growth and limiting risk in an M&A transaction involves leveraging what they term the companies’ “journey edge” -- identifying opportunities to expand what both companies currently offer through new products and services built upon their existing capabilities, resources, and customer base.
In other words, don't craft a grand plan for tremendous change. Instead, companies should look for opportunities around the margins of their current success to identify marketplace gaps to fill.
M&A strategy considerations
Author Sher suggests CEOs considering the M&A should process think about several key areas:
- Does the company have enough management capacity to integrate the businesses?
- How well will the proposed M&A deal fit in with the company’s strategic plans?
- Will the company have enough financial resources post-transaction to handle the integration while delivering an acceptable return on investment?
- Do the two companies have compatible cultures?
- Is the transaction truly the best choice among all alternatives available to the company?
He adds that weakness in any of these areas suggests the companies will encounter difficulties in the integration process. “No amount of management can fix an acquisition that should never have happened to begin with,” Sher notes.
Discipline is key to M&A success
Overall, a disciplined approach to the entire process is the key to successful transactions. Company leaders who focus on how the M&A deal will better address customer needs, and how it will allow the combined company to leverage its assets to create value in other contexts, will reduce the inherent risks of the deal.
Finally, companies considering an M&A deal would be wise to develop a backup plan. This plan provides alternatives if the deal just isn’t shaping up to be as good as what was first envisioned. It can be disappointing to pull the plug on a planned transaction. But it’s better to endure a temporary setback than to proceed with a merger or acquisition that may fall short of your expectations or damage your company.
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.