Acquiring new products or whole companies is a popular activity for many growth and market-share-oriented companies. Financial or strategic acquisitions – are they good ideas?
As I say probably all too often–it depends. I get involved in company or product acquisitions frequently in my consulting practice. I have also led and integrated acquisitions myself from within software businesses. There is nothing inherently good or bad about acquisitions in the technology business. However, there is nothing inherently bad about opening a restaurant, either. Nonetheless, a very high percentage of restaurants (I’ve seen figures as high as 90%) fail within 5 years.
The failure rate for tech acquisitions may not be quite as high as for restaurant startups. But both financial and strategic acquisitions in software and hardware businesses are also judged to be failures at shockingly high rates. Caution should rule when approaching either of these very popular activities. As I’m also fond of saying about success or failure in any complex business activity: the devil’s in the details. And this is a VERY complex business activity.
Common motivations for acquisition activity
As opposed to what company management may say publicly, let’s examine the common (real) reasons that acquisitions are considered in the first place:
- It’s exhilarating and “sexy” to buy another company
- Growth for growth’s sake (often under pressure by investors)
- The belief that buying a competitor is the ultimate “victory” over them
- A consolidating market (often also commoditizing) with room for a only few large players
- Truly great strategic acquisitions with great fit where 1+1 truly equals 3
As you might have guessed, reasons 1-3 above aren’t great justifications for such a risky activity. Number 4 can be a good justification. But often this is given as the rationale when the actual market case doesn’t truly support it. Number 5 can be a good or bad rationale. It depends upon whether the business case really calls for diversification, or if focus would make more sense. Number 6 is by far the best reason to acquire a company. That’s particularly true if you aren’t an industry giant, pitted in a death match with another titan of your marketplace (4. above).
So let’s assume you’ve actually thought it through and have used sound analysis and judgment in deciding to pursue a strategic acquisition. Congratulations on passing the first test. But there are still myriad things that can trip you up on the way to acquisition success. Let’s quickly examine a few of them.
Great Ways to Fail
First acquisition to be done “on your own”
I strongly urge all first-time acquirers, whether of the product or company variety, to seek assistance. Acquiring a company or even a product is very complex. There are a lot of ways to trip up. Retaining an experienced hand that has seen and gone through mistakes before may prevent the most expensive education of your life.
Bad cultural fit
In the excitement of a tech acquisition or merger, people have a tendency to not look past the surface. It’s much like dating an attractive potential mate and impetuously proposing based on infatuation. This is often done without establishing whether there is common ground in the way you live your lives. M&A is the business equivalent of marriage, folks. Compatibility in business philosophies and practices is crucial. Sadly, this is often overlooked until after the fact, when everything is unraveling.
Poor organizational integration
Even with an excellent evaluation of potential partners, a great many mergers fail based on the execution of integrating the organizations. That’s because integration is HARD. Almost always. You are generally merging two organizations with disparate operating styles, as well as overlapping functions and people. Fear, uncertainty, and doubt experienced by the individuals involved can by themselves scuttle a potentially great fit. Dealmakers often get caught up in the “numbers” of the deal and forget that ultimately M&A success is about the people. This area is often quoted as the reason many acquisitions fail.
Poor product integration
This is the reason a lot of supposedly “strategic” acquisitions in the software product business should be called off early in the process. It is often very difficult to rationalize how you are going to support two different code bases or technologies aimed at the same market. The plan usually calls for integrating them over time. But that often proves to be very difficult from a technical perspective. This is a real red flag when buying a direct competitor. Yet the price of mergers in high tech often assumes that the products can be integrated acceptably, without losing customers from either of the existing products. Unfortunately, this plan is usually a very tall order and is often scrapped after the deal closes, with one code base being obsoleted. Your competitors will salivate at the prospect of picking off customers from the code base that “loses” and is made obsolete.
Paying too much
Price plays a major role in software acquisitions. Due to high growth rates and the perceived need to move quickly in fast-growing, competitive software markets, software deals are often priced in multiples of revenue. This is in contrast to the more conservative multiples of EBITDA used in other less dynamic industries. Often the target isn’t even profitable yet! But the target company still commands a high price-to-revenue multiple, due to the “hot” nature of the market space and the perceived value of the acquired technology. This high price puts severe pressure on the downstream execution of the merger to be “perfect”, as discussed above.
So with all of the landmines in the acquisition arena and the high failure rate, is it simply nuts to ever consider a financial or strategic acquisition? Doesn’t it make sense to just stay away from them? NOT NECESSARILY.
Sound Approaches to Pursuing Mergers
This often happens when companies reach a certain size. They simply lose their ability to innovate. Rather than innovate internally, they acquire smaller companies with market-changing technologies. These smaller innovators often don’t have the resources to fully exploit their technology in the marketplace on their own. Price multiples here tend to be high. But the risk is somewhat mitigated relative to the risk that internal Research & Development also might not “pan out”. In addition, the size of the acquisition is often very modest relative to the resources of the acquirer. Acquisitions of this nature can lead to the example of a true 1+1=3 strategic fit. This approach to truly strategic acquisitions has been used with great success by Cisco, Microsoft, and many other large companies.
Buying companies or products that truly fill a hole in your offering
Some companies tend to overuse this as justification. But the acquisition of a reasonably priced company or product at just the right time can mean the difference between continued growth or inevitable stagnation.
Buying undervalued assets
This is harder to do in high-tech than in other industries. High-tech companies have a habit of overvaluing their businesses and technologies. And markets also assign high valuations to tech companies due to high growth potential. But an executive team with a keen eye for a bargain can sometimes pick up a diamond in the rough. For example, buying a division of a larger company which may have suffered because due to a poor fit with the parent company’s core business.
Truly appropriate diversification
Sometimes you run out of runway in your current market. The amount of cash flow generated by your current business may dictate that an investment in another growth area may be prudent. The key here is to pick a market segment adjacent to the existing business. If that isn’t possible, at least a business that the management team can easily adjust to. However, management teams often are over-confident in this last area. They have a habit of deceiving themselves, and end up investing in an area where they really don’t belong.
I could write a lot more about acquisitions. But instead of putting everyone to sleep, let’s begin a dialogue on this topic. Inform us all with your own M&A stories. What in your opinion constitutes TRULY strategic acquisitions best practices? Provide your own cautionary tales by posting a comment below.
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