Mergers and acquisitions can be an effective tool for small- and mid-sized companies to grow, but the merging of two entities does not always guarantee successful outcomes.
Just ask a gardener. How easy is it to grow apple trees that produce the same variety of fruit? In 1811, the Canadian farmer and fruit breeder John McIntosh carefully nurtured a tiny seedling that became the parent tree for one of the world’s most delicious apples.
John wanted to grow his business and capture the market with his McIntosh (or Mac) apples, but he failed to reproduce the original apple tree by planting the seeds of the champion fruit. When he ultimately did, they gave him other varieties of the fruit and not the original Mac.
Then a stroke of serendipity helped him turn the corner. Around 1835, a traveling handyman showed him and his son the art of grafting fruit trees — merging the branch of the tree you want on the rootstock of another. John used this skill, grafting his precious Mac onto other apple trees to ensure it survived. Apple’s Macintosh computer, launched in 1984, is named after the fruit.
The successful merging of two different fruit trees is a specialist skill. It does not always work — and gardeners know why — but when it works it can be spectacular. The art of grafting is not dissimilar to that of mergers & acquisitions (M&A).
In his memoir The Ride of a Lifetime, Disney CEO Bob Iger shares his perspectives on the M&A transactions related to Disney-Pixar-Marvel-Lucas Films, which he describes as major milestones in the company’s history. Over the past two decades these mergers strengthened Disney’s market position and its evolution shows wise decisions taken to meet every challenge.
The main reason for companies to merge is to create higher value at levels greater than they could achieve on their own. Against the backdrop of the current volatile macroeconomic environment, one can see greater consolidation happening across industries.
Research reveals that the success rate of M&As is low: About 70% of deals do not deliver the expected results. Why?
It turns out, integration is a primary problem for companies acquiring businesses. Success is more than just careful integration of the newly acquired business; it’s also about ensuring that the customer/client needs of both companies are met: they must like, approve and see the logic of the new combination, which may require a well-planned communication of the impending change.
M&A challenges facing small-to-mid-sized companies
Smaller companies often face additional hurdles that can make a merger more difficult. Limited resources and experience with the M&A process, as well as the struggle to attract and retain top talent, can all increase the risk of failure.
M&A deals that fall through have some commonalities, not far removed from the factors that cause graft failure in fruit trees:
- Lack of strategic clarity: Many M&A deals are driven by a desire to grow quickly or respond to market pressures, rather than a clear strategic rationale. This often results in deals that are not well aligned with the acquiring company’s overall strategy.
- Poor due diligence: Companies often overlook key risks and challenges during the due diligence process, which can lead to problems later on.
- Integration challenges: Integrating two companies is often more complex than expected, and many M&A deals fail due to poor integration, planning and execution.
- Cultural differences: Understanding and managing cultural differences between the two merging companies is critical to ensuring a smooth integration process.
- Unmet client needs: Misreading client needs could result in a failure of the business model and a consequent failure of the M&A.
How can small-to-mid-sized companies increase the probability of a successful merger?
In the face of these challenges, small- and mid-sized companies can increase their chance of a successful M&A transaction by having a clear strategy and effectively managing the integration process.
- Focus on compatibility: Small-to-mid-sized companies should focus on finding a merger partner that is compatible with their business culture, vision, and values. Compatibility is particularly important for smaller companies as they often have a stronger and more unique organisational culture that is critical to their success.
- Conduct thorough diligence: Conduct a thorough analysis of the financials including assessing revenue and profitability, cash flow, debt and other financial metrics. Evaluate and consider potential risks or challenges in the merger process which includes conducting a comprehensive analysis of legal, financial, operational, and cultural issues that could impact the merger’s success.
- Assess true synergies: Consider the potential synergies between their business and their potential merger partner. Synergies can include cost savings, operational efficiencies and access to new markets, customers, and technologies. I have noticed that revenue synergies are often cited as a key driver for M&A deals, experience shows that it is often easier to model and diligence cost synergies and capability benefits while revenue synergies can be more challenging to accurately forecast.
- Thorough integration plan: This includes being open to new ideas, approaches, and ways of working to ensure a smooth integration process. It is important to create a culture of continuous improvement and learning to enable the combined company to grow and succeed post-merger. Develop a detailed integration plan that includes clear objectives, timelines, and milestones. Assign clear roles and responsibilities to the integration team, and monitor progress regularly. Manage cultural differences. Understand the target company’s culture and identify areas where cultural differences may cause challenges during the integration process. Develop a plan to address these differences and ensure that both companies are aligned on the vision and goals of the merged entity.
M&As might never get the impressive success rate that gardeners achieve by grafting fruit trees, but methodical planning and careful strategising can dramatically increase the chances of success.
The author is Founding Partner at the investment firm B Capital.