How to maximize success in a merger and acquisition transaction Featured

8:00pm EDT July 26, 2010

What might seem like the perfect acquisition opportunity may, in fact, create risks that threaten business viability.

Christopher Meshginpoosh, CPA, director of the Audit & Accounting group at Kreischer Miller, says that the development and execution of an M&A strategy must be based on careful consideration of the buyer’s business strategy, the pros and cons of both M&A and organic growth options, as well as common pitfalls in M&A efforts.

“The harsh reality is that the vast majority of mergers and acquisitions destroy value, rather than create it,” he says. “Deal-making is addictive and, far too often, buyers jump into transactions without proper consideration of strategic objectives and transaction risks, increasing the likelihood of failure in M&A initiatives.”

Smart Business spoke with Meshginpoosh about what to consider before entering into a transaction.

What steps should a buyer take before launching M&A efforts?

The foundation for successful M&A efforts is the development of an overall business strategy, which ordinarily includes the consideration of potential strengths, weaknesses, opportunities and threats. After identifying these elements, management can determine whether M&A transactions can help capitalize on strengths and opportunities, as well as address weaknesses and threats.

What questions should management ask when considering a potential acquisition?

The first question to ask is whether M&A is the only option. In some cases, it might be difficult to find a suitable target at a reasonable valuation, and overpaying the seller might jeopardize the solvency of the buyer.

In these cases, companies might consider whether strategic alliances, distribution or licensing arrangements, or establishing new businesses organically might be more cost-effective or result in a lower level of risk.

Do you recommend that companies focus on small or large transactions?

Unless a management team has extensive experience with mergers and acquisitions, it is often better to start small; the best acquirers tend to be those that are serial acquirers of comparatively smaller businesses.

How does a buyer know whether it’s paying the right price for a target?

Aside from performing extensive due diligence and preparing a quality of earnings analysis, it is important to make sure that an effort is made to identify a reasonable number of potential targets.

By broadening the pool of potential targets, the buyer can ensure that it identifies the candidate and transaction structure that result in the highest probability of achieving the buyer’s objectives in the most cost-effective manner.

What types of mistakes do buyers often make when negotiating price?

Companies enter into transactions with the goal of increasing shareholder value, and value creation is a simple mathematical exercise: Post-merger increases in income or cash flows must provide a reasonable return in comparison to the purchase price. Far too often, buyers fail to establish a walk-away price before starting negotiations and, as a result of the cumulative effect of small changes during negotiations, end up paying too much in relation to anticipated post-merger income. Failure is often almost assured before the transaction even closes.

Another common mistake is basing the purchase price on financial projections that include post-merger synergies. Synergies represent positive post-merger changes, such as increases in revenue or decreases in costs, that are the direct result of the buyer’s post-merger efforts.

By using the effect of these synergies to justify the purchase price, a buyer is essentially paying the seller for value the buyer is creating. Add to that the fact that up to 90 percent of revenue synergies and 70 percent of cost synergies are usually not achieved, and you have a recipe for disaster.

What aspects of negotiations, in addition to price, impact the success of M&A efforts?

It is essential that the roles and responsibilities of the target’s existing management team are clearly defined, and that those roles and transaction structures do not present obstacles to execution of the business plan.

For instance, in some transactions, buyers offer contingent future payments to the seller if the standalone performance of the target achieves certain thresholds during a period of time after closing of the transaction. Additionally, buyers often allow the seller’s management team to continue to manage the operations of the target after closing.

If integration of business processes is essential to the achievement of the buyer’s objectives, arrangements like these can undermine integration efforts because the seller is motivated to focus on standalone performance instead of integration. These issues are complicated but, if not addressed, can undermine the buyer’s ability to achieve its objectives.

In light of all of these risks, should management teams rely on outside experts?

Almost every transaction involves legal, financial, operational and human resources experts. While it is critical that the due diligence team includes managers who will be responsible for executing the integration plan and achieving post-merger objectives, the sheer magnitude of the effort, the complexity of the risks and management’s day-to-day responsibilities drive a need for outside experts. By selecting legal and financial advisers with deep hands-on experience with a wide range of transactions, management can maximize the probability of creating value in their M&A efforts and achieving strategic objectives.

Christopher Meshginpoosh, CPA, is director of the Audit & Accounting group at Kreischer Miller. Reach him at (215) 441-4600 or cmeshginpoosh@kmco.com.