I have always been a fan of considering mergers & acquisitions (M&A) as a workable way to quickly scale your business. However, this road is not foolproof by any means. Let’s go over some of things that can go wrong, so do your research, consult a professional and plan accordingly.
The skillsets your team must possess to grow a larger business through M&A activity is much different than the skillsets your team needs to grow a small stand-alone business. You want to ensure that you have someone inside “Newco” has past experience dealing with M&A related issues such as merging businesses, teams, financials, etc. and someone who knows how to operate a much larger company, typically with increased procedures and many more controls for scalability. Keep in mind, the CEO’s role must evolve as the company scales.
TEAM & CULTURE MERGE
You can relate a merger to a marriage. You are merging people, personalities, and company cultures. And, marriages do not always go as planned, in a lot of cases ending in divorce. But, “divorce” in the M&A scenario is typically harder to transact, meaning you are stuck with these issues, whether you like it or not. It is vital that you take the time to do your homework and make sure that the senior management team has clear roles and responsibilities allowing them the best opportunity to mesh as a new team. By creating a meshed senior management team, the employees on the remainder of your team will aspire to share a collaborative healthy culture of “we” instead of a toxic culture of “us” vs. “them”.
POOR OR INCOMPLETE DUE DILIGENCE
I am positive that you tried to ask all of the right questions during the due diligence process. (I have a great guide that I can provide you as a starting point). I guarantee, even the best advisors and/or lawyers miss things that can come back to bite you. Not to mention, let’s be real here, a seller is trying to sell! Meaning, they are going to present you with things from a rose colored glasses perspective. It is important that you utilize your M&A agreement to protect you with things such as proper seller representations and warranties.
BIG COMPANY LETDOWN
I have seen a lot of entrepreneurs think that selling to and working for a large company will solve all of their problems, they assume because large companies have large budgets, etc. Having been through multiple sales to large companies, large companies bring just as many if not more headaches, as they do solutions. Large companies tend to move at a snails pace compared to the light speed movement of startups, and add many layers of bureaucracy and decision makers. In a large number of cases I have seen that the powers to be at the top of the large companies are focused on the “Big Fish” which means that your startup can get lost inside a large company. You must have a well documented agreement with detailed and guaranteed support ahead of time.
PROPER FINANCIAL TARGETS
In this scenario let’s say that you have two $10MM businesses merging together. It is reasonable to estimate that they combined revenue the combined business could do would be $20MM if not more from cross-selling of products, etc. The reality is that it is likely your revenues will be around the $17-18MM range. Why? Well, it is likely that key employees may not be content with the merger and choose to leave the business, or the more likely scenario that the revenue target was overly optimistic, etc. It is important to build in a safety cushion for situations such as these, and make sure the pro forma economics make sense and 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 cruel reality sets in when it does not. So, if you are a seller, regardless how well written you think your earnout is, things are likely not going to pay out as you desire. Take more upfront cash in hand, where you can and be happy with the deal even if a zero earnout is achieved.
Properly documenting M&A transactions for maximum protections in the event something goes wrong down the road is no easy task. It requires the skills of detailed and very experienced legal council. I cannot express enough the importance of utilizing council that has deep M&A experience who has lived and breathed “tough negotiations”. This is one area that I would not be cheap in, pony up for the best M&A lawyer you can afford, it can end up saving you millions in capital and a lifetime 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. At MCDA CCG, Inc. we have experienced, battle proven M&A advisors and legal resources to help you make your transaction a 100% success. Contact us today and let’s discuss your M&A activity and let us save you time, money and potential heartache.