6 Reasons Why So Many

Acquisitions Fail

In my last post, Why Innovation Through Acquisition Is Such A Darn
Good Idea, I commented on the crucial importance of mergers and
acquisitions in the business innovation ecosystem. From an
entrepreneurs-eye-view, M&A provides lucrative shareholder exits.
Viewed through the lens of the public company, innovation-through-
acquisition can be a legitimate strategy for entering exciting new
technologies or markets by first allowing startups to do the de-risking.
And yet history shows that, in at least half of all cases, after the deal
closes, acquisitions sour. (There are dozens of studies and papers, and
estimates of how many M&A deals fail to meet financial expectations run
from 50 percent to as high as 90 percent.)
So all too often from a startups perspective, the good news is that
entrepreneurs, option-holders and investors cash out, but the bad news
is that the employees find themselves in an oxygen-starved bureaucracy
and the startups customers end up confused or even orphaned. And
from the acquiring companys perspective, its all too common for the
business advantages they sought some combination of access to new
products, access to new markets or geographies, market share increases,
growth faster than purely organic growth, and/or economies of scale to
simply fail to materialize.
Ive sat on both sides of the fence in M&A on multiple occasions, selling
my startups to public companies as well as being on the acquiring side.
Ive witnessed things from the executive seat, the board seat, and as an
advisor, and Ive experienced superb outcomes, mediocre results, and
unmitigated disasters.
From that perspective, heres my list of 6 key reasons why M&A deals
come unraveled after the fact and what you can do about it:
1. Misgauging Strategic Fit
If the acquisition is too far outside the parent companys core
competency, things arent likely to work. A company that sells to its
business customers chiefly through catalog and Internet sales ought to
be very cautious about acquiring a company that relies on direct sales
even if the products are, broadly-speaking, in the same industry.
Similarly, a company whose traditional strength lies in selling products
to businesses might want to think twice before making a foray into a
consumer-oriented business. Consulting firms have been known to
acquire software companies driven by the rationale that the parents
client companies use these sorts of software apps, and the applications
are in the same broad domain as the consulting firms expertise; then
they discover that selling B2B applications is wholly different from
managing consulting engagements. An honest strategy audit up-front is
the answer: dont stray beyond your core competencies, and ask whether
the target company fits your strategy, your operations, and your
distribution channels.

2. Getting the Deal Structure Or Price Wrong
We all understand that if the acquiring company pays too much in an
auction environment, its going to be tough to get the acquisition to show
a positive ROI. To protect themselves, some acquiring companies like to
structure acquisitions with half or more of the purchase price held back
based on achievement of future performance hurdles. But watch out:
such earn-outs can backfire on the acquiring company in unexpected
ways. If, for instance, a major payment milestone is based on post-
acquisition sales performance but 99 percent of the sales people are
working for the parent company and therefore are neither aware of nor
incentivized by the sales milestones then the acquired company
employees may well feel demoralized due to having scant control over
achieving major payment milestones. Ive seen similar things happen
with product-delivery-oriented earn-out payments: the good news is that
the parent company hires in dozens of additional product developers, but
the bad news is that only a tiny proportion of the newly-constituted
product team knows about or is incentivized by achievement of a major
earn-out milestone for the acquired company. In both cases, well-
intentioned deal structures that held back payments based on future
performance ended up having unintended consequences and souring the
deal. The better bet easier said than done is negotiating a fair price
up-front.

3. Misreading The New Companys Culture
Just because your two companies are in the same industry doesnt mean
youve got the same culture. Its all too easy for the acquiring companys
integration team to swagger in with winners syndrome, and fulfill the
worst fears of the new staff. Far better if they enter the new companys
offices carrying themselves with the four Hs: honesty, humanity,
humility, and humor.

4. Not Communicating Clearly Or Enough
In the absence of information and clear communication, rumors will fly,
and people at the acquiring company will assume the worst.
Communicate to the entire team, not just the top
executives. Communicate clearly and honestly and consistently. If
theres bad news, be sure to deliver it all it once, not piecemeal, and
make it clear that thats all there is that folks dont have to worry
waiting for another shoe to drop. And when you think youve
communicated enough, youre one-quarter of the way there.
5. Blindly Focusing On Integration For Its Own Sake
Dont assume that all integration is good. Ive watched all too often as the
parent company insists on fixing things that arent broken: The acquired
company has established a strong brand, but the parent insists on
improving things by replacing it with something that blandly blends
with the corporate naming conventions. New standard operating
procedures are imposed that suck all the oxygen from the room and
demoralize the team. A small sales team has clear account authority, but
the parent knows better and makes the newly-acquired offering the
1,400th anonymous product in its sales forces price list. The acquired
product works perfectly well as-is, but the parent company insists on
rebuilding it so that it fits into the parents technical architecture
thereby punishing customers and freezing all product enhancements for
years. The bottom line is dont be too heavy-handed. If this company was
worth acquiring, its probably worth trusting, funding and encouraging
to thrive.
6. Not Focusing Enough On Customers And Sales (vs. Cost
Synergies)
The most fundamental scorecard of acquisition success is financial
performance, and on that count its far more important to focus on
revenue growth than cost control. An insightful McKinsey study
(published a decade ago, but whose conclusions remain completely valid)
pointed out that small changes in revenue can outweigh major changes
in planned cost savings. A merger with a 1% shortfall in revenue growth
requires a 25% improvement in cost savings to stay on-track to create
value. Conversely, exceeding your revenue-growth targets with your
newly-acquired company by only 2 to 3 percent can offset a 50 percent
failure on cost-reduction.
And the worst thing you can do is have a sales drop-off immediately after
the acquisition which is all too common given confusion among the
newly-merged team and the customer base because you can never
make up those lost sales. Knowing the paramount importance of
uninterrupted revenue read: sales momentum the first thing the
parent company ought to do in concert with the acquired-company team
is get out in front of customers, tell them whats going on, and reassure
them. Yet its amazing how rarely that happens. As with the acquired
companys staff, with their customers, in the absence of clear
communication, rumors and negative assumptions will fill the void. So
get out in front of your newly-acquired customers, tell them theyre still
loved, and provide them with a clear, comfortable, consistent and honest
story. And when you think youre done communicating with your new
customers youre probably one-quarter of the way there.





How Normalization of Income helps you establish a value for your company.


To determine an expression of value of the net worth of shares or assets of a company, the first exercise is
to analyze and normalize the companys financial performance as if it were a company being run By the
Book.
Today, the most common thumbnail valuation methodology is based on a multiple of
normalized EBITDA. (Earnings Before Interest, Taxes, Depreciation, and Amortization)

EBITDA is the approximate measure of a companys operating cash flow based on the companys
financial statements, before charging, interest, income taxes, depreciation and amortization, plus all other
normalizing adjustments; some of the more common being described below.

Common items requiring a normalization adjustment to net income include, but are not limited to:
Management Salaries Careful consideration should be given to what a normal management
salary, or salaries, would be for the new owners to operate the company effectively. Net income
should be adjusted accordingly.
Costs that would not exist under new ownership. Automobiles, cell phone, gas cards, car
insurance, internet home office costs etc,
Family members or others on the books, who draw a salary or receive other benefits but do not
actually perform work for the company.
Commercial rent or property costs should always be adjusted to reflect actual market costs that
would be incurred if the business premises were to be leased by the new owner at prevailing
market rates.
Perks that will not exist under new ownership. Examples are personal meals, entertainment and
memberships.
Owners benefits such as key man insurance or personal term or whole life insurance, as well as
pension or RRSP contributions being paid for by the company.
Each individual company may have other costs or revenue adjustments that may be required; the above
are the most common.
A review of the Balance Sheet should then be conducted to determine what the true retained earnings or
net worth of the company is. This exercise helps identify other assets or liabilities that may impact on the
valuation of the company. In the case of a share sale, this review will also help determine how much cash
will be required to be left in the business as working capital.
Other important shareholder items of concern are loans to, or advances from, the company, and capital
gain taxation considerations
The final factor to be determined is appropriate multiple of EBITA; essential to establishing a provisional
value of your company.
"Normalization of Income: Where Business Valuation Meets Forensic Accounting, Part 1" by Terry
Silver
by Terry Silver, CPA, CVA, CFF
This article was originally published in The Legal I ntelligencer Blog.
The valuation of virtually every closely held business requires normalization adjustments. Although these
adjustments may be made to either the balance sheet or the income statement, the most common
normalization adjustments are imposed upon the income statement. The International Glossary of
Business Valuations Terms defines Normalized Earnings as the economic benefits adjusted for non-
recurring, non-economic, or other unusual items to eliminate anomalies and/or facilitate comparisons.
As closely held businesses are controlled by one or just a few individuals, the valuation analyst should
consider whether the economic benefits being paid to its owners are above, below or at market levels.
Sometimes the analyst can easily identify which items require normalization and at other times the analyst
is left to his or her own devices to identify the income normalization issues.
The International Glossary of Business Valuations Terms defines Fair Market Value as the price,
expressed in terms of cash equivalents, at which property would change hands between a hypothetical
willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open an
unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable
knowledge of the relevant facts. Both the hypothetical buyer and seller base their respective value
estimates on the anticipation of the entitys true economic income. Normalization may be required to
adjust to the true economic income.
Examples of common items that are normalized in the valuation of a closely held business are:
Related party rent
Prerequisites such as insurances, automobile, employee benefits, etc.
Items that would normally be considered personal, but are nonetheless paid for through the business
Owner and related party compensation
Business owners sometimes compensate themselves with the remaining profit left over after the payment
of all other business expenses. The analyst must determine whether that compensation is at market level.
Fair market value requires that the future cash flow be burdened with the market level compensation
instead of the actual compensation that was designed to soak up any remaining profits. There are
databases that assist in identifying market level compensation by reference to industry, location and
employee demographic attributes (age, responsibility, experience, accreditation, etc.) The analyst
normalizes the owners compensation actually paid to a level consistent with their peers.
Entities often lease real property, machinery and equipment from related parties. The rents set by the
owner(s) may be above or below the market rental. Any excessive or bargain rents paid between affiliates
require normalization. Owners sometimes manipulate the entitys earnings by diverting revenue,
enhancing expenses or fabricating journal entries. Because the identification of true economic income is
so vital to valuation, the analyst may find it necessary to go to more extreme steps, for example, a forensic
examination. A forensic examination includes the interviewing of management and employees, obtaining
information from other third parties, and the use of data mining software. More on that in my next
posting.



1. Business Risk
A company's business risk is the risk of the firm's assets when no debt is used. Business risk is the risk
inherent in the company's operations. As a result, there are many factors that can affect business risk: the
more volatile these factors, the riskier the company. Some of those factors are as follows:
Sales risk - Sales risk is affected by demand for the company's product as well as the price per unit of the
product.
Input-cost risk - Input-cost risk is the volatility of the inputs into a company's product as well as the
company's ability to change pricing if input costs change.
As an example, let's compare a utility company with a retail apparel company. A utility company
generally has more stability in earnings. The company has les risk in its business given its stable revenue
stream. However, a retail apparel company has the potential for a bit more variability in its earnings.
Since the sales of a retail apparel company are driven primarily by trends in the fashion industry, the
business risk of a retail apparel company is much higher. Thus, a retail apparel company would have a
lower optimal debt ratio so that investors feel comfortable with the company's ability to meet its
responsibilities with the capital structure in both good times and bad.

2. Financial Risk
A company's financial risk, however, takes into account a company's leverage. If a company has a high
amount of leverage, the financial risk to stockholders is high - meaning if a company cannot cover its debt
and enters bankruptcy, the risk to stockholders not getting satisfied monetarily is high.

Let's use the troubled airline industry as an example. The average leverage for the industry is quite high
(for some airlines, over 100%) given the issues the industry has faced over the past few years. Given the
high leverage of the industry, there is extreme financial risk that one or more of the airlines will face an
imminent bankruptcy

The two primary risks that every company has to face on a daily basis are business risk and financial
risk, and contrary to common belief, they are not one in the same. Understanding these two types of
risk is critical for keeping your company profitable and manageable, especially during times of
economic uncertainty.
Knowing the difference between financial risk and business risk is also important when it comes to
speaking with investors, financial institutions, and other people or organizations that may have a
financial interest in your company.
What Is Business Risk?
Business risk usually involves all of the risks attributed to the businesss strategic decisions, with the
exception of the companys financial decisions. Such risks could include the decision to introduce a
new product or service into the market, or a potential partnership with another company. In
estimations of business risk, internal efficiency and production quotas are commonly measured to
determine whether or not a key business decision is worth the risk.
What Is Financial Risk?
A companys financial risk is predominantly targeted at its shareholders and those who own or buy
the companys stocks as this type of risk is based on how a companys finances are structured, and
traditionally focuses on corporate debt. Companies that rely heavily on business financing are often
considered risky.
What Affects a Companys Business Risk?
There are several factors that can affect the business risk level of a company. The fluctuations in
demand for a certain product or service can certainly affect business risk as this will have a direct
impact on a companys profits. In addition, every time a competing company introduces a similar
product to the market, it has the potential to drive down costs and sales, both of which can affect a
companys earnings. Changes in business risk can also be attributed to external factors like
government actions and changes in consumer preferences as well as internal factors like the
companys ratio of fixed to variable expenditures.
What Affects a Companys Financial Risk?
One of the most common things that can affect a companys financial risk is the quality of the
financial system within its country of operation. If a company is based in a country that has a poorly
functioning financial system or devalued currency, its financial risk will usually be relatively high as
the companys holdings could easily be eliminated. For most American-based companies, however,
their financial leverage is usually used to determine their risk level. Financial leverage is a
companys debt to equity ratio. The more a company relies on debt to finance the business, the
higher their financial leverage is and therefore, the company is a higher financial risk.
Definition of 'Capital Structure'
A mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The
capital structure is how a firm finances its overall operations and growth by using different sources of
funds.

Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common
stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also
considered to be part of the capital structure.
Investopedia Says
Investopedia explains 'Capital Structure'
A company's proportion of short and long-term debt is considered when analyzing capital structure. When
people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which
provides insight into how risky a company is. Usually a company more heavily financed by debt poses
greater risk, as this firm is relatively highly levered.

These two terms, merger and acquisition are frequently used as though they are synonyms, but have
different implications. The main difference between a merger and an acquisition is their mode of finance.

A merger takes place when two companies, usually of around the same size, decide to become one new
firm instead of being seperately owned and operated. This type of action is more exact reffered to as a
merger of equal value. Both companies' stocks are given up and new stocks are distributed in its place.

However, real mergers of equal value don't often occur, normally, one of the companies will purchase the
other and as a portion of the contracts' conditions, merely permit the attained company to declare that the
deed is a merger of equals, although it's officially an acquisition. To be purchased very so often bears
negative conotations, nonetheless, by describing the transaction as a merger, contract makers as well as
the chief managers try to make the buyout more acceptable.

A securing contract can as well be known as a merger if the two CEO's be in agreement that joining
together is in the paramount attention of the two organizations. But if the contract is not acceptable, that is
when the aim organization doesn't want to be bought, it is at all time considered as an acquisition.

For a purchase to be viewed as a merger or an acqusition actually depends upon whether the purchase is a
pleasant one or unreceptive and the way it is announced. The actual difference however, is in how the
purchase is articulated to and accepted by the target organization's top managers, the workers, and the
owners.

An acquisition is a bit different from a merger, infact, it might just be the name that differs. In the same
way as a merger, an acquisition is an action by which organizations seek out bargains of weight,
effectiveness as well as improved market connectivity. The only difference between mergers and
acquisitions include one organization buying the other, they don't have to exchange reserves or alliance as
a new organization.

An acquisition is very so often agreable, and all the parties involved feel more satisfied with the deal.
Another kind of acquisition is a reverse merger, a deal that allows a private organization to get openly
listed in a very limited period of time. A reverse merger happens as a private organization with strong
prognosis is keen to increase its investment purchases an openly registered organization, normally one
without a business and with very limited assets.

Acquisition vs Merger

Diffen Economics Business
Although they are often uttered in the same breath and used as though they were synonymous, the terms
merger and acquisition mean slightly different things.

Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is
friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is
communicated to and received by the target company's board of directors, employees and shareholders.

When one company takes over another and clearly established itself as the new owner, the purchase is
called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows"
the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go
forward as a single new company rather than remain separately owned and operated. This kind of action
is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new
company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when
the two firms merged, and a new company, DaimlerChrysler, was created.

In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy
another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a
merger of equals, even if it's technically an acquisition. Being bought out often carries negative
connotations, therefore, by describing the deal as a merger, deal makers and top managers try to make the
takeover more palatable.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the best
interest of both of their companies. But when the deal is unfriendly - that is, when the target company
does not want to be purchased - it is always regarded as an acquisition.