Acquisitions often seem to be an expensive way to destroy value rather than creating it. That is often because standard due diligence procedures don’t even look at the main reasons behind M&A failure.
Readers are often told that half of M&A deals fail to add value. A 2012 report from McKinsey is a typical example. Its analysis of shareholder returns at the world’s top 1,000 non-banking companies, which among them had completed 15,000 deals over a decade, showed that large deals resulted in negative returns of ‑1.7% for investors. Large deals in fast-growing sectors fared even worse, delivering returns of ‑12% for shareholders. While executives were distracted by integrating the newly merged companies, they missed the necessary innovation and new product launches required to keep up with their rapidly growing marketplace.
To be fair, the report also shows that different types of M&A strategy produce different results—companies that made a number of small acquisitions to increase market share did succeed in boosting shareholder returns.
Encouragingly, a more recent report, again from McKinsey, suggested some deals do create value, at least in the short term—though the same report suggests that this value is all accrued by the acquired entity. The fact remains though, that M&A can be a leap of faith.
If we stick to an examination of why so many deals go wrong, failure can often be blamed on causes that standard due diligence procedures miss completely. The most critical risk an acquisitive company faces is human risk—how the behavior and reputation of management, shareholders, suppliers, and regulators can increase or undermine value in a business. The vast majority of due diligence requirements, on the other hand, involve looking at financial and legal records and public documents. Due diligence can be reduced to getting ticks in the necessary regulatory boxes, and tends to be passed down the chain to junior staff.
However human intelligence gathered from discreet sources such as ex-employees, customers, suppliers, competitors, and regulators can help your company understand vital issues at the target company, from the management’s track record to its reputation in the market, or the target’s relations with stakeholders.
Having this sort of information to hand early in the deal process can influence negotiations on terms and price. Without it, buyers can feel that advisers on both sides, or at least those with a success fee, have a vested interest in the deal progressing at the highest price, whatever is going on beneath the surface.
Deals where human intelligence is particularly relevant are those involving asset-rich companies or service providers where human capital is vital, such as advertising. In the former, proper due diligence can ascertain whether assets are worth what they’re purported to be, and assess the relationship with local governments and agencies awarding vital licenses and access. In the latter, knowing whether the company might lose its big rainmaker and his or her clients and contacts—information that won’t be contained in last year’s accounts—has a significant bearing on what a fair price for the business would be.
Combining publicly available information and financial results with human intelligence is also particularly important in emerging markets, where public and financial records may be inaccurate or very limited. K2 Intelligence’s strategic M&A advisory work has increased since companies started going further afield to do deals, because of our experience and knowledge of these markets.
Taking time to analyze the human risk at a target company, as early as possible in deal cycle, can pay off handsomely. The worst it can do is reinforce your decision, but it may help you avoid a costly mistake.
- There is valuable information to be uncovered in developed and developing economies prior to any M&A, if you know where to look. One recent K2 Intelligence case was for a client looking to expand in the United States. It asked us to review the assets and operations of three businesses.
- K2 Intelligence identified and interviewed numerous sources including the previous management team and large suppliers. It also assessed output at plants and made test purchases to verify quality. We established that while two of the businesses appeared to be operating as described, the third was underperforming, with a poor management team and declining customer base. Based on the findings, the client was able to negotiate a lower price than previously agreed for the deal.