With a big smile and wave, Aiden McPhee walked through French Laundry to your corner table. You put down your glass of 2010 Silver Oak Cabernet, giving him a big hello.
“I can’t believe the traffic,” he said. “Yountville is hard to get to these days. Hey, great restaurant. Didn’t I hear that French Laundry just received another three-star rating from Michelin?”
You settled into a casual conversation, fueled by excellent wine and exquisite appetizers. Soon the conversation turned to McPhee’s company. Weblastic was a dealer website platform company. A recent entrant to the space, it had nonetheless grown meaningfully over the past three years. Two hundred auto dealers were now live on the platform, translating into $8M revenue.
McPhee was Weblastic’s founder and CEO. He took pride in the fact that he had built the company from scratch with no external funding — just a $4M loan from his father. Indeed, you were impressed. You knew only too well how hard it was to start and scale a company, even with external funding. As you took another sip from your glass, you pondered how to broach the subject of acquisition.
“Aiden, you know I’m interested in buying your company. I like your product. It’s designed for today’s mobile, social, transparent, consumer-centric world. There’s lots of flexibility for dealer customization. I like your team. Your product and engineering guys are top notch. And many of your numbers look great. Churn is very low, your NPS scores are high, gross margins are solid, and customer acquisition costs are reasonable. But now we’re talking price. And I can’t justify the valuation you are asking for — for two reasons. First, for your stage of company, your rate of growth is too slow to justify a 5X multiple on revenue. Second, unlike your top competitors, you don’t have any manufacturer endorsements that we could leverage to drive faster growth.”
McPhee’s lips pursed in consternation. “This company’s a jewel, and you know it,” he said. “The only reason we’re not growing faster is that I’ve chosen to avoid VCs and self-fund. With your cash, you can turn on the spigot and sales will pop. My final offer is 4X revenue — $32 million, take it or leave it.”
Eight weeks later, the deal for Weblastic closed at a price of $26M — a bit more than 3X revenue. With 85% of the company owned by Aiden, he was suddenly rich. You both decided on a “slow integration” path. Aiden would be General Manager of a separate Weblastic division, reporting to you. His compensation package was determined based on market comparables. On top of the purchase price, Aiden bargained for and received an option grant equating to 2% of SparkLight Digital.
The product would continue to be branded Weblastic, with “by SparkLight Digital” shown underneath in much smaller letters. For the first six months, the only integration points would be in HR (the payroll system) and in Finance, where a separate P&L would be built and maintained in the financial reporting system. Product, engineering, and even marketing and sales would remain separate. You expected that in time, the latter two functions would begin to integrate — but this would be a shared decision.
You and Aiden made one immediate integration decision: to merge headquarters. SparkLight Digital’s new A-class office was ripe for expansion, occupying the 12th and 13th floor of the KPMG building downtown. It was home to 170 SparkLight Digital employees with ample room to accommodate Weblastic’s thirty-five employees. Weblastic’s 9,000 square feet of B-class space was quickly sublet for a profit.
At your first one-on-one meeting with Aiden after the close, you reassured him that you were committed to a slow and cautious approach to integration.
“Aiden, you can count on it — I’m not going to rush integration. At SparkLight Digital, we collaborate. Our executives all try hard to get to consensus — sometimes it takes longer, but I find that in the end, we make better decisions that way,” you said.
He smiled, then frowned. “Well, I’ll tell you this. I do expect that you will honor your commitment giving me veto rights over any integration proposal you may have. But don’t expect me to manage the same way you do. At Weblastic, I run a tight ship. No one understands the business as deeply as me, so I make the decisions. That’s why we’re so efficient — everyone knows their place.”
You frowned, then smiled. “I see. Well, we both want to make this business successful. So let’s make these integration decisions one at a time, together — including culture. You keep yours, and we’ll keep ours,” you said.
The moment you said these words, you regretted them. Autonomy yes. But two cultures? That felt risky.
. . .
The primary objective of acquisitions is to receive a positive return on invested capital. The acquiring company chooses a target based on its attractiveness as a vehicle to increase scale, to increase scope, to round out a product, or to provide needed talent.
A scale acquisition is one in which the acquired company operates a business similar to the acquirer; the thesis is to buy market share and gain cost synergies. In a scope acquisition, the acquired company brings the acquirer diversification of capabilities by adding a new market, new product, or new technology. Here, the thesis is revenue diversification and expansion. A round-out acquisition is one in which the acquired company’s product bolts onto the acquirer product thereby augmenting it to secure a competitive advantage. The thesis is higher customer satisfaction and accelerated revenue growth. A talent acquisition generally disregards the acquired company’s product and focuses on re-deployment of the acquired company’s talent.
All this is well and good, but there’s a problem: most acquisitions don’t work. Research shows that between 70% — 90% of acquisitions fail.¹ This is shocking. Indeed, Harvard Business Review researchers quipped that M&A deals should come with a warning label: “Acquisitions can result in serious damage to your corporate health, up to and including death.”²
Clearly, leaders inside acquiring companies struggle in their efforts to acquire and integrate companies successfully. This is a staggeringly expensive competency gap. To address it, we must look more closely at the four alternative theses most likely to drive acquisition — shown in the table, below.
In a scale thesis scenario, the acquirer buys new customers to grow market share and achieve cost savings. The acquired company’s products are close in features and value. They may be so close that the acquirer can convert acquired company customers directly onto its platform. But even if customers remain on separate platforms, there is still integration of key functions such as marketing, sales, customer success, operations, finance, HR, engineering, and product.
For acquired company employees, the end state of integration equates to a loss of all autonomy given subordination into the parent company. For this reason, it is crucial that before finalizing and announcing the acquisition, an integration plan is in place that identifies the impacts on each employee. A fully staffed integration team is critical to successful implementation of the plan. Many employees in the acquired company will lose their jobs as the integration plan unfolds. Some level of emotional turmoil is unavoidable. However, a poorly executed process can turn turmoil into trauma and anger. Honesty, transparency, consistency, and rapid pacing are the four fundamental principles of a well-run integration process in scale acquisitions.
The integration imperative is best accomplished when the acquiring company features an efficient, top-down decision style in its culture. If you are the CEO of a company whose natural decision style is more empowered and collaborative, you must ensure that the integration team “shifts gears” into a command-based, top-down decision style until the integration is complete. Because this is difficult, the CEO must be intentional and forceful in ensuring it. A scale integration is like surgery — it’s precise and painful. There is no benefit to dragging it out. Efficient execution requires a top-down approach.
It takes time to integrate all parts of the acquired company. Some employees remain in their jobs for a period despite knowing that they will eventually need to go. It’s critical to be clear about that with these employees right from the outset. It is common to offer a “stay bonus” to ensure impacted employees stick around. In this case, the employer-employee relationship is transactional. You can expect task compliance, but you should not expect allegiance and buy-in to the new strategy and mission.
In a scope acquisition, the acquirer buys new capability. It may be a new product, a better product, a new market, or a new technology — but in all cases, it is a capability that the acquirer does not already possess. The purpose is to diversify and expand revenue to drive continued growth. There are several reasons this might be necessary.
For example, the impetus for a scope acquisition may be competitive product disadvantage. In this case, the purchase overcomes the problem. The acquirer may shut down its product and convert customers to the new platform, or create a tiered product offering with the new platform offered as the premium product. Or the acquirer may determine its core product is bumping up against the total addressable market and continued revenue growth requires diversification. Or there may be a new geographic or vertical market that the acquirer wants to access. Finally, there may be an underlying technology that transforms product value.
The common denominator is “new capability.” In most cases, the new capability comes with a team uniquely qualified to understand and continuously improve it. Compared with a scale acquisition where the goal is to deconstruct and assimilate the acquired company to realize value, the scope acquisition seeks to do the opposite. Here, the objective is to retain the “special sauce” of the acquired company — both the capability and the team.
Since the special sauce and the team are linked, job one is to win the hearts and minds of the acquired talent. You want that team to buy-in and become full partners in the growth of the overall business. In a scale acquisition, success depends on fully leveraging the cost synergies to create added value. By contrast, the value creation focus in a scope acquisition is the successful integration and satisfaction of the acquired company’s team.
Structure your entire acquisition and integration plan accordingly. For example, deal terms should include assurances of team retention. If you are the acquiring company’s CEO, you must invest significant time and energy with the acquired company’s CEO to build trust before finalizing the deal. Specifically, you need to work with the acquired CEO to determine her role, title, reporting relationship, compensation plan, and decision authority boundaries before the close. Going further, you should seek clear alignment on vision, strategy, and culture. If you and the acquired company CEO find it difficult to sync on vision and strategy, this is a red flag: you should reconsider whether there is a deal to be made at all. Alignment in these areas is central to your entire investment thesis. Cultural alignment is also an imperative — but some variance between cultures may be tolerable for a period.
Given the purpose of a scope acquisition, it is usually best for the integration plan to specify high autonomy for the acquired business unit, especially in the beginning. The more the post-acquisition business looks to its employees like the pre-acquisition business, the less disruptive the acquisition will be — reducing the risk of talent drain.
This high-autonomy approach implies a decision-making style that is empowered and collaborative. The parent delegates significant authority to the business unit’s CEO. In decisions that exceed delegated authority and require higher level approval, the preferred approach is collaborative. The relationship between the acquired business unit’s CEO and the person he reports to should be flexible, supportive, and characterized by high tolerance for ambiguity.
Compared to a scale acquisition, a scope acquisition places a higher premium on cultural alignment, particularly regarding decision-making style. In a scale acquisition, it is challenging, yet possible, for a company that naturally prefers a collaborative, empowered decision style to adopt a more top-down approach during acquisition and integration. However, in a scope acquisition, if the acquiring company’s dominant decision style is a top-down, command-oriented style, it is highly unlikely to succeed.
To a hammer, everything looks like a nail. The command-and-control leader only knows how to be a hammer, despite the fact that this approach is sure to prompt a talent flight and destroy value in a scope acquisition. More than any other type of purchase, a scope acquisition depends on the acquiring company possessing an empowered, collaborative decision culture. Even an empowered culture may not be enough if the acquired company has a command-oriented culture. Despite significant business unit autonomy, the general manager (former CEO) may not be able to collaborate effectively with his superior and business unit peers.
Over time, appropriate points of integration arise. Eventually, there may be extensive, even complete integration into the parent. In successful scope acquisitions, these integration steps rely on a collaborative decision-making style shared by both the parent and the business unit. Further, the business unit must fully support the pace of integration.
In the round-out thesis, the acquirer purchases a company to augment its existing product or service line. The end state is to bolt-on the acquired company. The new business unit appends to an existing organizational unit inside the parent company. For example, a B2B enterprise SaaS company may spot an opportunity to sell professional services along with its platform product and acquire an independent company to achieve this goal. The acquired professional services company becomes an organizational unit inside the customer success function, with the CEO or new leader reporting to the VP customer success.
As with all acquisition strategies, it’s critical to develop a thoughtful integration plan pre-acquisition. Specific functions in the acquired company will no longer be needed — such as finance and HR. Depending on the thesis, you may not require other functions such as sales, marketing, product, and engineering. However, all talent that impacts the capability you are buying is essential. You must cultivate their buy-in using the same strategies and techniques that apply to a scope acquisition.
The round-out thesis exhibits some attributes that are the same as a scale acquisition. For example, since you will not retain all employees, a top-down, command-based approach is best until all separation steps are complete.
The round-out thesis also exhibits attributes similar to a scope acquisition: for those employees you seek to retain, you must honor their unique competencies in much the same way. Also, if you retain the CEO of the acquired company, you must build alignment around vision, strategy, decision authority, and culture before finalizing the acquisition. If you choose to hire a new leader, you must select a replacement immediately following acquisition, ideally from the ranks of the acquired company. The goal is to ensure tight alignment on direction and execution expectations.
The acquired company becomes an organizational unit inside a larger organizational unit. This larger organizational unit is responsible for the integrated product offering that includes the newly acquired bolt-on. The leader of this larger organizational unit must be the final decision maker in a way that is less empowering to the acquired company’s CEO than under the scope scenario. Only she can integrate the acquired organizational unit into a broader view of the total product offering.
Given this reality, there are fewer restrictions on the acquirer’s decision-making style than in a scope acquisition scenario. A collaborative, empowering decision style can work. The leader of the larger organizational unit has full integration authority, but the decisions that drive execution can be made through collaboration. A command and control style can also work. This approach brings a higher risk of alienation and non-alignment, but hiring and firing decisions over time will eventually yield an organizational unit that can efficiently operate under this decision-making style.
The need to acquire talent can drive an acquisition. Successful talent acquisitions depend on the parent company’s ability to retain and leverage the acquired company’s employees. In this scenario, most of the hard work happens pre-acquisition. It’s critical that the terms of the deal center on retention. Furthermore, you must sit down with each individual you seek to retain and gain alignment on vision, strategy, culture, role, title, compensation, and job expectations. In fact, this process looks very much like hiring — because it is. The objective is to minimize the post-hire risk of flight or underperformance.
In summary, you must win the hearts and minds of the employees you wish to keep before the deal closes. For those you don’t want to keep, you or the acquired company must provide a dignified termination right before or at the close of the deal.
Steps in the Acquisition and Integration Process
All acquisitions demand a significant amount of resources. In particular, they exact a toll on the time and attention of your top executives and managers even when well-executed. If executed poorly, the damage may be less at the outset, but is likely to be higher in unanticipated and adverse ways down the road.
The critical first step is to confirm you have the human resource capacity to manage the process from start to finish. Perhaps the most common mistake an acquiring company makes is to underestimate the significant costs in time and effort required to achieve successful acquisition and integration. You can’t cut corners on the project team. At each stage, you will need the full attention of every member.
The team will evolve as the process moves forward. For example, the team that develops the vision and strategy will be different than the team that conducts due diligence which will be different than the team that leads the first 100 days of implementation. From start to finish, the acquisition and integration process places an enormous strain on both the acquiring company and the acquired company. Having the right team is crucial.
Research confirms that successful acquisitions require strong leadership selection and adequate staffing of integration project teams, as seen in the graph below:³
The project team manages the acquisition and integration process through a series of critical steps:
Tejas Oza, in his presentation “Post Acquisition Integration Framework” offers an organizational structure for the integration team:⁴
This structure includes multiple functions, support areas, lines of business, and geographic regions. Of course, smaller acquisitions do not involve this level of complexity. However, the overall learning is that the integration project team is a serious endeavor. Additional sub-teams may be needed to address various dimensions and stages of integration.
Before you proceed, you must come to terms with the impact of acquisition and integration on business performance. The employees assigned to the project team are typically entirely occupied by the project. Given this resource drain, can you easily backfill? To what degree are you putting current business performance at risk? If you are putting a significant degree of uncertainty on current productivity, the acquisition may still make sense. But you should size the cost and then make sure you have full board support before you proceed. The process of integration is also likely to have a negative impact on the acquired entity’s performance, at least in the short term. Confront and accommodate these constraints in business planning.
Pay special attention to culture. While there is some variation in the importance of full cultural alignment depending on the acquisition thesis, it’s always better than non-alignment. Research by McKinsey shows that failure to address cultural integration increases the risks of a failed acquisition:
“ . . . the essence of culture is reflected in a company’s management practices, the day-to-day working norms of how it gets work done — such as whether decisions are made via consensus or by the most senior accountable executive. If not properly addressed, challenges in cultural integration can and often do lead to frustration among employees, reducing productivity and increasing the risk that key talent will depart, hampering the success of the integration.”⁵
In summary, there are ten primary reasons why acquisitions fail:
- Lack of clarity in the acquisition thesis and its strategic implications
- Inadequate pre-acquisition due diligence, resulting in negative surprises
- Failure to define the desired degree of autonomy (from mostly separate and stand-alone, to highly integrated)
- Failure to establish a new vision for the culture, both within the acquired entity and the acquiring company
- Failure to develop a comprehensive integration plan
- Failure to adequately resource the integration team and project
- Failure to select leaders consistent with decisions on the degree of integration and culture
- Failure to execute ongoing management decisions consistent with the degree of integration and culture
- Failure to communicate effectively at all levels, across both the acquiring and the acquired company
- Failure to maintain momentum in executing the integration plan
Before you finalize your decision to acquire, make sure your plans, processes, people, and financial resources fully address these risk factors.
. . .
It didn’t take long for problems to arise. The Weblastic business unit occupied 35 desks in the northwestern quadrant of the floor, right next to the SparkAction CRM’s product and engineering groups. The daily scrums were the culprit.
Every day for 15 minutes, all SparkAction CRM product managers and engineers gathered in a circle, in full view of their counterparts in the Weblastic business unit. Each day, the scrum master would go through the burn up and burn down charts, clarifying current status and the day’s required work. The weekly sprint review meeting required more time. The scrum master, product owner, and subject matter experts sat down around a mobile whiteboard to review status and plan the next sprint.
Both the scrums and the weekly sprint review meetings were brisk, crackling with round-the-circle inputs, and sometimes combative. They were vibrant displays of the empowered, collaborative SparkLight Digital culture at work. Junior programmers regularly asked tough questions of Joe. Junior product managers routinely challenged Vijaya’s points of view. Everyone knew that plans and ideas improved with critical review; at SparkLight Digital, rank was no protection from an inquisitive mind.
Ten steps away, Weblastic engineers and product managers held their weekly meetings. Aiden and his VP Product, Ashley, stood in front of chairs lined up neatly in rows, filled with engineers and product managers ready to take notes. Assignments were dished out to each worker each week. No questions. No debates.
One day, Shaleen, a Weblastic engineer, raised her hand in the midst of Ashley’s work assignment review. Caught off guard, Aiden wondered if Ashley had not been clear. “What? Shaleen, what is your question?” Aiden said.
“SparkLight Digital uses agile development methods. Why don’t we?” Shaleen asked. The engineers and product managers looked at each other then furtively glanced across the room where the SparkAction CRM daily scrum was underway.
“Don’t pay attention to them. We do things my way here,” Aiden said. “Ashley, proceed.”
Later that day, when Aiden walked into the lunch room, he saw two of his engineers at a table with three SparkLight CRM engineers. It seemed to him that his two were grumbling.
Five minutes later, Aiden was in your office. “I demand it!” he said.
“But Aiden, that’s ridiculous. I’m not going to put up a wall. It’s a waste of money, and it makes no logistical sense.”
Aiden was obdurate. You told him you’d think about it.
After much equivocation, you finally decided this was the wrong battle at the wrong time. Let people settle in. We can’t lose Aiden a month after the acquisition. The reality is that with $16M in after-tax cash sitting in his bank account, he’s a volunteer — so tread lightly. Integration, cultural and otherwise, could wait.
Two days later, the carpenters completed the wall.
. . .
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- Lakelet Capital, “Success and Fail Rate of Acquisitions,” lakeletcapital.com (blog), March 15, 2017, http://lakeletcapital.com/blog/2017/3/15/success-and-fail-rate-of-acquisitions.
- Alan Lewis and Dan McKone, “So Many M&A Deals Fail Because Companies Overlook This Simple Strategy,” hbr.org, May 10, 2016, https://hbr.org/2016/05/so-many-ma-deals-fail-because-companies-overlook-this-simple-strategy.
- Rebecca Doherty, Oliver Engert, and Andy West, “How the Best Acquirers Excel at Integration,” mckinsey.com, January 2016, https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/how-the-best-acquirers-excel-at-integration.
- Tejas Oza, “Post Acquisition Integration Framework,” slideshare.net, LinkedIn Learning, April 2012, https://www.slideshare.net/tmoza/post-acquisiton-integration-framework-to-12536177.
- Doherty, “How the Best Acquirers Excel at Integration.”