Creating Corporate Development Acquisition Strategies

I'm Kisam Patel and you're listening to M and A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies, and what actually happened during M and A Deals. In this episode, Joe Feldman and I explore M and A from a business.

Consultant'S point of view.

Joe has owned his own consulting practice for over a decade and works with middle market companies on acquisitions. He has extensive experience in diligence checklists, company inconsistencies, post closing surprises, and getting help from deal savvy lawyers while closing deals. Here's more on Joe's background.

Good morning. It's great to be here. For the last 10 years I've had my own consulting business, Joseph Feldman Associates, and my primary activity is working with middle market companies on acquisitions. So I help companies that don't have a corporate development executive as part of their team to help them develop an acquisition strategy, identify potential targets, and move ahead to close those transactions that are most attractive to them.

You know Joe, the reason I wanted you to come in and chat with me is I know you've published a lot of stuff around diligent surprises and it's always an interesting point in the interviews I have. I wanted to hear a little bit, maybe start the conversation off with what you think the best due diligence checklist is in your experience?

Sure. The question that I hear from time to time is can you share with me the best diligence checklist you've got or the one that's best for us? And I think it's a little bit of a trick question. So on the one hand I've seen a lot of different checklists that I think are really terrific as prompts for legal questions, accounting questions, environmental questions and the like. And you can find a lot of these online. In the meantime, I think one of the the most detailed ones that I've seen was published by Grant Thornton in collaboration with Dicoma. It's available online. It's got almost 500 bullet points with ideas of questions that might be asked as part of an acquisition process. And of those questions, none relate to a lot of the places where surprises are most prominent, those being related to organizational fitness, culture, potential changes that might occur with customers or suppliers. So checklists are can be useful as a starting point, but they can also give you a false sense of security if the thought is, well, all we have to do is complete the checklist and then we're, we're done and ready for closing.

I think at some point the goal is to encourage the team to start thinking outside the checklist. How would you go about doing that?

Well, one of the things that I have advised clients early and often is to start the integration process at the time that the acquisition campaign begins. That can be at a modest scale to begin with, but it needs to begin. And by integration planning, I mean starting to involve the operating executives of the company who are oftentimes excluded from the deal process. In the thinking about how a particular company might fit with the firm that's doing the buying makes sense.

Now, in terms of executing the diligence process, what would be the strategy to eliminate post closing surprises?

Well, I think the goal should be to prepare for post closing surprises, not to eliminate them. I've had CEOs or CFOs say to me something along the lines of have we completed due diligence? And I think while the intention is not to imply that that work is said and done, the expectation is that the response is going to be yes, we're all done and ready to go. I think what's better for a company is to try to anticipate where surprises might come, what flavor they might take, and to prepare for a wide range of different possibilities that they might see. So I'll give you one example. Companies in not all acquisitions, but in most are going to have certain key employees. They could be at an executive level or they could be key salespeople or key research scientists. And knowing you know what those individuals intentions are after the closing of the transaction can be difficult if not impossible to know beforehand. So the assumption might be, well, these are key folks and we're going to want to keep them no matter what. But the no matter what may not involve actually talking with those individuals before the deals close because you may not know who those folks are, you may not have access to them during the negotiation process. And even if you do have access to them and have had a conversation, it could be that what you have to offer them before the deal closes is not consistent with really what they have in mind when they're still trying to be part of selling the company. So the idea that you might have to deal with an employee who you thought was critical to the organization, who leaves or who is not happy or who turns out to be not a good fit within the culture of the go forward company. And so having multiple different scenarios in mind is one way to prepare for a potential surprise as opposed to thinking that you can completely eliminate that risk.

It seems like a big challenge because companies can get so large and Complex and I guess how would you think that through and map out what those different scenarios would be?

Right. So each case is obviously specific to itself. I think financial modeling is an area where scenario analysis is, is maybe easier to, to get your arms around and might be useful as a jumping off point. So the idea of identifying the key drivers in how value will be created from a mathematical standpoint. So I think deal deal executives and, and certainly bankers and other advisors are very accustomed to looking at a set of financials and saying, okay, the key drivers here are price or certain new product volume or expansion into new markets or certain synergies that might be realized. And mathematically you can identify the top, say, three, four or five drivers of value and also potential risks of not achieving the results you have in mind. Each of those different scenarios on a spreadsheet will correspond to different scenarios that might exist with people in the organization or people who are in key positions at customers or maybe key positions at suppliers. And so that can be a good jumping off point to identify where you might look for surprises or where you might look for uncertainty.

You ever heard of anybody getting sideswiped out of something outside of those areas?

I can think of one example, a company that a friend of mine is the CEO of, it's a specialty retail business and they had about 20 different locations in the market that they were serving and they were regularly looking for opportunities to expand. Sometimes they would open up a brand new location, sometimes they would buy up a competitor and convert that retail location to their brand. And it was a very high touch service business. And they had identified a particular location that they thought was terrific, and it was in a neighborhood that they thought really suited their branding. And when they, so they negotiated with the, with the existing owner, the owner ran the individual store location and everything sort of looked hunky dory going into the deal. What they found within the first, say, 30 to 60 days after the deal was closed was that the staff, the frontline staff that were dealing with customers were very, very quick to offer discounts and giveaways and other, I'll say, off the books incentives that were part of the way they did business and part of the way they saw themselves serving customers well, but were very inconsistent with the brand that my friend was using across his other locations. And so what he found was that the profitability at that store was low and the satisfaction of the customers was also low. So even though they were getting maybe a better price, they felt like they were being pandered to and not being treated in A in a special way. And they, they tried bringing new staff in, but the location really was in a way damaged goods. And so that local community never could see the, this old, old retail location as having the higher quality of service that was part of the brand. They ended up having to close the store entirely.

I mean, do you think that was just culture of the management team for the location or culture of the community?

I think it was the culture of the frontline staff. And with retail, at least in this particular case, it was very hard to shake the reputation that that particular location had among its customers. And so the, you know, ultimately the decision that they, they had to make was close the location and start up a brand new site in a different part of the community. And they were successful in that regard. But they had a pretty significant misstep because that frontline staff had really spoiled the image of that particular location. Retail is a pretty cruel business in that regard.

Now when you're going through diligence, was there opportunity to have a management meeting and understand sort of what they were working with in terms of the management team over there?

In that particular case?

Yeah.

So in that particular case they were able to, I'd say they probably had greater access to all the aspects of the business than, than you'd find in a more substantial acquisition. This was one retail location in that was considered for addition to an existing retail chain that had just under two dozen locations. So a relatively modest size operation. So there wasn't so much management meetings. It was a question of looking at the financial statements being in the store and looking at the, at the assortment, understanding the demographics of the community and getting a sense of whether the brand imagery that might be brought in from the buying company could be applied in this location. And they bought many different individual locations over time. So it was really one more execution of a game plan that they had undertaken. But this one just turned out to be harder to read than they ever could have imagined. That the people in the community who went to that location knew that they could always get a cheaper price by asking. And that continued to drive down the quality of the product that was being offered. And it was a scenario they just couldn't see their way out of.

Yeah, hard thing to read up front. What other surprises have you seen outside of, I guess talent related or people exiting key hires exiting early? What other types of surprises have you seen post closing?

Sure. So I'll give you one example that's on the plus side. I was working with a consumer products company and they have a stable of really well known brands. And they were looking for new brands that were, I'll call them up and comers who they might be able to take advantage of their retail distribution, their expertise in consumer marketing, and particularly in social media marketing. And we identified such a company and we looked at a variety of different synergies that we thought would be would be interesting, including with existing key customers, key retailers in the grocery channel, in the mass merchandiser channel and the club channel. And those were relatively straightforward for us to think about. We also thought about international opportunities and the conclusion we came to was that international opportunities are just not going to be very interesting for this particular brand. Shipping costs would be very, very high. Distribution in some of the key markets, particularly in Asia, that this company did business with were very, very competitive. And so from a synergy and value capture standpoint, we really dismissed international expansion as an opportunity. Within two or three years of the deal closing. The markets in Southeast Asia in particular were a source of incredible growth for this, for this purchase brand. So from a synergy realization standpoint, we ended up getting, my client ended up realizing a significant amount of value that was completely discounted when we went into the deal. So that was a real upside for my client.

Good surprises. That's nice to hear. Why do you think so many acquisitions fail or are considered unsuccessful?

Well, this is a question that I wish I had an easy answer for. I can offer a few observations based on my experience. So probably the most immediate response I'd say is executives can risk falling in love with a transaction and begin to look at an opportunity with rose colored glasses and everything looks good and the risks and potential downsides are too easily dismissed and the conversation within the company becomes too driven towards we're going to get this deal, we're going to win the deal and we're going to be successful realizing synergies and we're going to not run into any bumps in the road and all of our best case scenarios are going to be realized. And it's at the end of the day a scenario that I hear about time and time again. And I think that's one reason that acquisitions are not as successful as they might be. Because expectations going into the close sometimes can be so high that realizing them is going to be extremely difficult. I think another way to think about acquisition success is, and the difficulty of achieving success is that acquisitions are a multi pronged growth strategy where you're doing three or four or five different initiatives related to growth all at the same time. So it could be that you're entering a new market. It could be that you're launching new products. It could be that you're trying to realize expense synergies by bringing two organizations together and realizing the benefit of operational efficiencies. Any individual one of those initiatives might have a 90% chance of success or maybe an 80% chance of success. Achieving success with, say, all five or all four or maybe more of those individual initiatives require success probabilities that mathematically move you way below 100%. So if you've got, say simplistically, four different initiatives, each one has a 90% chance of success. And you take 90% times 90% times 90% times 90%, pretty soon you're down to just over a 50% probability of success. And 90 might not be the right number to begin with. So I think that's another also mathematical way of thinking about how challenging acquisitions can be.

That's a good way to look at it. What would be your consideration to counter that?

Well, what I, you know, going back to something we talked about earlier, I think bringing operating executives into the conversation as early as possible is a significant way to mitigate the potential risks of failure or disappointment with acquisitions. So thinking about, you know, where are the surprises that we might encounter and how might we best prepare for those? So not how do we eliminate the risk, but how do we prepare? What are the different value enhancing opportunities that we might have available to us? And then thinking about those as a portfolio and then valuing the portfolio not based on succeeding with each and every one of those initiatives, but based on success with say three out of the five, or maybe it's two. Two of them are definitely going to succeed and then maybe two of the remaining five are going to be successful. So you're tempering your expectations about how many different home runs you're going to be able to hit with a given deal. I think those are ways to mitigate the potential for disappointment.

How much transparency would you keep with that operational team? Because I feel like the one of the biggest challenges even throughout the integration is breaking the bad news. We're going to do massive headcount reduction in this department. How would you go about that?

Well, I think there's an obvious tension between confidentiality associated with the deal on the one hand and bringing operating executives in on the other hand. It's going to be even more sensitive in the case of public companies where discussion about potential deals might be necessarily limited to a very, very small number of executives, none of whom might on a day to day basis be responsible for the deal after it closes. So obviously the CEO is still responsible, but the operating executives who are going to be doing the integration might be involved to a lesser extent. I think that's a dynamic that has to be looked at very closely and I think erring on the side of including operating executives earlier than not is advisable and will pay dividends. In terms of better planning of what the deal can deliver, greater assessment of what the risks might be and how to prepare for them, and finally better identification of very high risk possibilities that might be mitigated ahead of a deal closing.

What risk or surprises do you consider the easiest to uncover?

Well, I think the easiest to uncover are those that are subject to check the box kind of diligence. So that could be looking at, in the case of manufacturing companies or companies that have a significant number of physical operations looking at environmental studies, those can be relatively straightforward to to identify. So I'm not dismissing the complexity associated with those experts, but the, the mission and the standard by which those sorts of of surprises are judged is a relatively straightforward activity. Accounting and tax diligence can also be relatively straightforward again because the baseline that you're comparing against is well established and as a general matter, not subject to much interpretation. It's always the people side that gets to be more subjective and challenging.

Are there things that require thinking out of the checkbox to find or how do you go about getting your team to think outside the checkbox to see a different view of potential hidden surprises that could come up?

One thing that I've seen companies focus on and I think it's really appropriate is how customers are going to react following an acquisition. And I think some of the most successful pre closing activities that I've seen are role playing or role playing based activities on the part of the acquirer. So thinking about having executives in the company play the part of a major customer or some customer that's critical to the success of the business and playing out the conversation that's going to take place after the deal closes when the buyer or one of the representatives, or maybe it's even one of the current contacts from the seller calls the customer and says in effect great news, this acquisition has just closed. And then having a variety of different role playing scenarios where the customer says something other than well that's wonderful, I'm so glad to hear that and I look forward to years and years of fruitful business together. So it could be that the role playing explorers, well that's great, I hope my price drops by 20% or that's interesting. I don't plan to renew because the company that, you know, that just made this acquisition is one that I would never do business with. I had a bad experience years ago. And then there's a variety of other obviously specific conversations that might be explored. And just thinking those through ahead of time can be a very effective tool for. You could say those are rehearsals for the live performance after the deal actually closes.

That makes sense. During diligence, would you ever consider working with a third party to doing more of that in depth? Customer diligence.

So I've seen different organizations who offer customer diligence services. They can provide expertise by reaching out to former employees. They may have expertise through other industry contacts about what the trends are and what certain customer preferences are. But there are natural limitations to how much a customer is going to be willing to share with anyone ahead of an acquisition. And there's also going to be a lot of sensitivity on the part of the seller to how much access they will permit ahead of the acquisition. So there's often a lot of sensitivity to both the buyer and the seller of having customers weigh in on what their intentions are before an acquisition closes.

How about lawyers? Can they help mitigate the risks of surprises?

I think there's two very significant ways that lawyers can be helpful with surprises. So from a strict legal standpoint, there are lots of terms and conditions in a purchase agreement that are informed by a specific deal. So representations and warranties, holdbacks, earnouts, different terms and conditions that are contingent on certain truths being borne out or certain risks not coming to pass. And lawyers who are experienced with deals can be very, very helpful in identifying what are the market trends for representations, warranties and holdbacks, and also distinguishing general deal terms like there's no fraud with more specific representations and warranties. Where, for example, there might be. I can think of one scenario where I was working on a deal that involved certain transactions with a European supplier, and there was a question about whether certain royalty payments to that supplier had been properly withheld by the company that was being purchased. And it was not something that we were going to be able to resolve before the deal closed. But in working with the attorneys on both sides, we were able to very clearly define this as a specific representation with a specific holdback and a specific timeframe. So one way or the other, it would be resolved based on how the tax treatment was ultimately dealt with the company's tax filings. So that's one example of lawyers helping. The other is lawyers that are deal savvy. Can bring their expertise and bring their knowledge of other deals to bear far beyond their narrow legal contributions. And certainly finding lawyers who have an appropriate amount of deal expertise is crucial. I've seen particularly smaller companies that have a preferred legal counsel who's been their commercial attorney for a range of different activities, employment matters, incorporation matters. And they say, well, this is who we like to work with and we want to have them work on the deal. That can often be prelude to disappointment because you're not getting the expertise, whether on the deal side or more broadly on how issues might come up.

Are some types of acquisitions more susceptible to surprises than others?

Well, I think a few examples that come to mind are cross border deals. So if a company is acquiring a business in another country, that raises a number of issues which might be different than any that they've encountered before. Different language, potentially different laws, different contractual traditions or habits. So that's one I think as a general matter, companies that are very people intensive, so service businesses can be, I think, thought of as more prone to surprise because there's more value tied up in the people. And I think maybe a third example would be companies that have a very high degree of customer concentration or supplier concentration. I think that's a significant one. One acquisition that I was working on had the company that we were looking to buy had one customer who represented about 50% of the volume. And they were longtime customer of the buyer as well as the seller. So it was certainly a company that we knew fairly well. But we also knew that the risk of keeping the account was relatively high in any given year. And so in this case, we were buying a business that had about 50% of their volume in this one customer. And within a year after the deal closed, that customer decreased their volume by about 50%. So that was a huge surprise. We had certainly looked into what the, what the likely trends would be. We also had looked into other customers that could be brought in to replace lost volume if that were to happen. And in fact that loss volume was made up. But of course it takes time to, to do that. So that was a real, you know, that was a really big blip and an example of a high surprise risk deal.

Yeah, I can see that happening when you have that low concentration of a customer base. How about bankers? How can they help mitigate risk of surprises?

Well, I think they can certainly help with financial modeling that then serves as a basis for identifying operational areas that are going to be critical to the success of the, of the acquisition. And they also can bring to bear their experience with other related deals. The thing to keep in mind is investment bankers get paid for deals closing. And so their, their motivation is going to be to, to have a great client relationship, but first and foremost to have the deal closed. So I think, you know, that's an area where bankers can be very helpful, but it's always good to keep in mind that their incentives are to get the deal closed. A friend of mine who's an investment banker used to talk about how wedding planners don't predict great marriages, they predict great wedding events. And in the same way, investment bankers can be very helpful to having a really successful deal close, but they won't necessarily be helpful to how that post closing enterprise operates on a go forward basis. So it's just, it's important to remember their job is to focus on the transaction, not to focus on the durability and the long term capture of value.

Now you've done a lot of research and taken surveys focused on post closing surprises. What are some of the interesting things that you've seen from that?

So one of the most interesting things I've seen is that members of boards of directors who I've spoken with have I'd say a relatively straightforward view about what makes acquisitions successful, which is to say I want to see an opportunity presented that is straightforward, that's ambitious, but is also presented with a level of humility and a level of candor so that I can understand what is, you know, what the management team is bringing forward. So I think that's, you know, I'll say simpler advice than I would have expected. You know, as far as how to prevent surprises coming up that you're not prepared for. Many board directors that I've spoken with say, let's keep this very simple and if there are red flags going off about a culture not fitting, or if there are red flags about customer concentration issues, let's step away or let's look at a price or a structure that's going to be satisfactory. That was pretty surprising to me just.

Having a board that's realistic about their view of the transaction.

Right. And that's not to say that there aren't boards that are going to be very aggressive and push the management team in a very aggressive way and have very, very high expectations. But I think whether public boards or even private equity boards, I think the ones that I've seen that are most successful and that I've spoken with about how you prepare for potential surprises all say the same thing, which is be humble, take it one step at a time. Don't be so ambitious that you're biting off more than you can chew and be prepared to under promise and over deliver.

So what's the craziest shit you've seen for a post closing surprise?

I'll tell you a story that a friend of mine told me. He ran a medical products company and his acquisition team brought forward an acquisition. They were very excited about it, really excited about the CEO coming in and being a part of the go forward organization. And they negotiated a, a deal. The CEO who was still a very significant owner of the company, had a tremendous payday, just took home, I think it was tens of millions of dollars, maybe more. And they signed an employment agreement with the CEO. So they thought they were all set there. And the Monday morning after the deal closed, they had planned a the first session at the corporate headquarters to discuss the how the two organizations were going to begin to implement the integration plan that had been jointly developed by the buyer and the seller. And the CEO wasn't there. And so my friend who was the CEO of the buyer was asking, you know, where's, you know, where's this guy, what's going on? He's always here, he's always on time. And they couldn't, they couldn't figure out what was going on. So they started calling around and they finally reached his assistant who said, oh he's in the Caribbean somewhere, he's on some island. So they got ahold of him and he said, you know, I decided that I've got all the money I need and this is a great thing and I think I'm done. So I won't be at your meeting today and I'm not going to join the company. I'm going to declare victory. And so this friend of mine said after that he was much more sensitive to making founders rich who are part of the buyout and thinking about what that might look like. Even when you think you've got it all figured out and have a go forward employment agreement, sometimes you might have what he came to refer to as the island problem.

Wow, that is a pretty big one. Would that also turn into be the most costly surprise you've seen?

I think the most costly that I've seen are deals where the integration was deferred all the way through the closing of the deal. I can think of one transaction that I worked on. It was a company making its first cross border deal. They had done business in one market outside the US always through a set of collaborations and they finally decided that they had enough business in that market that it made sense to try to buy an existing player that had the infrastructure and certain customer relationships that they could then use as a, as a base of operations. But they didn't have anyone in the home office who was prepared to move to that other market to run the business. And the founder of the company that they were interested in buying had already indicated interest in leaving and going off to do something else or to retire. So there was really no game plan for who was going to run the business on a day to day basis. And trying to do that remote became the default game plan. And that was a huge disappointment. And so they ended up losing a lot of the business that they bought and it made it dramatically harder for them to transfer some of the existing business that they had with other collaborations into this new entity. So it was really a, from an operational standpoint, it was an integration that really just never got traction.

So the big fail point was just.

Poor integration planning, the absence of, of integration planning. It was the, you know, integration planning began the day after the acquisition closed. Rather than thinking in advance, well, so who are we going to send, you know, who's going to be on a plane to run that office and to be the point of contact, even if it's on a, on a six month basis to get things going? That was all deferred and much to the company's disappointment.

Thanks for tuning in to M and A Science. We hope this podcast provided valuable insights. If you have interesting M and A stories or suggestions to share, reach out to me. You can find my email in the Show Notes as well as any links or tools mentioned in the podcast. Join us next time when we uncover more perspectives to successful MA transactions. This podcast was brought to you by Day One Day One takes an agile approach to the management of the entire M and A lifecycle process. We develop strategies to drive innovation, to create the highest return on M and A transactions. Day One can work with you to implement custom solutions for your most complex problems. Visit ondayone.com to learn more.

Sam.