- June 22, 2020
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
Steps to execute Digital Mergers and Acquisitions successfully
Acquisitions in digital, analytics, and technology space—what we call “digital deals”—is distinct from trying regular transactions as in these deals, there are higher odds of costly mistakes. In this article, I explain the steps to execute digital mergers and acquisitions successfully. Further, I shall explain how to surmount those hurdles and join the ranks of companies that have delivered outstanding performance by strengthening their digital-transformation forces with successful mergers and acquisitions (M&A). Digital leaders seek M&A about twice as hard as everyone else. According to Mckinsey, Digital leaders spend three times more on M&A. They dedicate 1.5 times more of their M&A activity to acquiring digital abilities and assuring that software acquisitions are among their most important priorities. This statistic is before the COVID-19 crisis, presenting it even more crucial for many businesses to rewire themselves in ways that sometimes need acquiring digital capabilities.
High-performing acquirers programmatically address M&A, from strategy to deal execution and on through integration. An acquiring company usually falters before it has even begun, not conceiving through its approach or what types of assets and skills it needs to acquire. In other instances, the acquirer doesn’t adequately understand the technology it’s buying, or how to value it. And even when acquirers steer the strategy and execution phases smoothly, they can still fail during integration.
Sophisticated acquirers usually face three kinds of challenges—across strategy, execution, and integration when closing digital acquisitions.
Step 1 to execute Digital Mergers and Acquisitions successfully – Strategic readiness
Don’t assume that a deal completed on an impulse will turn out to be a winner. An acquirer must rigorously examine what it aspires to achieve, why an acquisition aligns with its direction, and what precisely it is acquiring.
Be explicit about the motive.
Digital transformation must move beyond merely acquiring stand-alone products and services to deliver to the market. An acquisition should pursue a strategic blueprint. It needs to be explicit about the strategic gaps looking to fulfill. The acquirer should be clear on the deal rationale – Why do this transaction? Is it for market leadership or Technical abilities or skill? Some sequence of those goals, or maybe for other strategic purposes? Simply because a technology works, or is on course to work, doesn’t indicate it’s the best asset for the organization.
The acquirer should first enunciate the strategy; then identify the target. It’s fine to perform a trade-off amid economic scale and cash flow, on the one hand, and more uncertain (though possibly pathbreaking) innovation, on the other, so long as the firm understands what it is acquiring. Acquirers that buy profitable, mature assets cannot demand game-changing innovation. Other times, companies requiring fast growth or earnings accretion are frustrated when buying compelling intellectual property (IP) with limited commercial traction.
Mature acquirers understand the distinction. They ensure they are spending on what they need. If a transaction, however attractive, doesn’t fulfill a demonstrated gap, the acquirer is setting up for failure.
Perform technical due diligence
Still, if the strategy is explicit, it will be jeopardized if what one buys from a technical viewpoint turns out to be not what they believed were purchasing.
Technical due diligence is the sole most significant differentiator of deals done thoroughly—or inadequately. In many transactions, technology does work, but only in controlled environments, and won’t scale. In other instances, crucial parts of the IP turn out not to be held by the seller.
Some businesses do more limited technology due diligence on targets they intend to buy for millions of dollars than on firms they are assessing (assume, for an internal pilot program) for a fraction of the price. One reason is the inherent confidentiality associated with M&A. Large, market-moving transactions need consideration—which can be questionable for digital deals if it hinders leaders from bringing individuals with crucial engineering know-how into the information loop. Further compounding matters: some businesses may not even have the in-house ability to verify that the target can do what it implies to do.
Experienced acquirers always attempt to assess the target’s technology before a transaction. Digital M&A is a skill, and best-in-class acquirers approach it that direction, with dedicated technology teams to stress-test planned acquisitions. It’s ideal to be a customer before one becomes an acquirer; this factor only can dramatically decrease risk. If that’s not feasible, do whatever to become well versed in the technology before the acquisition, and understand how it will function within the organization under real-world circumstances.
Step 2 to execute Digital Mergers and Acquisitions successfully – Strategic readiness – Financial outlook
Making the valuation wrong can, of course, ruin returns as well. Mature acquirers take pains to recognize value from a range of aspects—not only from the view of the acquirer but further from that of the target and “the market.” Acquirers less intimate with digital M&A may fail to value a digital asset correctly. That usually arises from misunderstandings about the value proposition.
Analyze the root source of value.
As M&A in the digital, analytics, and technology areas is decisive, it usually is expensive. “Underpaying” is nonsensical; bid excessively low, and you’ll the acquirer miss out.
However, what does it purport to “overpay”? For instance, let us evaluate the acquisition of Instagram by Facebook. At the time of the transaction, Facebook was amongst the most valuable technology companies in the world. It had experienced numerous years of extraordinary growth, and its skilled workforce had a superior standing as an innovation powerhouse.
When Facebook acquired Instagram, the platform had generated practically no revenue but had the potential to complement the company’s software offering and approach a new market of mobile users. The platform made no income over the year after the closing. When Facebook acquired it in April 2012, the platform had only 30 million users. Eighteen months after, it has crossed 150 million users, handling more than 55 million pictures per day, thanks to Facebook’s attempts to integrate it into its platform.
Value in the digital context is no distinct from the value in other sectors—companies add cash when their return on invested capital surpasses their opportunity cost of capital. However, the route from deal conception to value creation can be distinctive enough that if one approaches digital M&A valuation only by conventional means, they are likely to get a sketchy picture. When evaluating digital acquisitions, bring attention to establish explicit expectations about synergies and time horizons. Revenue synergies typically weigh more than cost-cutting. Don’t over-index on earnings; digital purchases made now may not improve cash flow for multiple quarters to come. If an acquirer looks to buy a digital asset to extend its technological capabilities, remember that financial results will indirectly manifest.
The digital whole does outperform the sum of its parts. An acquirer may have a series of products with a gap; the appropriate acquisition will make the entire series more valuable, pushing sales not only for the acquired product but also for neighboring products.
Develop a valuation tool kit
Securing the fitting digital target value is difficult if one constrains the valuation approaches. As in any transaction, the buyer should always work a discounted-cash-flow (DCF) analysis. However, in digital, that DCF should appear in two characteristics. The first should be from the acquired company as a stand-alone entity, applying target management’s prevailing financial projections as a guide. The second should illustrate what the target may be worth inside the acquirer. In this latter scenario, some expenses may be higher (for instance, acquirers usually have higher labor costs than start-up companies). However, there may also be both cost and revenue synergies, such as expediting sales.
The application of comparables, also, should go beyond the traditional. “10X EBITDA” (or whatever your earnings comp maybe) doesn’t make insight when purchasing an early-stage technology—comp on revenue rather. Furthermore, the revenue-driver hood uses metrics explicit to the target, such as multiples based on numbers of users.
Multiples are a flavoring. If you treat any multiple or sequence of multiples as the central ingredient, you’re likely to rot the valuation broth. Yet multiples do present a fuller taste of the deal. They helped establish the parameters of a “fairway,” filling into market baselines and adhering to the target company’s expectations on price.
While the acquirer may confront accounting effects such as possible write-downs in the treatment of the target’s service revenue, these shouldn’t affect the view of the deal, so long as actual cash flow is not changed. Be conscious, though, that write-downs can happen and need to understand the problem in detail to have transparent investor communication at the deal announcement. Recognize, too, that costs almost always go up when obtaining a digital start-up company. Start-up employees are usually paid below-market salaries in a swap for stock options and operate in below-standard office spaces. That indicates the target’s earnings trajectory can level, at least in the brief term, after the deal has closed. Revenues take time to build, but expenses begin to eat instantly. Accomplished acquirers factor this in when they develop their earnings forecasts.
Step 3 to execute Digital Mergers and Acquisitions successfully – Strategic readiness – Execution follow-through
Sadly, even when the strategic, financial, and accounting actors align, before-deal expectations and after-deal effects may not. To improve the odds for success, aim at post-closing execution.
Prioritize talent recognition
It’s hard to emphasize the significance of talent retention. In digital M&A, we acquire not only IP but also the abilities of those who make that IP work. Software engineers are not regularly interchangeable in the means that people in other skilled jobs are. Retention incentives are standard, which may supplement the deal price. However, saving on employee compensation can be a formula for disaster. Don’t be pound foolish.
Often in digital M&A, and as is typical for companies that are start-ups or a few years older, the acquirer will be buying a company with several classes of stockholders. Depending upon how many series of financing a target has been through, one will be trading with sellers who have diverse interests, motivations, and contractual claims, particularly liquidation choices.
That’s why the buyer should regularly request for the target’s capitalization table, shareholder agreements, and additional agreements between and amongst the company and its stockholders before settling on a closing deal price. In some instances, little fluctuations in price may disproportionately influence the attractiveness of a deal for one group of the seller’s shareholders over another. Many acquirers have encountered situations where the target’s preferred group of investors made a neat profit from selling at a negotiated price, while some employees–shareholders gained nothing. As a consequence, the buyer may be dealing with dissatisfied employees right from the start.
Acquirers do strive to retain critical employees. Yet it is seldom evident from an acquirer’s viewpoint who the most vital workers are. One constant blunder is to mix seniority with importance. Engineers, even junior people, can be crucial to getting the acquired IP function quickly. Conversely, some of the target’s executives may be serial entrepreneurs. They concentrate on preparing VC-backed start-ups for acquisition but lack the passion or skill set to operate in large acquiring organizations.
Considering cultural fit increases retention as well.
Identify sales-force responsiveness
Similarly, relevant to talent retention, it is crucial to reduce sales-force conflict. When acquired businesses come with their own sales forces, these workers often face obstacles in their brand-new environment. For example, they may no longer get sanctioned to reach out to customers directly. Instead, they may require to go through a list of foreign channels and gatekeepers. Sometimes there can be many relationships with a single buyer that need to be defined, or the target’s salespeople may require to sell into different industries. Each of these points can immediately lead to disappointment and attrition.
Mapping two sales forces collectively is always a trial. Usually, the best method is to turn the acquired sales force into an “overlay” function. This method is perfect when the acquirer and acquired have a comparable subset of customers, and the buyer also has a much broader set of customers, relationships, and salespeople. It’s also the most significant practice to over-incentivize sales of the acquired product in the initial two years. This way, the acquiring sales force, which may have many products to sell, won’t ignore the new addition.
Usually, the acquired company has no sales ability; the target is only too early-stage. In this situation, the acquirer needs to have a strategy to train existing salespeople sooner and setting an incentive package to reward salespeople for selling the new product immediately from the start.
Continue the integration momentum.
Regrettably, delays in integration are a frequent hazard in digital M&A and happen well beyond the sales force. The vast majority of companies’ digital acquisitions are small (less than $50 million in target revenues) than the buyers. Consequently, acquired digital assets can turn up abandoned, lying next to other products in an acquirer’s portfolio—out of sight and out of mind. That endangers letting revenue synergies go untapped.
Integration is a nitty-gritty business. Employees’ interest for inclusion into the acquired entity may or may not be high, to start with, but it seldom gets higher over time. Moving immediately after an acquisition is crucial in digital technology, where technology unfolds so quickly that neglecting to do so can be fatal. Mature acquirers have an integration plan, headcount, and budget in position before the acquisition is closed. High performers select a full-time integration leader from the parent company for at least one year, if feasible. Merging the acquired workers into one physical location with the parent isn’t always possible, but it is desirable if it doesn’t mean getting the whole staff to relocate to a new town. It’s better not to leave the acquired company in a separate facility any longer than needed.
When times get difficult, one of the most natural expenses to cut is acquisition-integration spending. Hold the temptation; a lack of momentum can doom an acquisition. Consequently, the acquirer can miss its commercial targets, which can ultimately lead to the write-off of the acquired company.
Digital M&A is an engine of digital transformation, and ignoring it is an invite to slipping behind the competition. Mature acquirers develop digital M&A as a core competence.