CHAPTER 2
Am I a Prepared Acquirer?
M&A Strategy and Governance
Successful M&A begins with becoming a prepared acquirer—focusing on an “always on” watch list of the most important deals and making M&A strategy a part of a company’s larger strategic aspirations and priorities. Prepared acquirers make difficult choices to establish a thoughtful agenda for their luxurious capital and pursue acquisitions based on a coherent strategy of how to compete and win in their chosen markets—and delight customers in ways not easily replicated by competitors.
Most companies, though, don’t have an M&A strategy—they don’t know what they want. Instead, they are reactors. Executive teams have kicked around lots of ideas for growth and M&A, but they aren’t aligned around what the goals of their M&A program should be. They haven’t thought through the deals they believe are the most important for their businesses, nor have they confronted a universe of other deals they may have no business even examining in the first place. They have few priorities.
Consider the hypothetical case of a company we’ll call Homeland Technologies, a rapid-growth company that competes in the government IT services business. Founded in 1975, Homeland went public in 2011 with revenue of roughly $500M. Through internal growth and several small acquisitions, Homeland has successfully grown to $2B in revenue with respectable shareholder returns. Now, Homeland CEO Chas Ferguson is preparing to announce he intends to double revenues within three years and has asked an investment banker to bring him prospective acquisitions that will enable him to meet that goal. The board has given the thumbs up for Ferguson to begin conducting due diligence on deals brought to the company.
Is there anything wrong with this familiar picture? While motivated by the best of intentions, Homeland and its board are unwittingly about to join the growing ranks of other reactor companies—companies that make the often fatal mistake of outsourcing their inorganic growth strategy to investment bankers or other external parties, and merely react to available deals.
Unless it gets extraordinarily lucky, Homeland, like the vast majority of reactors, will likely execute one or more transactions—major capital investments—that disappoint investors as they send clear signals to sell rather than buy their shares at announcement.
Such mistakes are most common during merger waves, when inexperienced companies rapidly enter the acquisition game or companies with experience look for more or larger deals and radically change their risk profiles. That’s how we get a wave shape. Companies can be driving toward M&A simply because so many other companies in their industry have started pursuing deals, and their banker warns them about being left without a dancing partner. (See the sidebar, “Great Myths of Reactor Behavior.”) No one wants a Wall Street Journal reporter to write, “The world was changing and Charlie just sat there,” but that pressure rarely yields a good result. Lacking a well-developed growth thesis, these unprepared companies engineer their own failures as they become part of the merger bandwagon.
Even worse, when reactors bid but don’t close a deal or two, and the news gets out on their failed attempts, they feel even more compelled to close something. Sellers really love those reactors. Their largest strategic choices get made for them.
Great Myths of Reactor Behavior
Merger waves bring with them powerful myths that help support many reactive and unfortunate decisions. The following is an all-star lineup from the last few decades. Board members in particular should hold shareholders’ pockets tightly when hearing any of the following:
- “Initial market reactions don’t matter, we’re in this for the long term. The stock price of acquirers always drops on announcement of a deal.” Well, not on good ones. Negative market reactions are bad news—they are the investors’ perceptions of what the company has communicated to the marketplace.
- “The financials looked fine on paper, but we didn’t manage the cultures right.” This excuse for past deals gone bad has become so powerful that “culture” often gets blamed for everything that goes wrong. Many deals that ultimately fail were predictably failures and managing cultures well rarely rescues a deal with bad economics.
- “Good deals must be accretive to earnings.” There is little correlation between accretion or dilution and the stock market’s assessment of deals.a Stock price is earnings per share (EPS) times price-to-earnings (P/E) ratio and a short-term increase in EPS can easily be offset by a drop in the P/E ratio—a proxy for expectations of long-term profitable growth.
- “If we don’t do this deal, we’ll be the last man standing without a dancing partner.” Committing capital to an acquisition through fear of having nothing left to buy is never a good bet for your shareholders. This logic is a signal to all of a lack of preparation.
- “It will cost us much more money and time to build it from scratch.” That may be true, but it might not be the right business or investment in the first place.
a. David Harding and Phyllis Yale, “Discipline and the Dilutive Deal,” Harvard Business Review, July 2002, https://
Prepared acquirers are the antithesis of reactor companies. These companies have developed a disciplined process that allows them to find good opportunities and avoid predictably poor ones, thereby enabling them to accomplish the chief objectives of successful corporate development—beating competitors and rewarding investors. They establish an agenda for M&A capital through an orchestrated process of strategic choices. They have many options.
Becoming a prepared acquirer is the main focus of this chapter. But, first, let’s continue to shine a spotlight on reactors because it’s through understanding the problems reactors create for themselves that we can uncover insights and solutions.
The Reactor Condition: Playing Not to Lose
Reactors predictably drive up pre-deal costs and risks and will have significantly reduced expected value from their deals. In an important sense, reactors are anti-strategic.
Reactors typically outsource—that is, hand over—their largest capital investment decisions to third parties who effectively drive a reactor’s growth strategy by bringing them deals to consider. They have given up their power of choice—they don’t have options. They kick around a lot of ideas that don’t yield clear milestones or priorities. Without those priorities, reactors can’t create or maintain an active deal pipeline. As a result, every potential deal that is presented to them is likely to be important to some executive, meaning that the process becomes political and not strategic. Since the CEO can’t explain the, say, 20 most important deals they want to pursue over the next 12–18 months, they don’t have an M&A strategy.
Instead of agreed portfolio priorities or capability needs driving their search for targets, reactors work backward—from an available deal that determines their strategic priorities. That is, reactors have deals chasing a strategy instead of strategy chasing deals. Rather than consider on an ongoing basis the total universe of options, reactors tend to focus exclusively on the deal at hand.
Viewed in isolation, a deal might look attractive, but compared with other potential M&A candidates, it could likely be a poor fit. This is a little like marrying the first seemingly compatible person you ever took out on a date: It could work—but the odds are against it. And the mistake often compounds itself. Enamored with the deal in front of them, reactors often fall prey to a confirmation bias—management may ignore or explain away negative information that emerges and search for positive evidence they are doing the right thing, even in a thorough evaluation of the candidate.
In negotiation terms, it is difficult for reactors to walk away from a deal because there is no better alternative to walk away to. A deal without a BATNA—a “best alternative to a negotiated agreement”—makes it far easier for a reactor to get caught up in the deal frenzy, racing to sign a deal, with full support of their advisers and confirmation bias, because there are no alternatives under consideration. The result: Without discipline and alternatives, internal target valuations converge to how other comparable acquisitions are getting priced, with the focus being on what the reactor must pay to get the deal done as opposed to how much it should pay for the deal at hand. Overpayment and the winner’s curse become predictable.
Reactors also fail to consider potential operating model and integration issues that may affect the ease of actually realizing the value they are paying for. Some deals are going to be tougher and more complex to integrate than others. But because reactors look at deals sequentially, they miss the opportunity to differentiate deals that may more plausibly create value. Even worse, as reactors are forced into a compressed time frame to do diligence, they typically close a deal with few details of the operating strategy of how the target businesses will be managed. So not only do they run the risk of exaggerated claims of synergies—unable to justify the premium—they greatly increase the risk of damaging the growth value embedded in the target’s stand-alone business as they try to achieve synergies that are unlikely to occur.
Acquiring the wrong company will just create a new set of operational problems beyond the ones that already exist for both companies as stand-alone firms. Little wonder that bad buyers often become good targets themselves. Evidence also suggests that wealth gains from corporate spin-offs may result from the correction of prior M&A mistakes.1
What’s more, when reactors trap themselves into reacting to deal pitches from outsiders or by jumping into auctions, they waste precious time and resources that could have been devoted to finding more suitable opportunities in the first place. That’s because management must conduct extensive and expensive due diligence for merger opportunities that present themselves, even though many should never have made it to the table. Careful due diligence may help avoid bad deals, but it doesn’t help a company find the right ones.
Here’s the crux of it: Reactors spend most of their time in diligence on deals that emerge trying to avoid false positives (accepting deals that should have been rejected) and thus drive up their risk of false negatives (rejecting a whole universe of other deals that might have been better). When a company reacts to a single opportunity, it has implicitly ruled out other potentially better alternatives that were not even considered. They trap themselves in a constant game of playing not to lose and, ironically, increase their risk of losing. They have great difficulty explaining to their board why they rejected other opportunities.
Becoming Prepared: Playing to Win
Successful M&A and corporate development require much more than simply attempting to avoid economically unsound deals. Prepared acquirers have a process that enables them to avoid bad deals and at the same time find the value-creating ones. It means the ability to reduce the risk of both false positives as well as false negatives.
Prepared “always on” acquirers play to win instead of only playing not to lose. They fully use their power of choice to bring strategic integrity to M&A by developing a thoughtful agenda for M&A capital. Although they may use external advisers to help them better understand a changing industry landscape, they don’t outsource their strategies. Prepared acquirers treat capital like it is luxurious—expensive to touch and best treated with care. Most important, prepared acquirers have an identifiable M&A strategy. They know what they want and how they will create value.
Playing to win means putting in place a strategic process that allows you to answer the following five questions:
- What is the role of M&A in our company’s growth?
- What companies or divisions do we want to buy, and why?
- Which do we not want to buy?
- Which do we not want our competitors to buy?
- What deals are we going to do after this one, whether or not we close?
Senior teams should be able to project their appetite for deals to their business leaders. They know if M&A is going to make up 10 percent of their growth or 30 percent or more. They will be able to discuss with their boards the most important targets they are monitoring over the next 12–18 months (or a shorter horizon in rapidly evolving markets) and be able to describe a universe of targets that would be of little or no interest—and why—so they don’t waste time or money on those if they were to become available. They will have also considered the deals their competitors might do that could impact their businesses as the competitor attempts to generate synergies at their expense. Before they would jump into an auction, just because their competitor is doing so, they would need to value just how much they would be impacted before they open the bank vault to do a defensive deal. Moreover, whether or not they close a particular deal, acquirers that are playing to win have a view on what deals might come next.
These five questions beg a series of other questions and force leadership teams to have conversations and debates, among themselves and with their board, and conduct analysis to get on the same page and establish priorities. It also helps to avoid—or at least dampen—internal politics. This is a point worth pausing on. Reactive acquirers can get tripped up by internal politics because a deal lacking a strategy will inevitably have an internal champion who feels strongly about “winning” the deal. Without any priorities or criteria to say whether this deal is a good one or not, that internal champion can push their deal through their management team—a team that doesn’t share a common understanding of what role M&A plays in the company’s growth or other deals that should be under consideration.
Prepared acquirers don’t look at deals in isolation. They think about portfolios of assets that the deals on their watch list represent, and how those portfolios can be assembled over time to grow their existing core businesses or create new, advantaged businesses based on their organic capabilities. In other words, companies that play to win have prioritized the most promising pathways along which they search for the most important assets in the market. Pathways might be focused on certain products, services, and customer segments, end-market applications, emerging technologies, or different approaches to serving specific customers in ways competitors will have difficulty replicating.
Imagine our Homeland CEO Chas Ferguson was presented with a list of 100 deals, some related to the core, some in adjacent spaces, and some new businesses that might be part of Homeland’s future. If Chas were to look deeply into the list, like a Rorschach test of sorts, he would see many different strategic pathways. For Homeland, that might mean prioritizing major government customer segments like the Department of Defense, Central Intelligence Agency, or Federal Bureau of Investigation, or certain businesses to prioritize in Homeland’s portfolio of government IT services like secure infrastructure or military systems engineering (we illustrate this later).
Perhaps no company illustrates development of pathways better than Amazon.
Amazon: Creating Pathways for Acquisitions
Amazon’s humble beginnings as an early internet book retailer run out of Jeff Bezos’s garage bely the strategic ambitions that made the company the successful behemoth it is today—one that would be barely recognizable to anyone traveling into the future from 1994. While Amazon still sells books, it has expanded into a wide range of seemingly unrelated areas. Through more than 150 transactions (87 full acquisitions), including nearly $20B spent on its top 10 deals, M&A has played a central role in the development of several strategic pathways from e-commerce to the Kindle to Amazon Web Services (AWS) to grocery to Alexa and the connected home.2
From its earliest days, Amazon has invested in companies that, on their surface, didn’t seem core to its business but offered potential pathways for future growth. For instance, Amazon acquired a 35 percent stake in Homegrocer.com in 1999 to test the waters in food, but it wasn’t until 2017 that Amazon was fully credited with its commitment to grocery and food retailing, buying Whole Foods for $13.7B. Wall Street analysts often failed to understand this approach: An analyst from Piper Jaffray, for example, commented that endeavors such as AWS were a distraction to profitability.3
Some of these forays have yielded full-fledged products or business lines such as the Kindle and AWS. Others served as beachheads into developing technologies or markets, such as artificial intelligence (AI) (e.g., TSO Logic), home automation products (e.g., Echo and Ring), healthcare, media, or retail investments (e.g., India’s Aditya Birla and Witzig).
An aptitude for learning and a penchant for highly strategic acquisitions have enabled Amazon to penetrate and lead many business and consumer categories—and for journalist Brad Stone to call it “the everything store.” Amazon’s original business model of selling books online laid the foundation for its hyper-scalable platform of bringing buyers and sellers together. Since the late 1990s, it has broadened its product focus from books to an extended portfolio of retail goods, supported by both organic growth (e.g., operating other e-commerce platforms such as CDNow) and M&A (e.g., Back to Basics Toys for hard-to-find toys, Woot for electronics and household goods, Quidsi for baby and childcare, Zappos for footwear, and Shopbop for apparel).
Going beyond adding new categories, Amazon embraced its platform, initially as a two-sided online exchange, enrolling external vendors by providing them with a self-serve merchant platform and giving them access to its millions of existing customers who, in return, benefited from access to a wealth of new vendors. These new vendors quickly went beyond the initial rare and out-of-print books categories Amazon had acquired through Bibliofind and Exchange.com, which were closer to its original core business of bookselling.
From there, Amazon has expanded along many pathways—not always successfully but always using a highly strategic lens for acquisitions. Amazon had a blueprint for extension into peripheral segments, sometimes taking a stake in adjacent markets that would bear fruit several years after initial acquisitions and investments.
The development of Kindle, for example, can be traced back to 2004 when Jeff Bezos and Steve Kessel assembled a team of veteran hardware, software, and computing engineers to create the secret Lab126 “skunkworks.” Through acquisitions complementary to their hardware development, especially Mobipocket, an ebook publishing platform accompanied by e-reader software for handheld devices, the Kindle launched barely three years later. The Kindle, beyond just innovation, allowed Amazon to enhance the network effect of its platform, and indeed Amazon customers who owned a Kindle spent over 55 percent more per year ($1,233 vs. $790) than customers who did not own one.4
Guiding principles
Amazon’s approach to M&A is rooted in several key guiding principles. It first identifies business models and pathways with growth potential and then assesses what capabilities are required to successfully enter those areas. It then looks for companies with the necessary capabilities and assesses its targets based on specific criteria. This means that Amazon is always evaluating dozens of targets rather than being fixated on one deal or being reactive to deals that others are bringing to it.
This is a key point: Amazon has made M&A strategy a core part of its overall growth strategy. Whether through full acquisitions or minority stakes in companies where it sees potential, Amazon M&A is focused on supporting and relentlessly exploiting its core capabilities of customer experience, lower cost structure, and lower costs for seemingly unlimited choices.
This approach—a customer-centric business model with specific capability needs driving the search for deals that will complement Amazon’s portfolio of existing assets while making a portfolio of bets on the future—has resulted in a dramatic transformation of the company over 25 years from an online book retailer to a multi-sided online marketplace (customers, merchants, and financing sources for merchants and customers) to a top-tier player in a multitude of distinct, yet related, pathways including cloud services, food ecosystems, and connected homes.
One can see these principles at play, along a clear pathway, in Amazon’s development of Alexa, Amazon’s virtual assistant, introduced in 2014 alongside the Echo line of smart speakers. Lab126, Amazon’s internal skunkworks, started the development of the Echo in 2010. Alexa, its main interface, is a voice-activated assistant. To develop it, Amazon had to augment Lab126’s hardware with AI capabilities to enable functions such as text-to-speech, voice recognition, and natural language processing.
Amazon bought Yap in 2011 (a speech-to-text company that provided expertise in translating the spoken word into written language), Evi in 2013 (a UK AI company with software that could process and respond to users’ spoken requests), and Ivona in 2013 (a Polish company with text-to-speech technology that enabled Echo to generate natural voice). As Wired reported, “Initially, Amazon planned to leverage Evi’s technology to build an artificial speech-based book reader. This narrow vision later evolved into an idea to create a new platform that would be powered by a combination of Amazon Web Services (AWS), speech recognition, and high-quality speech synthesis and would be tied to an affordable piece of dedicated hardware, ultimately producing the Alexa-powered Amazon Echo Smart Speaker, which launched in late 2014.”5
The Echo offered an entry point into homes everywhere and has allowed Amazon to establish itself as a strong competitor to Apple in home automation—which rapidly became the connected home ecosystem—with a suite of products coming from various acquisitions. Amazon acquired Blink in 2017 (security cameras), Ring in 2018 (intelligent doorbells), and Eero in 2019 (mesh Wi-Fi routers).
Our brief example of Amazon shows how M&A strategy, if done right, allows acquirers to strengthen and extend their business models and leapfrog organic growth scenarios. More important, M&A is an ongoing effort of establishing priorities and making strategic choices of what to develop organically versus what to acquire. That requires being fully aware of the landscape of companies and capabilities in the market and pursuing those assets that will allow the acquirer to delight customers in ways not easily replicated by competitors. Amazon made clear choices of its pathways and the deals it wanted, regularly reviewing a universe of options.
The upshot: Successful M&A is rarely a one-shot effort. Prepared “always on” acquirers can afford to be patient, and don’t necessarily need to be active, because they know the landscape and they know what they want and why.
It takes a tremendous amount of work and time discovering and prioritizing deal candidates, but it yields so many benefits. As one Fortune 50 executive told us: “The more you look, the more you find; the more you look, the more you learn; the more you look, the more you test your strategies.”
The good news: You don’t have to be as impressive as Jeff Bezos and Amazon, but the company’s impressive use of acquisitions to expand beyond its core business and fundamentally transform itself—from online bookseller to AWS and the connected home—should give you a sense of what a clear, “always on” M&A strategy looks like, and how totally different it looks and feels compared to being a reactor.
From Reactor to “Always On”
It is no coincidence that the most successful acquirers are also the most disciplined. Before making a deal, experienced acquirers such as Disney, PepsiCo, Ecolab, and Amazon satisfy themselves that their strategic alternatives and acquisition opportunities have been carefully explored and their potential for creating value quantified. They understand which of their businesses should be developed organically, which should be sold, and which would benefit from growth through acquisition. They are often the most credible buyers, able to pay the most, because they know what they are looking for and how they will integrate the acquired assets. Ultimately, valuable growth through M&A is an outcome of overall corporate and business priorities and strategy through a regular and relentless pursuit of a portfolio of the most important deals.
Few companies fall into the category of Amazon regarding acquisition experience. But inexperience is no excuse to be a reactor. To avoid becoming a casualty of merger mania, every company that seeks growth through acquisition must first look itself in the mirror to determine whether it is a reactor or an “always on” prepared acquirer. Companies that want to become prepared before beginning or ramping up their acquisition strategy must see the process as a transformation—a dynamic state change. It requires an ongoing process of alignment, learning, and execution in the market as companies play to win in M&A.
That transformation process, regardless of experience, involves four major steps toward answering the questions we outlined earlier on playing to win:
- Self and competitor M&A assessment
- Aligning the top team on strategic pathways and priorities
- Developing a master list of potential acquisitions across chosen pathways
- Strategic screening and detailed profiling of a priority watch list
Self and competitor M&A assessment
Because superior performers are typically judged by their investor returns, M&A strategy development begins with an evaluation of how the market values a company and what the company has led investors to believe. That means ultimately understanding their current operations value and future growth value (we cover this in detail in chapter 4), and the growth trajectory implied by their market value and investor expectations. If there is a gap between that and their organic growth trajectory, M&A may play a role in closing that gap. Corporate-level growth expectations can be de-averaged to business-unit level and used to highlight gaps—and advantages—and prioritize the role that M&A might play across those business units.
Some pathways and specific deals along those pathways may be far better than others in delivering management’s aspirations and investors’ expectations. Because capital is expensive, this kind of evaluation should be table stakes for business units to earn the right to grow through M&A.
It’s also important to set the stage by evaluating competitors’ strategic intent. M&A strategy is a three-dimensional chess match that includes not only your own competencies and growth plans, but also the strategic intent competitors are signaling from their past deals. There’s often a lot to learn from examining the M&A deals your competitors have done over the last several years, in terms of geographies, capabilities, size, product or service offerings, and targeted customer segments. Call it “competitor signaling”—their past behavior will often foreshadow which acquisition targets may be next on their priority lists. Armed with that information, a prepared acquirer will have a better view of how the industry is evolving relative to what competitors are signaling in the market with their largest investment decisions and how their competitors are trying to win. It also may highlight the cases where the acquirer and some of its competitors are likely going to battle over the same transaction.
Figure 2-1 shows what an acquirer can learn by looking at the pattern of competitor deals and by plotting its own deals, the signals it is sending to its competitors and investors about what might come next. Ultimately, Homeland—our example here—needs to make choices on where it wants to play in M&A. Preparing a similar chart sets the stage for the choices that an acquirer will need to make as it establishes priorities (e.g., customer focus, capabilities, businesses, geographies, and so on).
Aligning the top team on strategic pathways and priorities
Before considering any acquisition opportunity, senior management and boards of directors must agree on important strategic choices that set the direction of the businesses. These include realistic growth aspirations and the most profitable growth opportunities in light of how competition in the industry and unmet customer needs are evolving. Management must decide which customer segments, end markets, respective geographies, and so on they want to serve, with which products, and how they intend to do so in ways competitors cannot easily replicate.
Such an analysis calls for assessing the company’s competitive strengths and weaknesses as well as setting priorities for what capabilities will be required to win in their targeted markets. Executives must consider what they have led investors to believe about their growth prospects and their strategies and investments to achieve them. Major capital investments such as acquisitions often leave investors puzzled about what the company is trying to accomplish beyond merely getting bigger.
A real danger is that without alignment among the top team, individual members can champion a deal for purely political reasons. Without a common understanding of what role an acquisition is going to play, a passionate investment pitch from someone looking to increase their profile or expand their part of the business can drive the process forward—again, often with disappointing results.
Homeland Technologies M&A strategy
Note: Government agencies and offices are abbreviated.
Most boards and management teams complain they spend little time discussing where they want their business to be over the long term. A common frustration among directors is that they spend too much time talking about current and recent past issues instead of focusing on future growth. These short-term issues are important, but they can keep the board and management from setting and regularly updating a forward-looking vision and strategy.
Without that vision, it’s hard to answer the question of whether to achieve growth targets organically or through acquisition, or some balance of the two. There is no substitute for regular discussions between the board and senior management on this issue. This process helps identify the rationale for acquisitions—especially priority pathways—and initial criteria for screening potential candidates along those pathways. If an acquisition shows up out of the blue, then at least there will be a strategic context to decide whether it is worth any time to evaluate it. An examination of the successes and failures of past acquisitions gives an invaluable backdrop for discussing industry evolution and strategy adjustments to make for the future.
Business leaders will all have their favorite adjacent pathways to their core business, and those all need to be debated and tested. Acquirers must be aware that today’s adjacency is tomorrow’s core. That might sound obvious, but it is a cautionary note. Although adjacencies may be attractive areas for growth, an acquirer might be opening the door to a whole new set of competitors that will not sit idly by as the acquirer attempts to generate synergies at their expense.
Quaker’s move in 1993 to buy Snapple is a classic case. Once Quaker announced it was going to turn Snapple into a greater threat in the ambient beverage segment, it meant Quaker would have to wrestle shelf space away from Coke and Pepsi. Nearly overnight, Coke and Pepsi announced marketing campaigns greater than the entire Snapple marketing budget. The best way to avoid such a rude awakening is to anticipate competitor reactions, which lies at the heart of any M&A strategy.
Amazon too faced the challenge of determining the universe of pathways where it would face new competitors: from selling other consumer goods to an e-reader to retail grocery to web services. While Amazon has displayed patience and a willingness to invest capital (both through M&A as well as R&D) to enter then-adjacent now-core markets, an obsession with its customers has guided its strategic decisions over the long term. Amazon leadership has been steadfast in its belief that unrelenting customer obsession in whichever markets it serves gives it a sustainable competitive advantage. This has proven largely true and has enabled Amazon to lead categories and keep formidable companies at bay, for example in web services where AWS holds a commanding market share lead over Microsoft, IBM, and others. As Bezos said, “If we can keep our competitors focused on us while we stay focused on the customer, ultimately we’ll turn out all right.”6
Further, failing to have clear and agreed M&A strategy priorities instead of “many ideas for growth” up front will create difficult questions about “strategy” during diligence, when it will be challenging to develop clear hypotheses you are trying to test in the market. It is not uncommon for those stuck with the task of diligence to ask how that deal ever got to that stage.
Developing a master list across chosen pathways
Casting a wide net, management should then generate a master list of acquisition candidates in its priority core or adjacent industry spaces where it has decided it wants to grow and compete. The purpose is to leave no stone unturned and to learn along the way. The goal is to know all relevant players so well that it’s difficult for an outsider to bring an opportunity management has not already considered in some way.
Once all major players begin appearing on subsequent searches and few new businesses emerge, management can be confident of a solid initial list. The next step is to consider the high-level information that will later force choices—to sort the list and make it meaningful. At this stage, only the most relevant information needs to be collected on these companies: size, geography, and whether public, private, or subsidiary of a larger parent. As the process proceeds, more and more relevant information will be collected for those companies that remain under consideration.
This is not a one-shot process. Over time, competitors may buy companies on the list, emerging companies will appear, and rapid growth companies doing deals may become a peer competitor right in front of your eyes. If you have never done this before, you are likely going to be amazed with all the potential targets that exist in your priority markets. As you stare at the list, before you even start to screen you will see clusters of opportunities that you probably haven’t ever considered. This is all part of the learning process that sets up the need for choices on how you will screen those potential targets. Those clusters are different M&A strategies along the pathway you are about to screen.
A note on pathways. As you search and build your master lists, it will become quickly apparent that if you haven’t prioritized the parts of your core or potential adjacencies to explore, you will have a mess of potentially thousands of potential targets across multiple pathways. There’s no harm in populating multiple pathways with players to see just how many different M&A strategies exist within and across those pathways, but it’s far better to establish your priorities early or you will face several predictable problems. A look back at many unsuccessful M&A programs shows scattered unintegrated deals, signaling that the senior team wasn’t aligned on an M&A strategy.
It’s vital to recognize that pathways are not screening criteria. In other words, most companies will have multiple pathways they can pursue in core, adjacent, and new business, but making the difficult choices of where you want to play and what advantages you have, or need, to compete should come before you start looking for and differentiating among a universe of targets.
Both pathways and specific screening criteria represent strategic choices. But if you mix them up and start screening a bunch of targets before you have prioritized broad strategic pathways in your core business or potential adjacencies, the pathway question will inevitably emerge later. If you find someone asking what your strategy is for a proposed target during screening—“Hey, what was the strategy here?”—it’s a pretty good sign that you have a target in search of strategy, any strategy, rather than a clearly delineated strategy that the team understands and can articulate.
Confusing pathways with screening criteria will later lead to the question of whether the work has been done to establish strategic priorities. We call this common issue “pay me now or pay me later.” That is, if you don’t make the tough choices early, then you will end up debating deals that represent entirely different strategies later on. Or worse, without that prioritization, you can expect to be back in that political process where more powerful executives push their favorite deals that may not be in the best interests of the company.
Strategic screening and selection of a watch list
Once the universe of opportunities is identified, prepared acquirers must develop strategic screens of increasing detail to narrow the list of candidates. While M&A strategy helps develop prioritized pathways for growth, target screening filters the deal universe within those pathways to help generate portfolios of priority candidates.
This is hardly a mechanical exercise. Gone are the days when the state of the art was to take a list of, say, 100 specialty chemical companies and then “come up” with nine screening criteria—ranging from size and geography to whether the targets had any unwanted businesses, each of which would be assigned a weight based on its perceived importance. Then a junior analyst would score every deal on that list on a scale of 1 to 10, across each of the nine weighted criteria. And boom, the short list would emerge.
The problem is, of course, if the weights or scores were changed just a little, you would get a different list. The lesson, and it’s a big one, is that this is no way to do screening. One never knows all the things one will need to know to choose criteria—strategic choices—up front, especially if one has never been through the exercise. Screening is essentially an orchestrated process of making strategic and operational choices, and the depth of those choices gets finer grained as the list gets smaller.
Executives often find this the most challenging part of the process because it involves implementing a whole set of tough choices about the assets they believe they need to compete and grow. Let’s admit it: Choice is hard because it shuts down seemingly attractive options. Management may debate what those strategic priorities are along chosen pathways. But the screens are actually important strategic choices that can help senior management and the board understand why a particular priority target was identified in the first place—and why others did not make the cut. Screening out bad fits—while identifying good ones—based on agreed-upon criteria is what this process is all about.
Initial screens may be based on size or geography consistent with the broad strategic needs of the business; subsequent deeper-dive screens might concern specific product lines, specific customers, R&D and manufacturing capability, facility locations, and management experience. Designing these criteria forces executives to revisit and refine their strategic priorities. Executives are often surprised about how much they learn about the landscape from working through the process across a universe of targets. Additionally, this effort helps minimize the risk of doing the wrong deals by preventing unsuitable candidates from even being considered.
Later in this screening process, as more detailed profiles have been completed on remaining candidates, the ease or difficulty of post-merger integration becomes a more important part of the discussion. Then, potential transition risks such as culture fit, outstanding labor or supplier contracts, geographic or customer concentration, distribution gaps, and management depth can be identified to differentiate deals and identify those opportunities most likely to create value. It is virtually impossible to conduct a sophisticated financial analysis of synergy potential—including probability estimates and timing of expected synergies—without evaluating integration risks and opportunities early on. Prepared acquirers begin these considerations during the screening process. Different transactions will have different integration issues that directly affect due diligence and valuation, and, ultimately, whether a candidate should remain under consideration.
Bankers are great at bringing prospective deals that appear to be attractive based on market growth or target growth. Such targets may appear attractive but are often not plausible for an acquirer because they don’t fit with the agreed-upon strategic needs of the business or might be extremely complex to integrate. This distinction is important as you get to later phases of fine-grained screening to differentiate the best-fit deals.
The product of this exercise is a watch list of the most attractive and plausible acquisition candidates, subject to further diligence, with detailed profiles of each candidate. Even with the smaller watch list, each target will still represent a slightly different strategy offering varying advantages and opportunities.
The watch list can also be grouped by transaction strategy—larger platform deals followed by smaller tuck-ins on the list or just the opposite. Creating a watch list also offers the opportunity to easily cultivate and refresh the pipeline and broader M&A program as the competitive environment shifts, potential disruptors emerge, and other deals get done in the industry.
At times, the process will require significant discussion and heated debate, but there is no substitute for guiding what the company is searching for and what is competitively meaningful. In the end, management will have a much better view of its competitive landscape, what it needs to create value for customers, and the true priorities of its businesses. Moreover, this process will allow senior management to develop and communicate more sensible, credible acquisition stories to the board, investors, and employees. It should be obvious by now that reactors looking at one deal at a time cannot compare options.
Reaping the Benefits
Becoming a prepared acquirer—one that is “always on”—is less about executing a project and more about going through a transformation. Being “always on” means that you’ll develop a better pipeline of priority targets as part of your M&A strategy. It will allow you to save significant resources by not focusing on inappropriate deals. You will drive your own M&A process and timeline rather than being driven by someone else’s (e.g., seller or competitor) timing, meaning you’ll be less likely to be rushed to close. You’ll know which auctions are most important and which should be avoided—and why. You can raise diligence and integration issues before valuation and negotiation even begin. You can use this landscape education process to reassess growth pathways and alternative transactions. You’ll also build credibility with the board and efficiently move targets through the pipeline. And, finally, you will construct a better, more robust investment thesis that will be tested during due diligence (see chapter 3).
Even the most experienced acquirers, who may have dozens of people supporting them throughout the business units, typically complete only 10 to 20 percent of the deals in their pipelines. And many targets might not be readily available for sale. That low conversion percentage underscores the importance of being “always on” with plenty of smart alternatives and a full pipeline. You’ll also end up with a portfolio of desired assets that represent deliberate strategies rather than looking at a deal in isolation.
In other words, you’ll be playing to win in M&A instead of playing not to lose.
Management teams that go through the process we have outlined do not have to be active acquirers. They can afford to be patient because they have well-developed alternatives. They can negotiate with multiple parties on their watch list and seek the best values as they learn more about those candidates. After the stock market implosions in 2000–2002 and 2008–2009, these companies were in an excellent position to shop for valuable deals.
Routinely observing this process will also enable management to track what deals have been done by competitors and better consider the signals competitors are sending about their own growth objectives and how they intend to compete. Because they have a clear watch list of competitively important targets, management will also know those deals competitors might do or attempt to do that will, in fact, require an immediate response.
Becoming a prepared acquirer requires effort at multiple levels of an organization—but the effort is sure to help the people working at each level meet their responsibilities more successfully (see below, “A Note on M&A Process Governance”). Most important, an aligned “always on” management team is the lifeblood of a successful corporate development process, one that will give investors strong reasons to buy shares on deal announcements and will grow shareholder returns over the long run.
Directors who insist that a documented strategic M&A process be in place well before any opportunities are presented to them can avoid merely being the last hurdle on the CEO’s path to announcing a major transaction—and can thereby shoulder their fiduciary duties far more credibly. The business and corporate development executives who devise and implement the M&A process can be satisfied that any deals they do will be much more likely to succeed. Shareholders, meanwhile, can be glad their company has gotten a lot smarter about how to move ahead in a complex and fast-changing business.
Real M&A strategy is about creating value versus doing deals. It’s also a landscape education exercise that forces you to rethink your strategies. It’s a top-team alignment exercise that drives regular discussions about strategic priorities. And it adds to the tapestry of management credibility with investors, employees, and the board.
A Note on M&A Process Governance
Even with a dynamic watchlist of several priority targets, would-be acquirers are unlikely to get those deals done if they don’t have rules and practices that govern the entire M&A life cycle. Without formal governance, powerful executives can force through deals detrimental to the company. Others may have their deals killed by overly large committees with conflicting incentives before they even have a chance to present their case. Inconsistent procedures and metrics will cause confusion. Business unit executives may simply stop bringing deals knowing that their efforts will be wasted.
Like any governance process, the ideal is to know the scope of each stage of the M&A cascade, who must be in the room for each stage, a process for convening those stakeholders, required knowledge transfer during and between each stage, clear decision rights and accountability, and logical and stable criteria for those decisions.
The imperative is to establish an effective organization and specific procedures with capable leadership. Together, these will support an M&A process that everyone can follow and is repeatable: “This is the way we do deals.” Successful acquirers have well-developed M&A playbooks that all players follow.
M&A strategy, for example, begins with the CEO, the senior executive team, corporate development and business unit leadership, and the board. Together, they address the role of M&A in overall corporate strategy, which aligns executive leadership around issues like appetite for risk and the appropriate degree and purpose of M&A for growth. That guidance sets the foundation for determining priority pathways, at both the corporate and business levels, and, later, initial criteria for screening acquisition targets and the development of the deal pipeline—which will likely involve additional subject-matter experts from the businesses as business cases are developed for specific deals.
Each subsequent stage must rely on the analysis of the stage before. New stakeholders will build on the work of those who were involved earlier. Between each pre-deal stage are clear decision gates, with criteria for moving forward or ending the exploration of the deal.
Acquirers will need to decide the appropriate level of centralization of M&A-related activities. What are the specific roles and responsibilities of management at corporate versus the business units? Who owns the deal model? What are the reporting relationships during each stage? What competencies and level of talent are required? Which stages will require external support and who gets to decide?
The M&A process itself requires specific procedures and decision rights that cover the complete span and timing of activities. What issues must be addressed in the deal thesis? When and from whom are approvals required before proceeding to the next stage? What knowledge transfer is required between stages and which players need to become involved while maintaining confidentiality? When must leadership interface with the board and on what issues?
While many of these issues and questions might seem basic, we would characterize them instead as fundamental. By having a clear process and well-defined roles and responsibilities consistent with agreed objectives for M&A strategy, companies can monitor competitor M&A activity and sustain an active deal pipeline that is refreshed regularly. Ownership and accountability at each stage of the process, along with agreed evaluation criteria rooted in an M&A growth thesis, will help acquirers avoid falling prey to political games and allow them to drive toward closing the most important deals and creating value: one of the outcomes of being “always on.”