Merger or acquisition can be the best way to quickly expand the business to another country, often better than incorporating a new company. Let’s take an example: Poland is slowly but surely becoming a leading M&A market in Central Eastern Europe (CEE). Recent numbers show that Poland has shifted towards being an investor friendly country with a number of transaction possibilities, including high-value takeovers. However, being hospitable and favorable does not guarantee a successful transaction. In this article, we’ll take a look at why some M&A deals fail.
When do merger and acquisition deals fail?
There may be multiple common reasons for M&A failure, and they may occur at every stage of the process. Here are the stages of a typical transaction:
- Preparatory stage,
- Target identification and review,
- Negotiations,
- Integration.
Potential M&A problems during the preparatory stage
The first stage usually happens long before any M&A transaction. This is the point in which the company decides whether it wants to grow and how it will achieve that. The two most common choices are organic growth (internal expansion) and takeovers and corporate mergers of external targets. Strategic decisions must be taken at a high management level or by the investor if the entity has the need, capital and capacity / resources to carry out the takeover or merger. Moreover, it needs to assess its goals for the future with which all its policies will be aligned.
Any decision made at this stage may have profound consequences for the future of the entity. The lack of a clearly defined way of expansion or vision is the most plausible reason for future merger failure.
How can proper target identification and review prevent mergers and acquisitions from failing?
An entity or investor may have a diverse approach to searching for a takeover target. It can be either actively looking for a potential target or passively waiting for takeover opportunities to appear.
Wrong target identification may lead to “buyer’s remorse” once the effects of the transaction go south. It is also important to properly review the target’s situation (with the support from experienced transaction advisors) from as many angles as possible, with financial, tax and legal due diligence at the very minimum.
Properly conducted negotiations between two companies
Negotiations focus mainly on the method of selling and the price of the target. If carried out improperly, they are often the main reason for failed mergers and acquisitions. Though negotiations or talks start quite early in the transaction process, their most important part occurs after performing a thorough due diligence analysis. Supported by due diligence results, negotiations should lead to covering all identified risks that might be a reason for the failure of the transaction or cause integration issues.
Failure to cover all the risks which arose during due diligence in the share purchase agreement (SPA) limits the recourse towards the seller and exposes the buyer to cover such costs.
The target’s valuation is a similarly possible serious mistake that could be made at that stage. The seller’s initial claims and declarations about the target may vary from the actual situation. Therefore, it is crucial to link the valuation to variable factors that may be verified, adjusted and normalized based on a critical review carried out during the due diligence process. The shareholders or decision makers involved in the takeover transaction may overestimate the transaction benefits, synergy effects or future performance of the target. Moreover, the transaction, post-merger integration and / or restructuring costs may be underestimated. These costs altogether may, in some cases, be equal or even exceed the purchase costs and unexpectedly lead to the failure of the transaction.
Of course, when it comes to money, valuation is not the only reason for a high failure rate of transactions. Payment mechanism is another area that may create a potential risk for an unsuccessful M&A process. Payment by cash, debt or via another entity’s shares may have tax or legal implications to both the target and the buyer. In some cases, it might be crucial to keep the founder, seller of / and current management within the target for a transition period so as not to lose important skills or knowledge. Moreover, a commonly used mechanism in targets that operate in knowledge or new technologies sectors is split payment where part of payment is locked on an escrow account for either a specified period of time or until some KPIs are reached. The escrow option is also popular when the sellers claim potential high growth after the transaction, demanding a higher price. The split payment mechanism allows the buyers to verify such claims after a given period of time and pay accordingly.
Post-merger integration challenges
Strategic investors often decide to incorporate the target into their organizations or groups after the transaction in another country is completed. Financial investors may choose to carry out improvements or introduce other changes. Either way, the form of the integration or change is usually complicated and may severely impact the overall acquisition success.
The lack of well-defined integration plans may impede the operations of both the target and the integrating party. Not only both the companies and the people involved need to carry on with business operations, but they also have to integrate the structures at the same time. So much workload may lead to delays or other challenges once unexpected hurdles appear. For the integration to be successful, the entire staff of both the buyer and the target often need to be involved and understand what is expected from them.
Cultural differences and varying approaches in any aspect of business operations such as processes, decision making, organizational culture, etc. may reveal incompatibility between two organizations. This in turn may lead to the loss of qualified employees in either organization and eventually to the lack of full utilization of the integration potential of both structures, so it’s worth consulting professional M&A advisors before making any impactful decision.
If you are considering investing in Poland (and do not want to worry about the deal going wrong), learn more about our due diligence services and discover how we support our clients: https://www.rsm.global/poland/en/service/due-diligence
Feel free to contact the RSM team – we look forward to answering all your questions.
Author: Zbigniew Jaworowski, TAS Junior Manager, RSM Global
