Mergers & Acquisitions 101 For Managed Service Providers: Why Your M&A Transaction Should NOT Resemble a Crime Scene

M&A is a lengthy, time-consuming process that can be ruthlessly unnerving.

When done right, however, it can yield attractive transaction value. When done right, it doesn’t feel like you sold your puppy to the butcher, either.

In order to avoid your M&A transaction becoming violent, you need to remember one thing: your transaction is all about adding value to the target company. Keep that top of your mind and you’ll eventually get through it.

Until then, here are common pitfalls to be aware of, and how to navigate them.

How (and why) M&A transactions fail.

The business and financial world saw record-breaking M&A transactions between 2015 to 2019.

In the US, there were roughly 170 billion U.S. dollars worth of transactions successfully completed in 2020. But, that doesn’t mean each merger or acquisition was free of bloodshed.

Doing an M&A transaction has been described as one of the most unnatural acts in business.

Here’s why they’re hard and why they fail.

Poorly Planned and Executed Integration. Integrating the operations of two companies proves to be a much more difficult task in practice than in theory. This may result in the combined company being unable to reach the desired goals in terms of cost savings from synergies and economies of scale. A potentially attractive transaction could turn out to be ugly, once integrated. As good as the motivations for a transaction might be, a wish is not plan. You actually have to plan out how you will succeed together.

Overpayment. If company A is bullish about company B’s prospects, it may offer a very substantial premium for B. Once it has acquired company B, the best-case scenario that A had anticipated may fail to materialize. I often refer to this as “Deal Fever”. For instance, a key piece of technology being developed by B may turn out to have unexpected poor performance, significantly curtailing its market potential. Company A’s management (and shareholders) may then be left to rue the fact that it paid much more for B than what it was worth. Such overpayment can be a major drag on future financial performance and overall morale.

Culture Clash. This is usually one of the biggest reasons that M&A transactions fail. M&A transactions fail because the corporate cultures of the potential partners are so dissimilar. Corporate Culture is best identified in Core Values, Employee care, Customer care, and business philosophy. Think of a technology stalwart acquiring a hot social media start-up and you may get the picture.

If they’re so hard, why do an M&A transaction?

The simplest answer is growth.

Many companies use M&A as a business strategy for growth. It allows you to instantly grow and leapfrog your rivals. In contrast, it can take years or decades to double the size of a company through organic growth.

The next reason is competition.

This powerful motivation is the primary reason why M&A activity occurs in distinct cycles. The urge to snap up a company with an attractive portfolio of assets before a rival does generally results in a feeding frenzy in hot markets. Some examples of frenetic M&A activity in specific sectors include dot-coms and telecoms in the late 1990s, commodity and energy producers in 2006-07, and biotechnology companies in 2012-14.

The third reason is synergies.

Companies who merge take advantage of synergies and economies of scale. This occurs when two companies of similar offerings combine, consolidating (and eliminating) duplicate resources while every dollar saved goes straight to the bottom line which boosts earnings per share and makes the M&A transaction a lucrative one.

Another reason to do an M&A transaction, especially in the tech space is market growth.

When you engage in M&A to dominate your sector, the idea is to combine two firms that would result in a much larger one. Ideally, you should be able to go to market quicker with new and improved service offerings and have more resources for growth and investments. Market domination is about strengthening your positions in geographic markets as well as exploring new ones, with new products and technology solutions.

The last, but not least reason for an M&A transaction, is for tax purposes.

Technology firms can use M&A for tax reasons, although this may be an implicit rather than an explicit motive. For instance, until recently, the U.S. has the highest corporate tax rate in the world with some of the best-known American companies resorting to corporate inversions. This is a technique where a company in a high-corporate-tax-rate state or country merges with another corporation in a low-corporate-tax-rate state or country. Sometimes the company in the low-tax environment is much smaller and would normally not be a candidate for a merger, but would become legally located in the low-tax jurisdiction which subsequently helps you avoid unnecessary corporate taxes.

Other possible tax advantages are a tax loss carry-forward, which involves a previously sustained net loss that can be offset against the profits of the firm it has merged with. This provides a significant benefit to the newly merged entity, but it’s only valuable if the financial forecasting for the acquiring firm indicates that there will be operating gains in the future. That’s where I come in.

At iT Valuations, we help firms like yours determine value when it matters most, so you can stop fearing letting go of the vine and sell, and instead think about what life is like afterwards. To talk with us about how we can help you IT services business finally solve your selling-struggles.