How Do Mergers Succeed?
The successful deals have one thing in common—both parties are very open and specific about their plans and goals.
The opposite is unfortunately true, too. If the deal struggles, or worse if the post-deal execution struggles, it is usually because the goals were misrepresented. At times, the larger firm has no respect for the smaller firm or its methods and can barely wait to change everything. That means it was never really a merger—it was an acquisition disguised to feel friendly. Smaller firms, on the other hand, often sabotage themselves by presenting their desire to grow and build together, but then it turns out the owners only wanted to retire and cash out. Frequently in the negotiation process, both firms try to present their best sides, but eventually the flaws that drove them to the deal become exposed after the signatures dry.
The best mergers are usually not those where investment philosophies are compatible or technologies integrate easily. Instead, the best deals are the ones between leaders who can’t wait to call each other “partner.” The excitement about building a business together with a like-minded group of people is a powerful driver that can overcome many of the financial and operational obstacles.
What Is The Process?
Which brings us to the terms. The simplest thing to know is that the two sides will be partners and share in everything—all the success or all the struggles. If the discussion starts with the topic of valuations or terms, chances are it will not go very far, or at best the deal will feel like an acquisition more than a merger.
The ideal process should resemble concentric circles with every next circle (meeting) getting you closer to the center:
1. Your Shared Vision. What are the reasons you are combining firms? How will the combination make you more successful and competitive? Who will be your target clients? What services will you provide? What will be your goals for the next five years and beyond? What culture are you looking to create and be part of?
2. Your Personal Goals. What motivates you as individuals? What business values do you hold? What do you enjoy and hate doing? What do you see as your strengths? What are your goals personally?
3. Your Shared Data. Are both organizations profitable and growing? What do benchmarks tell us about productivity and efficiency? What is the quality of client relationships and the pricing of services? What will the combined financials look like?
4. Business Planning. What will the new organization look like? Who and how will service clients? Who will develop business and what kind of business? What systems will survive the merger? What are the milestones for combining the firms?
5. Partnership Structure. What will be your responsibilities as partners? Who will get paid how? Will you have profit centers or will you operate a combined P&L? What will be your titles? How will you make decisions? How will you use or distribute/contribute capital? What are the future risks and how will you deal with them?
6. Deal. What are the valuations or formulas for combining? Will there be an exchange of equity? What obligations to retiring and retired partners exist now? How will you “divorce” if something doesn’t work?
Again, it is very tempting to jump to the valuation discussion, but if this is truly a merger it is difficult to begin there. Since in a typical merger there is little or no cash changing hands, the valuations are a bit more abstract than they would be in a cash deal. What usually matters the most is the “exchange rate”—the rate at which one company exchanges shares for the equity of another. This gives rise to many complex questions of valuation and financial analysis that should be considered carefully. Valuation experts can certainly help here, but both firms also need to carefully educate themselves about the methodology and logic of the reports and carefully discuss the data and results with the experts.
The valuation is often not where the rubber meets the road. Often, what’s more important is the income to the owners after the firms’ integration.
The structure of the merger and the size difference between the firms may mean an immediate drop in income for one or more owners. The trade-off may force some decisions and a dose of reality. For example, if you really believe the merger will grow the firm quickly, are you willing to give up income to achieve that?
Who Should Be Thinking About Mergers?
It seems most advisory firms are already intrigued by mergers. After all, close to half of all firms are already discussing them. My advice would be that mergers are all about finding a good partner. If you find that partner, you should very much consider joining forces and achieving your vision together. On the other hand, if you are not convinced you have the right partner, there are no industry conditions or competitive dynamics that will make a merger a good idea.
The same applies to succession. If you have found a firm that you trust with your clients and your people, then a merger may be the right way to solve the problem. However, if you can’t trust the other firm completely, what are you achieving by combining your problems?
Many mergers may very well be dressed up acquisitions, but even the desire to signal collaboration is important. After all, if you examine the history of the accounting industry, this is how the Big 4 and even regional firms came to prominence—they were built through mergers, not acquisitions.
Philip Palaveev is the CEO of the Ensemble Practice LLC. Philip is an industry consultant, author of the book The Ensemble Practice and the lead faculty member for The Ensemble Institute.