VIEWPOINT: CORPORATE AFFAIRS
A successful merger or acquisition rests on solid best practices at the pre-acquisition, deal-finalisation and post-acquisition stages
n the next decade, a bulk of acquisitions, both global and domestic, will be driven by the need for scale, but mostly, by the need for relevance. Needing to stay ahead of the curve in a fiercely competitive world, firms will acquire capabilities in the digital arena also because they cannot be home built. Such acquisitions will be for products, services, and talent. That is, however, easier said than done. Compliance requirements are rising, particularly in Europe, but increasingly in India as well – and MNCs will need to be aware of that as they go outbound. Data protection laws are tightening, most visibly in the EU, with the GDPR law that shortly comes into force. Tech-related ‘buys’, must additionally contend with export controls, and anti-trust regulations for ‘data domination’ may be on the horizon.
Buyers and sellers must speak the same ‘language’ in terms of what, precisely, is for sale
From an integration perspective, the challenge with ‘shopping’ for (often much smaller) technology firms is that the targets tend to be much younger in their life cycle than what the big, established ‘acquirer’ are used to dealing with. This comes with a whole host of issues – from weaker governance structures, and therefore the need for greater due diligence, to valuation issues and limited information flows. However, what is the single most important consideration, in any merger, is the ability to build trust. Treating people with respect, avoiding having an ‘acquirer mindset’, and allowing cultural differences to exist – at least for a while – are key to making any such ‘marriage’ work.Often, a deal is made or broken in the pre-acquisition stage itself – and for a variety of reasons, M&A in the ‘digital economy’ can be particularly tricky. Robust due diligence, from both a financial and a legal perspective, becomes even more critical than in ‘conventional’ M&A, with data privacy/protection and trade restrictions getting added on to the usual issues around anti-trust. Compliance audits are also vitally important, particularly when conducting M&A deals abroad.
With start-ups in particular, the value proposition that a seller offers might be a very different thing from what the acquirer thinks it is buying. The gap between expectations – in terms of what the overall ‘package’ contains – and reality, can sometimes be massive. For instance, the ownership of assets, IPR, or even data may not be as clear-cut as they appear. The IPR may be open-source, or linked to third-party rights. Equally, there may be restrictions on how the data held by an acquisition target – something that forms a large part of its initial valuation – might be leveraged. To illustrate, the target may have secured usage consent for a specific purpose, but cannot then transfer that consent to the new owner. In fact, the acquirer may have to pay heavy fines for later using the data for a different purpose. Ultimately, forming a more realistic picture of what, exactly, is on offer can be expensive and time-consuming, but it is also a safer course of action for the buyer to take.
A unique business model might be a big part of the target’s initial ‘attractiveness’, but with regulation continuously evolving, these models can quickly become unviable. Start-ups are more frequently at risk, but as the recent crisis at Facebook demonstrates, even mammoth, established businesses can come under attack. Moreover, while many buyouts fall below the revenue- or asset-size threshold for anti-trust investigations, regulators are starting to look at issues around ‘data dominance’ – which might arise, for instance, if a ‘big data’ company looks to buy another data-rich firm. (That said, the dynamics of competition – and therefore definitions of concentration risk – are changing fast. In the media space, it is not other, local media companies that are the competition, but behemoths like Facebook and Google.) In the digital realm, potential acquirers also need to be aware of the acquirer’s hidden activities, which can pose both reputational and litigation risk. Due diligence, in terms of identifying compliance risk, is therefore critically important.
Holding on to key people – or the IP they possess, and managing cultural issues, are a big part of navigating towards a deal
Particularly with start-ups, people are at the very core of company valuation. Often, most of the firm’s IPR resides in the heads of a few individuals – and should they leave soon after an acquisition, a major part of the deal value might be destroyed. In structuring an M&A transaction, it is therefore important to tie key employees – not just the founders, but other senior executives – to the business, including through deferred equity considerations. Also advisable is to ring-fence the business with non-compete and non-solicitation clauses for the seller as well as other key individuals. (With respect to the latter, it can useful to fix a consideration amount, usually less than a full salary, which is to be paid for a fixed period of time.) Yet, while most regulators accept the need for such agreements – without them, it is difficult to buy a business with large intangibles – it is also important to put reasonable timeframes (usually 2-3 years) and geographical coverage on them.Right from the pre-acquisition stage, issues of culture occupy centre-stage. Acquirers must be sensitive to the fact that no one likes to be acquired, and they must look into softer issues, such as whether people will be willing to ‘accept’ the acquiring firm and its culture. When ‘shopping’ abroad, nationality can be stumbling block – and in some countries, the acquirer must first ‘sell’ India as a brand, and only then promote their own company, and the value that it can bring – in that order. (This is less of an issue in countries like the UK, where Indian firms have made several large, successful acquisitions in the last few years.) Beyond meeting potential employees, it is crucial to dig deeper into the organisation’s culture by networking with people who are familiar with the firm and its business: its bankers and suppliers, for instance.
Increasingly, firms in the digital space are competing with VC funds, investing in multiple start-ups to acquire technology at an early stage, but without paying massive late-stage valuations – which is where VCs typically seek to exit. Often, the founders are given both upfront value and the potential to earn equity-like returns by staying invested in some manner. Many tech firms are also incubating ‘internal start-ups’ that function much the same way, and operates on the same principle as a VC fund: invest in several different businesses, and be prepared for many of them to fail. In general, valuations will depend on the firm’s ability to scale-up, and the acquirer’s value-add will come from helping the target improve its market access, its margins, or both.
The classic ‘100 day integration plan’ is flawed. A better approach is to let nearly everything stay as it is, at least for a while
Having sorted through the many complexities of the pre-acquisition stage, there are several dos and don’ts to keep in mind in finalising the deal. First, and critically, it is important for those who will actually be running the business to be involved at all stages of the deal. Some make the mistake of getting a team of M&A experts to not do all the ‘detailing’, but to also entirely complete the deal before bringing the business side on board. Doing this, however, means that senior management feels no ‘ownership’ for the process – a leading cause of M&A failure. Far better to get top managers to anchor the process from the get-go, by having them willingly take on the project as something they believe to be in the company’s best interests. Second, particularly when purchasing foreign assets, it helps to tap local stakeholders – chamber of commerce, trade/export agencies, and private consultants – that can help see the deal through to completion. This is particularly important today, given the growing tendency to protect local companies from foreign acquisition. Third, to improve the chances of success, it is vital not to impose too much change from the top. Making sure that the acquiree enjoys the same systems, culture and ‘freedom’ as it did pre-acquisition, vastly improves acceptability. On the other hand, attempting to integrate a fledgling start-up too fast into a more ‘traditional’ business would probably kill it.
Building trust is the most important part of the integration phase, and it begins very early on. Typically, any kind of change will damage trust – and ultimately the business. After all, nothing destroys value like heavy-handed intervention, such as changing reporting structures or bringing in new senior management. The classic ‘100 day integration plan’ is inherently flawed, and a better approach is to let everything from the name of the organisation, to email IDs and people policies, to stay as they are for a while. Nor is it helpful is to run formal integration audits too early, because often, they yield very little real insight on underlying issues, while also making people uncomfortable. Instead, by earning trust, one can encourage people to share information more freely, and to also make them more amenable to change – albeit in small steps. The big danger, particularly early on, is that someone coming from the start-up world might find the new set-up ‘too corporate’ and simply walk off, taking a chunk of the valuation, and the company’s IPR, with them. To avoid this, one should remember why the company was acquired in the first place – and to allow what was successful about it to continue to exist. (With overseas acquisition targets, it is also critical to ensure that the people do not suddenly start to feel like they are working for a ‘foreign’ company.) At the same time, systematically transferring the knowledge and capabilities that the new team brings to the table, can ease some of these people risks. Finally, people need to be comfortable with the new arrangement on the acquiring side, too, so it is vital not to show overt favouritism to the ‘newcomers’.
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This article is based on discussions with Vineet Agrawal, Chief Executive, Wipro Consumer Care and Lighting & ED, Wipro Enterprises, and Sushil Agarwal, Group CFO, Aditya Birla Group & Whole Time Director, Grasim Industries, at the Doing Business Globally conclaves hosted by IMA India and Baker McKenzie in Mumbai and Bangalore in April 2018
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