The financial advice industry is awash with buying opportunities, and it seems that cashed-up buyers are in poll position to acquire quality assets with the institutions out of the running – as long as they avoid some pitfalls…
So, what do advisers need to consider when looking at merger and acquisition scenarios?
Paul Barrett, CEO at AZ Next Generation Advisory and the author of a new guide to merger and acquisition fundamentals, says M&A is not the right strategy for everyone and that ill-considered deals “…usually result in disruption, increased cost and complexity, and value destruction”.
…just because you can, doesn’t mean you should
While he sees M&A as an important tool for business growth and notes that in the next three years many advisers will be tempted to consider this path, he warns advisers that just because you can, doesn’t mean you should.
Taken from his paper, with our thanks, Barrett’s Build Or Buy: A Guide To Merger & Acquisition Fundamentals, details 11 reasons behind M&A failures…
M&A is highly disruptive, especially for the home-base and if that home-base is a small business with scarce resources, those resources are typically split between BAU and integration. Performance inevitably takes a hit.
In our experience, home-base EBIT margins suffer for a period of time so even if the target has a higher EBIT margin, there is no net improvement to the combined entity’s performance.
Buyers need to consider the opportunity cost of M&A because integration can take anywhere from six months to several years to bed down, depending on size and complexity.
2: Nasty surprises
There is no such thing as a surprise-free target.
Unfortunately, surprises rarely delight on the upside. The most common surprise is client and staff attrition. Due to inadequate due diligence, acquirers anecdotally experience higher attrition than expected. Our analysis shows best case client attrition is nine percent pa.
Cost savings through headcount reduction is touted as a key driver of value and synergies. But the promised land of lower staff costs across the broader organisation is a façade because resources are often added (or diverted from the home-base) to assist with integration activity.
Post-acquisition, many temporary resources become permanent, resulting in an increase in staff costs.
4: Acquisition costs
Buyers routinely underestimate the time and cost required to complete a transaction including legal, due diligence and advisory fees. As buyers become more sophisticated and discerning, these costs will only rise.
For example, the level and quality of due diligence being conducted by buyers today won’t cut it in the future. Investors are increasingly demanding more detailed analysis and insights, which comes at a higher price.
5: Efficiency code
A buyer’s EBIT margin can be treated as their efficiency code. Therefore, multiplying their efficiency code by a target’s revenue will provide an indication of the combined entity’s maximum pre-tax profit.
Basically, the efficiency of the home-base dictates the efficiency of the combined entity, however, mergers often detract from a combined entity’s efficiency code.
6: Connectivity paradox
The merger of two separate companies involves the melding of different cultures and ways of doing things.
As the dominant party, the home-base usually has more influence so if it is not operating efficiently, it will adversely impact the target and the performance of the combined entity.
7: Misalignment of values and motives
Effective due diligence is not just about confirming the underlying numbers and data, and assessing the probability of achieving those numbers in the foreseeable future. It is also about uncovering non-financial risks such as a misalignment of values and motives between buyers and sellers.
Both parties need to agree on what matters most and why in order to effectively engage staff, allocate resources to the right areas and achieve their objectives.
8: Lack of project management skills
The ability to create an integration plan and apply systems and methods to achieve specific objectives within a finite timespan is a real skill. That skill set and experience does not typically exist inside the average financial advisory SME, but it is exactly what’s needed to minimise errors and ensure timeframes and budgets don’t blow out.
Buyers routinely overvalue the synergies to be had from an acquisition for a myriad of reasons including enthusiasm.
Aggressive targets and forecasts may look good in an M&A thesis, but they are generally based on hopes and dreams not rigorous analysis.
10: All care no responsibility
Measuring, tracking and regularly reporting performance is difficult and often confronting, which may explain why businesses don’t do it. However, a strong accountability framework is a key determinant of M&A success.
Businesses that keep their focus on synergies by actively managing and tracking their performance are more likely to meet deadlines, hit their targets and grow enterprise value.
Revenue leakage is inevitable, but it can be so small and slow, it’s almost invisible (like evaporation). In any transition, whether it’s a change of ownership or licensee, there are a lot of manual processes such as transferring accounts and revenue. Dollars get lost.
Furthermore, once clients are alerted to a change, some will opt-in immediately. Others will gradually leave.
Paul Barrett is CEO at AZ Next Generation Advisory. Backed by AZIMUT Group, AZ NGA was established in 2014 to build an integrated accounting and advisory group. Its objective is to become the succession partner of choice for high-quality small-to-medium-sized accounting and advisory firms.
See also: Advisers Challenged to Rethink M&A Plans