The “Catch 22” of High Synergistic Fit in Merger and Acquisition Transactions

By design, merger transactions can have significant strategic value to two parties with different yet complementary operating models and philosophies. While these operating and cultural differences can yield a stronger and more complete organization, they can also make for a difficult transaction process—which in turn may put at risk the great strategic potential contemplated by the combination in the first place. This article illustrates this common transactional phenomenon and proposes several techniques to ensure that tension inherent in opposing but complementary business philosophies does not prevent a stronger combined entity.

Consider the following fact pattern:

Company A, a small but growing engineering firm, achieves great success in the industrial sector as it provides the same sophisticated services offered by the largest engineering firms in the world, but with client responsiveness and agility common in smaller firms. This responsiveness and agility, combined with some entrepreneurial risk-taking, contributes to better profitability. At the same time, Company A needs a succession plan, deeper operational resources, and the resources of a large engineering firm to continue to support its growth.  Company B is a $1 billion international firm with depth and sophistication of resources to support growth. Overly conservative because of adherence to strict operational processes, Company B is laden by bureaucracy and lack of responsiveness. While possessing deep marketing and other operational resources, the organization is too heavy and sluggish to penetrate the fast-growing industrial sector. Furthermore, layers of oversight and conservative decision-making contribute to limited risk taking—and lower profitability. 

Like all successful merger transactions, Company A and B realize they can both benefit from becoming one. The merger gives Company A the scale and international access needed to continue its growth.  For Company B, the merger introduces a culture of vibrancy and entrepreneurship that contributes to far greater profitability on its core business.  However, in classic “Catch 22” fashion, the same factors that make the transaction such a synergistic fit and success make it more difficult to execute from a transaction perspective. The exact characteristics that each needs in the other turn out to be those that cause trouble during diligence and legal documentation. Company A is concerned that greater recordkeeping and other administrative burdens from integration into Company B will impair the flexibility that makes it successful and profitable; likewise, Company B is concerned that it will be unable to keep up with the more agile and entrepreneurial Company A and is uncomfortable with some of its historical risk profile. And both parties—relying upon their historical culture—are emboldened in their transactional positions, while acknowledging they need the other’s culture to survive and grow in the future.

So how can two very different parties that need each other so much ensure that the fantastic transaction benefits are not lost to cultural differences?  While it’s easy to say that both parties need to understand the other’s perspective, seasoned transaction professionals know this is easier said than done, particularly in the heat of transaction negotiation. While there is no foolproof plan to ensure a transaction stays on track in this situation, a few tactics can be employed to prevent the Catch 22 from destroying a potentially perfect combination. 

• Establish Early Integration Expectations of Both Parties — While most early transactional negotiations do contemplate high-level integration analysis, most often this topic is deferred until much later in the process. In addition to discussions about value and strategic potential early in the transaction process, both parties should not be bashful about using early conversations as a forum to explore integration specifics. Planned reporting hierarchy, extent of decision-making, level of financial and other business-management reporting, and the risk-management processes and policies of the respective parties are good topics to consider before the parties decide to negotiate on an exclusive basis. For Sellers running an auction process, requesting the Buyer universe to document early their expectations for these integration items, while the Seller has leverage in the transaction, is ideal. If a Buyer is unable to document how they will take into account the unique aspects of the acquired business, it might mean that the buyer is unable to appreciate a different business model.
• Remember Strategic Fit — During due diligence and document negotiation, the cultural differences of both parties become very evident.  For example, a smaller company’s lack of formality in documentation may cause hairs to rise on a larger more corporate buyer; similarly, a large strategic organization’s diligence level and detail may come across as overly burdensome to a smaller Seller and may be perceived as a preview of the hassle associated with integration.  To prevent this from causing the transaction to derail, a “check-in” during diligence, in which both parties meet to reconfirm strategic fit, may be needed to ease tensions around the cultural differences and reassure both parties. 
• On-Site Buyer Visits — A common tactic to alleviate Seller’s concern about oppressive post-transaction management is on-site visits to the buyer. Most of the diligence and negotiation process is at Seller’s site. This one-sided investigation can certainly contribute to a Seller’s integration anxiety. Scheduled on-site visits to the buyer, where Seller can actually view the processes in place, are very effective to promote good feelings about synergy. Buyer should demonstrate some of the benefits of integration into their organization, such as access to a very large Human Resources and Marketing Department, for example. Allowing buyer to see the benefits of integration, in the middle of sometimes tense negotiations, is an excellent way to solve problems associated with cultural disconnect.
• Disconnect Diligence from Operations — It is common for a Seller to associate the due diligence process with post-transaction life. As a result of the diligence investigation, Sellers often envision long interrogation and oppressive recordkeeping as part of life with the Buyer. It is important for a buyer to disassociate diligence from integration, understanding that the Buyer has an unpleasant job to do before both parties can realize the great benefits of combination.  

The cultural differences that often come with the greatest strategic fits can be exacerbated by transaction-process functions.  When parties can work through cultural differences during this process, the potential for a promising partnership is assured.

© Copyrighted by EdgePoint. Paul Chameli can be reached at 216-342-5854 or via email at pchameli@edgepoint.com.