Navigating the Complexities of Mergers & Acquisitions with Fractional Executives

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Mergers and acquisitions (M&A) are complex transactions that involve the combining of two companies. While increasing market share is often cited as a primary reason for M&A activities, these transactions can sometimes fall short of this goal. Mergers and acquisitions fail for a variety of reasons, including cultural difference, integration issues, and strategic misalignment.

Cultural Differences

When two companies merge, there may be significant differences in the corporate cultures and values of the organizations. This can lead to conflicts and difficulty in integrating the two entities, resulting in a lack of collaboration and a failure to achieve the desired synergies.

For example, consider Google’s acquisition of Nest. Nest had a culture that was top-down driven with a visionary and vocal CEO. Google’s culture is more product-centric and bottom-up. It is known for giving engineers autonomy to experiment. To further complicate matters, Nest’s acquisition of Dropcam also resulted in cultural clashes. Ultimately, these culture issues led to the departure of Nest’s CEO.

Fractional C-suite executives are both insiders and outsiders at the same time. They are fully on board with the client’s executive team and leading their functional area of expertise. In this way, they are insiders. But, as newbies to an organization, they bring a fresh outside perspective to team dynamics. Fractional CXOs do not bring preconceived expectations from either side of a company merger, so their outside perspective allows them to identify concerns, drive collaborative solutions and head off cultural team derailments.

Integration Issues

Merging two companies requires significant effort and resources to integrate the operations, systems, processes and people of the two organizations. If the integration process is poorly managed, it can result in disruptions to business operations and customer service, leading to dissatisfaction among employees, customers, and shareholders.

A third-party assessment used to either derive or review an M&A integration plan can help fuel desired business outcomes. Business leaders, such as fractional C-suite executives, who have “been there, done that” offer an informed viewpoint and add value from due diligence to post-merger integration.

Strategic Misalignment

M&A activities require careful consideration of the strategic goals and objectives of both companies. If the strategic goals and objectives of the two companies are not aligned, it can result in a failure to achieve the desired synergies and increased market share between the two organizations.

Consider, for example, Unilever’s acquisition of Dollar Shave Club. Dollar Shave Club had sales of $152 million before Unilever paid $1 billion to purchase the company. Unilever did not have knowledge of the category before buying the company as it did not have a razor product. As the acquiring company, Unilever expected to sell more of its products direct-to-consumer, based on Dollar Shave Club’s success in the channel. The company also expected to sell more of its non-razor products to Dollar Shave Club customers. Neither of these things happened at the pace Unilever anticipated.

Experienced fractional executives can help evaluate sourcing goals and mitigate strategic misalignment. Such leaders often bring a perspective from multiple industries and can provide a vision on the future of each. It is safe to say that Unilever would have benefit from a stronger DTC business leader’s perspective that did not come from inside Dollar Shave Club. Such knowledge could have aided Unilever in setting expectations and informing its acquisition price.

Overall, M&A activities can be complex and require careful planning, execution, and integration to achieve the desired benefits. Failure to address the challenges and risks associated with M&A activities can result in significant financial losses and a failure to achieve the intended strategic objectives. Fortunately, fractional C-level executives are accessible to lower middle market and larger companies to help navigate the complexities of M&A from sourcing to post-merge integration.

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Term Sheets

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Congratulations.  You’ve made a compelling case for your company to receive funding, investors are interested, they’ve done a couple of rounds of due diligence and probably visited you and your team at your site – if there is one.

Next step is a Term Sheet.  Here are the pressure points within the term sheet that you and your lead (such as TechCXO) need to be prepared for:

Leverage

The simple truth is that your early-stage investors typically have more leverage than you.  They look at hundreds of deals and fund a handful.  However, you’re not necessarily weak.  Having interest from multiple suitors greatly strengthens your hand.  Just remember not to dig into your position too hard.  Investors are used to walking away from deals and you want that capital.  Word travels fast in this small community, too and you don’t want to be cast as a hard case.

Ownership

Our guidelines remain: no more than a 25% equity for investors in the Angel/Seed Round and no more than 30% equity in the Early VC or Series A stage.

Valuation

Using traditional industry comparables as you would for M&A transactions is tricky for start-ups.  Generally, the more mature your company and its metrics, the better the valuation.  Some metrics such as cash flow and revenue may apply.  Some metrics may not be available and you will need your Structure and Performance hurdles to aid valuation.  The assumptions made and agreed to within those hurdles such as customer acquisition, revenue, retention, profitability, etc. will help set your valuation.

Board Composition

One to two Board seats to investors is the norm. There is an increasing trend of an equal number of board seats going to independent members, with the founder/CEO as the “odd” member of the new Board.

The Option Pool

The purpose of the option pool is to provide incentive for management, key employees, and advisors. This range can vary based on how many of the management members are also founders and have founders stock.

Many firms provide options for all early employees – typically under the assumption that they are being paid below market cash compensation and are in a volatile employment environment. With each new raise, the option pool is refreshed to ensure that there are adequate incentives for key new hires.

For stock option plan composition, a good rule of thumb is for 15-20% of the capital structure reserved for the option pool at this stage.  Even better is if you can get this post-closing, so the new investors and founders share in the dilution.  With further rounds of financing, this pool may get down to 10%.    Target half of the pool for the leadership team (CEO, Board Members and direct reports to the CEO).

Key Rights and Preferences

Rights and preferences can get you down into the weeds. You’ll certainly need advisors to help you sift through this. Here are some quick highlights:

  • Liquidate preference – usually 1X original investment
  • Participation – conversion to common after the payment of the liquidation preference in order to “participate in the remainder of liquidation proceeds”
  • Anti-dilution rights – to protect against future issuance of equity securities at a price below the price the current investors are paying
  • Board of Directors participation – either board seat or observation right depending on the size of the investment and % of the company owned post investment
  • Veto rights on certain corporate transactions – preferreds vote as a separate class on things like senior debt, issuing additional securities, liquidation
  • Information rights – monthly/quarterly/annual reporting of financial results to investors
  • Registration rights – ability to register shares in the event of a public offering

Structure and Performance Hurdles

The primary questions to be answered are: how big is your market and how much of it can you capture…and in what time frame.  This is why we stress defining market niches so much during your preparation for funding. Other considerations such as the development of new applications and adding key team members can be factored in but there’s no getting around competing and winning in your defined market.

QuikOrder Acquired by Pizza Hut

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Congratulations to our client, QuikOrder, for being acquired by Pizza Hut. TechCXO supported QuikOrder with finance and accounting services for close to two years, including M&A support by assisting in due diligence pre-sale and interim CFO services from TechCXO’s Bob Brogan.

QuikOrder, is Chicago-based and a leading online ordering software and service provider for the restaurant industry. Terms of the deal were not disclosed, but it marks one of Pizza Hut’s largest acquisitions to date.

By acquiring QuikOrder’s online ordering capabilities, Pizza Hut U.S. will improve its ability to deliver an easy and personalized online ordering experience and accelerate digital innovation across its base of more than 6,000 restaurants in the U.S. In 2018, approximately half of Pizza Hut U.S. sales were processed through QuikOrder’s platform. Founded in 1997, QuikOrder specializes in developing and maintaining internet-ordering systems used across the QSR industry. It has served Pizza Hut U.S. for nearly two decades. Over that time, it has built an expert team that fully understands and meets Pizza Hut’s specific needs. The acquisition will include: Pizza Hut’s current digital ordering platforms, systems and services and QuikOrder’s in-restaurant technology and ancillary services, as well as its future generation products and programming.

Read more:

Chicago Sun Times
Chicago Business
PRNewswire

 

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Bob Brogan is a senior Strategy, Operations & Finance executive recognized for identifying and delivering profit-improvement objectives for software as a service, professional services and technology companies.
bob.brogan@techcxo.com
(708) 243-7004
See Bob’s full bio

 

Negotiating Price

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When it comes to negotiating a price in mergers and acquisitions, there are, of course, two very different perspectives: those of the buyers and those of the sellers.

The buyer wants upside, efficiencies, strategic fit and certain parameters met. The seller wants fair value (or maybe a little more than fair value) for their company. Effective negotiators get deals done by bridging the two perspectives. Below are some useful maxims for the respective sides.

The buyer wants upside, efficiencies, strategic fit and certain parameters met. The seller wants fair value (or maybe a little more than fair value) for their company. Effective negotiators get deals done by bridging the two perspectives. Below are some useful maxims for the respective sides.

Sellers

Valuation. What’s my company worth? There are many variables to valuation but you can get in a reasonable range to begin negotiations with the right information. First, there are comparables in your industry. If your firm is private, look at market capitalization and ratios for similarly-sized and positioned companies that are publicly traded.  NOTE: There is a discounted valuation for private companies versus public companies. In the past, public companies were worth significantly more — the valuation gap ranged from 30-50% plus. That dynamic has changed, but it is important to note that a private company discount still exists.
Along with public company valuations, you can also research M&A and other transactions in your sector for similarly-sized companies. Another standard and popular gauge is the historical revenue per employee calculation.

Strategic Assets + Future Value – We’ve talked before about the importance of the Seller’s Story. Specifically, negotiate a price based on the value your company brings to the acquirer; determine how you can accelerate their growth and/or enhance their value, then negotiate off that prospect. That means highlighting strengths be they geographic, unique market niches, key customers, market dominance, service abilities and more.

Buyer’s Disclosure – We often think of disclosure from the seller’s side, but there is also a buyer’s disclosure that can help the seller’s valuation. Buyers use a logical process for acquisition targets and pull together for their investment banker or consultant marching orders to find companies in a certain space or market sector with the specific attributes. The company will have obtained Board approval to seek companies with these attributes. Ask investment bankers callers what these attributes are – you might even ask for a document the I-bankers have prepared for their client. Do this right at the initial stages of inquiry and then build your story along these sought attributes.

Pay Only for Strategic Fit. Avoid price discussions until you thoroughly understand the acquiree’s business; put you best people on the project team until you validate the strategic value proposition and only pay for that. Remember: No amount of back office rationalization or tax benefits can justify an acquisition; the value always comes from expanding and penetrating new markets.

Buyers

Price: Keep it Simple. Adhere to the KISS rule of simplicity when establishing a price range / multiple for acquisitions price. Keep the variables few and simple. This will increase the likelihood that both parties are focused on the good of the combined entity post closing.

Room for Growth. Set a price with room to grow the multiple in order to make the purchase “accretive” to your company’s value. If the acquiring company is valued at say 10 times net income, the target price of the acquisition should be less than or equal to 10 times earnings. That way the acquisition itself helps increase the value of the acquiring company. Acquiring for more than your valuation will result in negative value to the purchaser. Also, price represents perceived value which should represent the ability to disrupt a new market with new advantages; base pricing on the asymmetrical competitive advantages.

Demand (from yourself) a Post-Deal Plan. Due diligence is not complete until a 6 to 12 month post deal plan is in place. Without it, you don’t really understand strategic fit and can’t justify the deal. Post deal plan should center on quick market wins demonstrating new strategy.

Keep Savings for Yourself. Cost savings through shared assets, like software and licenses; shared services like accounting, legal, HR and marketing; and share operations, such as facilities, belong to the buyer and should not be part of the price negotiation. There is always risk in not achieving the savings.