How to structure Mergers and Acquisitions in times when predictability and economic security do not exist? This is a current and important question that any professional in the field is asking. Let's explore some practical strategies to navigate this scenario.
First, the merger or acquisition process itself is already challenging. This is because it does not always happen in a smooth and homogeneous way, as there are many interests involved and, in most cases, companies and people with very different characteristics.
The union of different styles is healthy, brings diversity and opens new horizons, but it is not always harmonious.
How to conduct an effective valuation and due diligence?
First, it is essential to understand the financial health of the target company in light of these uncertainties. Assessing hidden risks, seasonal fluctuations, one-off events and the sustainability of cash flows is even more critical in times of uncertainty.
However, trusting the capacity to apply innovation and adaptability for future decision-making in the target company is very important in the process of projecting results and due diligence. This is because, in most cases, projections are built within already known scenarios and the synergies and gains that new leadership can bring to the business are not factored in. During due diligence, it is also important to analyze aspects that may become future opportunities and additional value to the business, aspects that only the buyer knows it can bring.
"Some of the most successful leaders are not afraid to seize opportunities and dare to take calculated risks." (Eirik Stranden, 2023)
Aswath Damodaran often says that our reaction to uncertainty has not changed much over time. According to him, our most common responses include paralysis, denial, mental shortcuts, herding, outsourcing and even asking for divine intervention. However, he believes the best way to deal with uncertainty is to "live in the world you are in, rather than the world you wish you were in."
Damodaran believes the first step to dealing with uncertainty is understanding that not all risk is equal. He describes three categories of uncertainty: estimation vs. economic uncertainty, micro uncertainty vs. macro uncertainty, and discrete vs. continuous uncertainty. Making these distinctions and classifications helps measure the degree to which these uncertainties interfere with your decision-making process and company valuation. Assign degrees to these uncertainties and do not be afraid to make mistakes.
Estimation uncertainty refers to the possibility of wrong models or inputs for valuing a company, while economic uncertainty arises from changes in markets and economies.
Micro uncertainty covers the potential market, competition and management team capabilities, while macro uncertainty deals with changes in the broader economic environment.
Discrete uncertainty involves latent risks that may arise unexpectedly, and continuous uncertainty refers to ongoing risks such as changes in interest rates.
"Do not go into denial, do not outsource it, do not act as if uncertainty does not exist. Accept it, be comfortable with it." (Aswath Damodaran, 2023)
Those with an appetite for deals in these times need to accept the reality of uncertainty as an inevitable part of the process and know how to work with it to their advantage. Facing uncertainty, rather than outsourcing it, is crucial. That is why it is important to run multiple analyses and consider different scenarios to make better-informed decisions.
How to identify synergies and operational efficiencies?
Identifying synergies and operational efficiency opportunities is essential. Companies that can implement synergies quickly tend to achieve better post-acquisition results. However, the rationale for a merger cannot be driven exclusively by the synergies on offer, since many other elements in that union must be anticipated, elements that can undermine the advantages gained from operational and business synergies, such as liabilities, risks, different cultures and integration costs.
"Mergers are like marriages. They are the union of two people. Just as you would not marry someone seeking operational efficiencies in running a family, then why do we think about joining two companies with unique cultures and identities for that reason?" (Simon Sinek, 1973)
Simulating future results with both companies working together is fundamental, but in the vast majority of cases there is excessive optimism about synergies and an explicit disregard for culture and governance issues after the merger. I have seen many deals undergo extensive evaluation on tax, accounting and legal matters, with nothing assessed regarding culture and ways of working between the companies. When that happens, uncertainty takes hold of everyone involved and there is a drop in results and productivity that, if recovered at all, will take time to settle into the new structure. So, before thinking about synergies, think about the similarity in operating methods and controls that the companies adopt. Give preference to companies that share the same values and ways of doing business.
What payment structures are advisable in an uncertain scenario?
Flexible payment structures are advisable, especially performance-based payments (earn-outs). These payments align the interests of buyer and seller, mitigating risks in an uncertain scenario. This technique prevents unrealistic projections from distorting the price definition, since that final price will be determined by the company's future performance, confirming or not the valuation.
"The earnout bridges the valuation gap between the seller's optimistic forecast and the buyer's healthy skepticism." ( Gundersen, 2005 ).
Why is it important to focus on long-term growth?
An acquisition cannot be made without professional planning, in which Opportunities, Business Threats and the need to pursue new businesses, markets and products are primarily analyzed. From that analysis and planning, it is possible to map out a range of Mergers and Acquisitions possibilities. It is not advisable to carry out this type of move to resolve immediate issues, as the M&A process is like a marriage and needs to be built carefully and with a well-developed plan. The instrumentation of the M&A process is important and must address all possible contingencies, but above that, the capacity for dialogue and the form of communication among those involved must be developed from day 1 of an acquisition or merger negotiation. This point, regarding broad communication capacity and clarity of the agreement, tends to be one of the most damaging issues after the deal is closed.
Maintaining a long-term vision is crucial. Mergers and acquisitions must position the company for future growth. Strategic planning does not involve only the analysis of numbers and operational matters. Present-day uncertainty can generate disastrous results in the future if it is not analyzed efficiently.
Hire experienced professionals who are accustomed to reading these scenarios and have already been through many of these situations. They can show the best path forward and help avoid the vast majority of common mistakes and uncertainties in this process.
Article also published on LinkedIn.
