Success Authorities spoke with Attorney David Silverman about mergers and acquisitions, M&A. It was a unique opportunity to discuss the challenges and successes of these complicated deals.
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Transcript:
Ronn Lehmann
How do you think about culture in terms of looking at a merger or acquisition?
David Silverman
I think about it as overlooked, not well considered, but thought of as well considered. And that’s dangerous. There’s a statistic that’s out there where something like 60 to 85 percent of M&As fail because of mismatch or an inability to match cultures. It seems so easy. If you make widgets and I make widgets, then this should be simple—we can make widgets together. It never happens that way.
One of the conversations I have with owners is to think about your own personal experience. If you were making a widget in your garage, and your neighbor comes over. Your neighbor makes widgets, but your neighbor knows everything—there’s nothing about widget-making that your neighbor doesn’t know. It’s about “Well, gee, this is the way I make widgets.” And “No, this is the way I make widgets and you should make them this way.” We are talking about two people. Now multiply that by however many people there are, and you see the problem.
Culture clash arises primarily from the lack of forethought, the lack of adequate collaboration within your own organization, the lack of planning within your own organization, and then the lack of collaboration between the organizations. There is going to be a multitude of different opinions between all those people. Then you have the ego problem.
The culture issue requires a lack of ego, some very thoughtful conversations starting at the top, and then filtering down. Really, it is part of preplanning. Because once you start getting into an indication of interest or memorandum of understanding, then you are getting into specific deal points. You cannot reduce culture to a deal point. Those things need to be very well vetted.
Jayne Sanders
What role have you experienced or seen leadership play in a merger or an acquisition working successfully?
Silverman
Whatever that leadership style is, it’s not going to change for this transaction. Whatever the leadership style is throughout day-to-day business, that’s what you’re going to see during M&A. It also takes a significant amount of focus and endurance over time. Not all leaders have the ability to stay focused. Because “I’m running my business.”
An M&A deal takes a great deal of time, concentration, focus, and a great deal of consistency. Those traits, among many others, that are inherent to whoever the deal person—the leader—is, those are the kinds of qualities that are going to pass through and flow into that deal. As the leader of this company, I have this whole culture that I built around my personality. If that works operationally day in and day out, that’s fine. Then if I run across something that requires far more patience, more diligence, and collaboration amongst the team that is not used to working slowly, patiently, diligently, and even collaboratively, now I’ve got a problem.
Think of this like a system conversion. That’s almost as big as an M&A in so many ways in terms of how it impacts your day-to-day operation. If any of you have been through an IT system conversion, and I’ve never heard of one that goes smoothly when you watch your organization go through that. If it’s an organization that’s used to going step-by-step methodically one thing at a time, do it right and then move on, great! But if you’ve got an organization that’s used to moving at 100 miles an hour every day, it gets frustrating really quickly for everybody. Now you’ve got to match that culture with whoever it is you are merging with. You can see that it’s really tough.
To bring this all back to the leader, the leader needs to be able to adjust him- or herself to this kind of lengthy transaction because it is a lengthy transaction.
Ed Bogle
Thinking back on your career and involvement with mergers and acquisitions, it’s a proven fact that 75+ percent of them overpay. That makes transactions bumpy down the road. Looking back on some of those, other than what you’ve already mentioned, where do you see them really failing in terms of legal issues, financial issues, etc.? Where is that overpayment coming from and how do we avoid it?
Silverman
Overpayment. We’ll focus on that number, that idea first. Let’s go to what’s happening right now. Then we’ll move back in history a little. Right now, the focus is on quote to value. We’ve heard about it for years. But especially small businesses tend to say “Oh, it will add great value to our company” without understanding what that is and where the hidden value is.
Typically, the value has been in topline. “They make $40 a month. We only make $30. That means we’re going to make $70 together.” Well, the math doesn’t exactly work that way. That’s one. But two, it’s not where the value is. The value isn’t in the topline. And even if you boil this down to margins. “Their margin is three percent; my margin is two percent. Now we’re going to have at least a five-percent margin.” That still doesn’t work. So, where is the hidden value in the other company and how can we find that?
If there are operational things that a buyer does that a seller needs and they can take that technology or human capital in order to plug into specific needs that lead to specific efficiencies and can translate into dollars, now you’ve dug a little bit deeper into where that value is. It could be that one company has an analyst that is just crazy good. One way of unlocking that would be grabbing data from one company and giving it to Company B’s analyst and saying, “What would you do with that?” Then you test to see where that particular analyst’s skills and talents can improve Company A. Now you’ve dug deeper. You can really see where that person has some great value.
You can do the same thing with systems. You say, “Let’s plug in your manufacturing system, or your sales training system, and apply it to us.” Then you see where that real value is. If you identify where that value is, then you can really see where value in a company is where there may very well be the dreamed synergies—the synergies that CEOs think are there because that’s what they want to imagine. There’s a big movement to that now. I think it’s only going to get greater as inflation keeps going and valuations have to be done a little differently—that’s what’s happening now.
Historically, why did they overpay? Because they don’t know how to find the value that I just described. They just look at topline dollars. Sometimes they look at bottom-line numbers, but they won’t look at the reasons behind them. Other reasons are, they just don’t look around corners. They don’t see what’s coming. Those are the kind of due-diligence things that have to take place now.
Bogle
So, what I’m hearing you saying—and maybe you can expand upon it a little bit—is to look at the underpinnings of both the cost and income side of the thing and see where the hidden values are, the relationships, the likelihood of those to continue, etc.
Silverman
You have no idea what’s going on underneath those multiples and have no idea if the financials are even close to being right. Ninety-nine times out of 100, they’re wrong. And they’re usually wrong because the owners don’t know how to verify their accuracy.
Bogle
Underpinning what you’re talking about is, “What is the likelihood of the current, or even three-year’s worth of trailing earnings, what’s the current earnings, and what’s the likelihood of that to continue with the component pieces?” It’s just devastating not to do that. To your comment about the financials, you can always get audited financials, but usually, the smaller companies don’t have them. Then you’re looking at sometimes $30,000, $40,000, and more to get a set of audited financials that go back for a while.
Silverman
Looking at tax returns and K1s, that doesn’t really help tell the whole story. They each have their own CPA, and CPAs all have different ideas and CFOs have different ideas on how you book things. They’re all right, or they’re all legitimate, I assume. But you just have to figure out what that is and if that fits your business model as well.
Linda Ruhland
Do they come to you seeking advice before they are ready to execute on one of these things, or do they see you as somebody who’s going to help them transact, and it’s moving forward no matter what?
Silverman
I really like the ones that come and ask me first. Because then we can have this kind of conversation. And that’s always very rewarding for me as a counselor. More often than not, the feedback’s been positive from the client in that, “I’m glad that we spoke. I have a lot of things now to think about.” If they decide to go through it, I get to be part of that transaction, the counseling stages, right from the very beginning. You know, “Talk to them about…Then we can go through all those communication issues, cultural issues, and all that.
Other people call me up and say, “Look, I’ve got a deal coming. I’m buying the widget company down the street. It’s $40; just write it up and we’re done. We already have the deal. We’re going to close on it in a month. There’s not that much, it’s not that big of a deal, just write it up, just give it to me.” Okay then, “If that’s what you want. I see deal points, and I just ask, I just want to confirm…” “Yep, that’s what we’ve got.”
Everyone of us has a different personality. We carry that personality with us through everything we do. Through our day-to-day socialization, in our family, and out in business, to our employees and colleagues in business, that’s just who we are.
Lehmann
As you’re working with people, do you find that they have accurately assessed the time, resources, and money that it’s going to take to achieve this magical dream that they have, what they get at the end of this?
Silverman
Most of the questions are “How much is this going to cost me?” and “How much is your fee?” To that extent, “Yes.” But then there’s the follow up. What about your time? What do you estimate your time to be? Who else in your organization are you going to ask, and what does that take away from their revenue generation, etc.? For the most part, everybody underestimates the lost opportunity impact in their organization. There’s a lot to do, especially on the financial side. What is the most important thing in one of these deals? It’s the money.
So, if I’m the seller, I need financials. Chances are that my financials are not up to date. And they need a little tweaking before I give them to my potential buyer. So, who am I going to ask to do that? I’m going to ask my bookkeeper, my CFO. That takes a lot of time.
If I’m the buyer, when I get those adjusted financials, I now have to give them to my CFO or CPA, who I have to pay out of pocket to validate questions and analyze those numbers. I now go to my salespeople and say, “Tell me what your projections are for the next year.” And that cost is lost. Nobody ever thinks about all of that. Those are all disruptions, and that costs money.
Lehmann
Once all that’s squared away, you still have to integrate these two organizations somehow, and get everyone to play nice.
Silverman
Right.
Lehmann
I loved your example of the IT systems change. No one that I’ve ever experienced has accurately estimated the amount of time, energy, and money it’s going to take to make that work. It’s a great example of fabulous sales and marketing. “You put this in, and your problems are solved.” They talk about what it’s going to deliver when it’s all said and done. But it’s never said and done.
Sanders
Things cost more, it takes longer, it’s harder to get the contractor and everybody engaged and in place.
Silverman
The other problem that the leadership faces, starting with the business owner, is who in their organization to involve and when in this process. Is there going to be a systems match? If not, and there never is, what’s the integration going to take? Who do you involve in this and when? Again, that goes back to what your culture is. You have to handle that situation very delicately. If your company’s strong enough and they, the individuals, can handle the thought that they are going to be sold and merge with so-and-so, great! Then do it. But, if they can’t. If they’re in the same industry and they’re going to start talking, now you’ve got a real problem.
Lehmann
I was talking to someone last week who was on the slightly less than equal side of an acquisition, or it looked like a merger. There was a lot of great talk about “We’re going to learn from this other company. We’re going to take this transition well…” And now they’re in the process of telling the other company, “Yeah, forget about that stuff we were going to learn from you, start doing it our way!” Nine months since the acquisition, they’ve spent a lot of time, almost three months, arguing in meetings about which expense report form they should use.
Silverman
Oh, boy!
Lehmann
As an outsider, I look at it and go, “We’ve got three choices: You guys do it our way. Or we’ll start doing it your way. Or we come up with a totally new way.” And they’ve spent at least three months in meeting after meeting after meeting arguing about that. As a result, by the way, just a side note, a tremendous amount of really key people had left. The reason I asked that question, in your example, “They make 40, we make 30, we’ll jam them together, and all we’ve got to do is sign the paper and make it 70.” Or “All I’ve got to do is get a really good contractor and, ‘Voila!’ I get the outcome I wanted.” But we don’t buy process. We don’t think about the process.
There used to be a commercial that was running years ago. It said, “What if everyone told the truth?” It had a contractor saying, “Okay, it’s going to take a lot longer than you think and there’ll be times when I disappear for three weeks. Don’t even try to find me. But, when we’re all done, you’re going to kiss me full on the lips.” They’re thinking about what it’s going to be when it’s all done, but not the road from here to there, which is going to be arduous.
What’s driving the need to acquire a company? What is it that you want? And is there another way to get it internally without buying this thing?
Silverman
I have that conversation with them all the time. It’s critical that I know what the motivation is because that’s the real interest. The deal has to satisfy that interest. If there’s something behind it, it’s far easier to make that deal work. Then the client has acknowledged, “This is the priority point. I need this. If I get this, everything else I can deal with.” So now we know how to play the chips. Give us that chip, you’re getting the big chip.
Lehmann
It’s easier to determine the true cost. I can put 50 bucks toward the acquisition, or I can put that 50 towards an organic solution to get what it is I want.
Silverman
That’s correct. And one of the things that you have to be aware of when you’re going into one of these transactions, is what happens if it doesn’t work. If you just never sign the deal. You spend two or three months working through these things. You’ve gotten yourself an LOI. I’ve seen LOI terms change all the time. So, that’s it! “We’re done!”
The question is, “What’s the impact on the industry—your standing in the industry?” That’s something you have to be careful about. The situation you were just talking about, where three of the people aren’t there anymore, my question is: Did they go to a competitor? And that’s always a problem. I don’t want to seem overly negative or pessimistic about these deals. They do go through. A lot of them actually get signed, and then there’s still work to do after the deal is signed to get the closing done.
Lehmann
By the way, in that example, the people did go to a competitor. Or an organization that will be some day. Noncompete agreements: I’ve heard that those are not enforceable legally, if you’re willing to go to court and spend all the money to beat it. Is that an inaccurate portrayal on my part?
Silverman
It depends.
Lehmann
Excellent consulting answer, by the way! Does it differ from state to state?
Silverman
Sorry, that’s the answer I’ve got to give you. Yes, it’s dependent upon state-to-state, and it depends on federal law, as well, because some of these are going to be governed by federal law. The floating factors are the industry, the job, the length of time involved, and the geography. You’ve got to balance all of those factors and the degree of noncompete. Having said that, the reason you see them in there is for deterrence. And they are very effective as deterrents.
Lehmann
It just comes up a lot in mergers and acquisitions. That’s why I took you down a little side trail there.
Silverman
It’s quite all right. We deal with those all the time.
Sanders
We all have talked about this huge percentage of M&As that don’t work. And the ones that do take more time and money, even than what they expected. David, you mentioned how you prefer they come to you first and say, “What do you think?” Well, that’s exactly what Success Authorities in that window is for as well. We help them match it up right, get prepared, and make sure it’s the right thing to do.
Silverman
That’s a great service!
Ruhland
For the sake of argument, as opposed to the dark side of M&A, what do you see as the bright side of M&A?
Silverman
The successful deals are those run by executives who are able to find solutions toward a mutually beneficial goal. That part I really like. If I’m working with another lawyer of the same mindset, my counterpart has the same attitude as my client’s counterpart, where they’re really focused on the deal, then it’s fun. Then it’s really a matter of linguistics to accurately reflect the parties’ intent and their mutual goals. When you get one of these done, at first, it’s just a big relief. I finally got this done! But now, you go forward with this new gig. What do we do? Well, you go back to all the things that we talked about doing, and now you get to implement all those because you planned them out. That part’s really great! And when you see one of these things succeed, it’s gratifying.