Why Most M&A Deals Fail: Love and Marriage?
What’s the dumbest answer you’ve ever heard in an interview?
I can think of 10-15 examples that might contend for first place.
But if you asked me for the most ironic answer, it would be the average response to the “Why investment banking?” question.
The most common line from career changers – consultants, lawyers, and accountants – goes like this:
“I want to influence major deals and take an active role in closing transactions instead of sitting on the sidelines or reviewing the paperwork after everything is closed.”
It’s true – you are more active in closing deals as a banker.
But it’s also an ironic answer because M&A deals often kill companies.
And they rarely turn out well for the buyer or seller.
So saying you want to “take an active role in closing transactions” is like saying, “I want to take actions that, in 50-90% of cases, will not result in a positive outcome for the buyer or seller.”
So why does this madness happen?
Why do most M&A deals “fail”?
And should we blame the bankers for everything?
What Exactly is “Failure”?
If you browse around online, you’ll find articles claiming that anywhere from 50% to 90% of M&A deals “fail” or are “unsuccessful.”
The median seemed to be 70% in the articles I found, though I always wonder where these figures come from.
These percentages don’t refer to deals that fail to close, but to deals that close but simply… don’t work out.
A deal that “fails” or “isn’t successful” or that “doesn’t work out” could mean any of the following:
- The buyer incurs a massive write-down afterward, as it acknowledges the seller wasn’t so valuable (e.g., Yahoo / Tumblr or eBay / Skype).
- There’s a mass exodus of talent from the seller, and the founder(s) and management team all leave (e.g., Credit Suisse / Donaldson, Lufkin & Jenrette).
- The buyer has to divest the seller afterward, as it realizes the deal was a horrible mistake. This divestiture often takes place at a much lower valuation (e.g., Wendy’s / Arby’s).
- The buyer ends up going bankrupt, consumed by the stupidity of the deal (e.g., New York Central / Pennsylvania Railroad – filed for bankruptcy just two years after the deal closed).
The M&A Failure Rate: Have You Seen the Divorce Rate?
To understand why many M&A deals end with these failures, think about a real-life analogy for M&A: marriage.
Everyone knows the divorce rate is high – ~50% in many developed countries – and yet, people still get married.
I don’t quite understand their reasoning, but I guess it has something to do with “the best intentions” and being emotional rather than logical.
Think about all the reasons why marriage, or any relationship, might fall apart:
- Cultural Mismatch: Two people start off with a very similar mindset, but over time one person becomes more work or family-oriented, and the other does not. Communication often goes downhill as a result.
- Romance != Successful Marriage: You might be madly in love with someone, but it doesn’t mean you should marry the person. For example, he or she might have small problems such as a drug addiction or a proclivity for murder.
- What You Didn’t Know: You didn’t get to know the person well enough, which is how you never noticed that he/she has been arrested five times in the past. Or that you can’t live in the same house together.
- Financial Failings: Right after you get married, the other person loses his/her job, becomes bored and lonely at home while you go to work, and then steals your money and your dog and flees halfway across the world. True story; it happened to a friend.
- Your Reasons Were Stupid: For example, maybe you got married due to familial pressure, or due to the other person’s killer body. Or maybe you just made a horrible mistake in Vegas one night.
- It’s Easy to Get Divorced: While this isn’t true everywhere, in plenty of countries it’s relatively easy to get a divorce. Sometimes there isn’t even much social stigma attached. So why bother to work things out if you can just hit the “reset” button and walk away?
There are dozens of other reasons that explain why a marriage might fail, but I picked these because they all apply to M&A deals as well:
Reason #1: Cultural Mismatch
This factor kills a lot of “acqui-hire” deals done by big technology companies acquiring tiny startups; sometimes it happens even with much bigger companies.
One example that comes to mind is Google’s $3.2 billion acquisition of Nest.
It’s not quite a “failure,” yet, but it also hasn’t generated much profit, and there are rumors that Google is struggling to keep the top talent.
On paper, the deal made sense: Nest made great “smart home” devices, and Google could leverage its AI and machine learning expertise to make them even better.
Just one small problem: the company cultures were completely different.
Nest was founded by ex-Apple employees, and had a secretive, reserved culture where people didn’t talk or socialize much. A friend worked there and left the company for this very reason.
Google encourages over-communication and wants employees to socialize as much as possible.
Inevitably, managers at both companies would have trouble seeing eye-to-eye.
This type of cultural mismatch might still work if the seller remains independent, but once it grows to a certain point, it can become a problem.
Reason #2: Romance != Successful Marriage
So your company just launched a successful joint venture or partnership with another, much smaller company.
“Aha!” you say, “Let’s acquire them so we can benefit even more, and so we can prevent others from stealing them away.”
Some executives at companies think this way, but it’s often completely wrong.
Just like a one-night stand or three-month relationship might not work as a marriage, a successful partnership or JV deal might not work so well as an M&A deal.
One example is MySpace’s $250 million acquisition of Photobucket.
You are probably too young to remember MySpace, but it was another social network before Facebook became the dominant force.
In theory, the deal made sense: tons of Photobucket users uploaded images to blogs and social networks like MySpace.
They were effectively “partnered,” so why not go further and make it work even better?
After the deal, Photobucket grew steadily at first, but being owned by MySpace eventually constrained its growth and made it harder to partner with other sites.
Reason #3: What You Didn’t Know
You could call this one “a failure of due diligence.”
A buyer conducts due diligence so it can find out everything possible about the seller before a deal takes place.
But you’ll never find everything as an outsider.
Due diligence can uncover specific red flags: onerous customer contracts, ongoing litigation, and problematic receivables, for example.
But it’s not as good at detecting intangible risk factors.
Is the entire finance team held together by one junior employee who prevents conflicts and ensures the team’s success?
Do many large sales succeed because the CEO gets personally involved?
Or does the entire sales team need to play Halo before dialing for dollars?
Disaster could result if the acquirer changes any of these elements, but they would never show up in a standard due diligence report.
And then there’s the chance that due diligence might not uncover material issues such as accounting fraud or improper revenue recognition.
Apparently, it was the result of “accounting irregularities” and improper revenue recognition.
Reason #4: Financial Failings
So let’s say that your culture perfectly matches the culture of the seller, due diligence checks out, and you’ve planned out how you’ll work together over 5-10 years.
Sorry, but you’re still not in the clear.
Those “plans” were based on financial results that may or may not materialize.
And if the buyer or seller’s performance comes in “below expectations,” the entire deal might not make sense anymore.
However, sometimes it’s an even bigger problem if the seller outperforms expectations.
That could lead to tensions between the buyer and seller, and result in frustrations and fighting over limited resources.
One example is Condé Nast’s acquisition of Reddit in 2006. They paid a relatively low price (~$20 million), and then the company grew beyond their wildest expectations (~100x growth).
Condé Nast hadn’t factored in that possibility and wasn’t prepared to give Reddit the resources it needed to grow, so tensions arose as the company tried to operate on a shoestring budget with minimal staff.
They ended up spinning off Reddit so it could “better handle future growth and opportunities.”
Reason #5: Your Reasons Were Stupid
The dumber the rationale for a deal, the more likely it is to fail.
The worst deals are those motivated by political/ego-related reasons, followed closely by those that happened “just because they could.”
I could use AOL / Time Warner as the quintessential example, but I’ll point to eBay’s acquisition of Skype instead.
While an eBay / Paypal deal made a lot of sense, most people scratched their heads at this one.
The rationale was that Skype would let buyers and sellers in auctions “talk for free.”
Did anyone want that?
The whole point of selling things on the Internet is that you don’t have to talk to annoying people or take phone calls.
After paying $3.1 billion for Skype, eBay sold 65% of it four years later at a $2.8 billion valuation.
But then they were saved by an even greater fool: Microsoft, which spent $8.5 billion to acquire Skype.
Reason #6: It’s Easy to Get Divorced
If something is difficult or impossible to reverse – like renouncing U.S. citizenship, or cutting off your leg – you’ll think twice before doing it.
But if it’s easy to reverse, who cares?
Many executives incorrectly assume that M&A deals are easy to reverse, or that it’s “no big deal” if something goes wrong, especially in smaller deals.
If you paid bankers to advise you on an acquisition, why not also pay them to advise you on a divestiture if it doesn’t work out?
The eBay / Skype example above illustrates this mindset quite well: first, eBay bought it… then wrote down its value… then sold the majority to Silver Lake and other investors… and then it was about to go public, but Microsoft stepped in to buy it.
The management team kept changing, so there wasn’t much consistency in any of these decisions.
And bankers were more than willing to earn fees for all these deals, regardless of whether or not they made sense.
What Really Kills M&A Deals: Humans
In short, many M&A deals fail because of the human element.
Bankers and company executives like to think the entire world can be reduced to a large Excel model, but it can’t be.
Some authors have suggested that bankers and corrupt government officials have conspired to make M&A deals easier and more common.
But I’m a bit skeptical because there have always been “waves” of deals going back over 100 years – sure, maybe they’re bigger and more common now, but it’s not as if the majority of deals ever worked out.
So you could reduce the number of failed deals only by making it harder to acquire other companies in the first place.
There are some merits to that argument, but it’s unlikely to happen anytime soon.
I’m no defender of bankers, but I also think it’s a stretch to blame them for so many failed deals.
Yes, they might advise on a deal that performs poorly, or even suggest the idea of the deal, but ultimately the Board of Directors has to sign off on major transactions. And if companies weren’t motivated to do deals, why would they even have corporate development teams?
So it’s unfortunate that many transactions don’t work out, but you can’t blame a single person or group for everything.
Wait, But How is Any of This Related to Interviews or the Job Search?
It’s not, really, but sometimes I get bored of that stuff and want to write about other topics.
No, you don’t need to change any answers to interview questions.
Please don’t get paranoid about your answer to the “Why banking?” question.
But next time someone says they want to be “more active in closing deals,” you can sit back and laugh as you think of the consequences.
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