Having been involved in numerous acquisitions throughout my career (At last count, I had twenty completed deals, and dozens more that didn't go all the way -- a pretty substantial total for someone who spent their career as an operating executive), I've become aware of a prejudice many buyers carry into their deals -- one that does them no favors.

There is a tendency to think of the target company as much simpler that it actually is.

Falling victim to this belief is almost always a mistake. It causes you to underestimate the complexities involved in integration -- particularly the drain it will put on your talented people -- and at its worst, it can cause you to overlook a fatal flaw.

An example

One acquisition I didn't complete, but later lived with, was of a small manufacturer on the East coast. The company had various state governments as its primary customers, and produced primarily a single product line. Sounds simple, right?

What was missed, was a tiny little product line the company manufactured for only a few years, one where they were producing a copy-cat version of a competitor's design. A year or so after the deal was closed, that product ended up at the center of a huge dispute between the acquired business and their largest customer. Ultimately, the tiny product line caused a series of events that resulted in us closing the business and losing millions of dollars.

Its not just the small things

While I've never been tripped up by failing to understand the primary product or service itself (tangible things are usually a bit more straightforward than some of the other critical characteristics that make a company succeed or fail), other areas can be vastly more complicated than they appear at first blush. The top areas to watch (based on my personal experiences) are: distribution channels, how customers derive value from the product or service, intellectual property protection, environmental issues, supplier power, and the likely competitive reactions. All of these areas can be deceptively subtle, and may hold a surprising revelation that can blow up your acquisition.

Another example

A company I purchased in a foreign country (which, in itself, makes accessing the market and competitive dynamics substantially more difficult and risky) was locked in an emotional battle-to-the-death with a smaller competitor in their home market.

Unfortunately, we somehow missed the nature of this relationship, despite the fact that the sellers provided a few hints (hindsight is 20/20, after all). When the deal was announced, the competitor immediately swept in with predatory pricing, trying to grab all the available business in the market -- a total surprise to me. In response, we let them take as much as they wanted, figuring they would eventually get their stomachs full of money-losing projects.

Unfortunately, it took a year. During that time, our original projections for the business were completely turned on their ear.

A knowledge deficit

Sellers always have buyers at a disadvantage. The know much more about their markets, competitors, products, and the internal company dynamics than an outsider ever can. It is in the seller's interests to keep the buyer operating at the highest possible level of detail, where they are only scratching the surface of how things really work. The simpler they can convince the buyer the business is, the more likely they are to get their hoped-for price.

To get beyond this, you have to dig. That means gathering information using unconventional methods. The best sources I've found include: former employees, distributors, competitors, analysts, or other outside industry experts. Relying only on the information provided by the seller is just asking for disappointment.

One more example

On company I eventually walked away from had several hidden secrets. When talking to the sellers reaching a deal seemed pretty shaky, but by completing the purchase we would be removing a major competitor from the market -- one that was a habitual bad actor in the market. Despite the challenges, the emotional appeal of the deal was huge.

Then things started to unravel. We discovered the main facility was built over a creek, which created some strange layout limitations and also raised concerns about pollution. That was followed up by a revelation about two remote sites with massive groundwater pollution problems. The final nail in the coffin was the discovery of a 20 year supply contract with a customer for excess capacity on one of their key pieces of equipment. Unfortunately, the pricing on this contract was pretty much guaranteed to produce a loss.

All three of these problems came to light through conversations with former employees. The sellers offered none of the information on their own, although when confronted they did admit the truth. Of course they tried to minimize the impact of these complications and ill effects. We halted discussions still wondering what other issues we might be missing.

Conclusion

When considering an acquisition, dig deep and long using whatever means are at your disposal. Assume the business is an order of magnitude more complex than it appears from the outside, and require facts to convince you that isn't true. Utilize any form of unbiased information you can put your hands on, remembering that if you rely on the seller alone, you are just asking for problems.

If a deal is worth doing, it's worth doing with your eyes fully open. 24.1

Businesses Always Look Simpler from the Outside

Tom Spears

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