History tells us that the current lull in M&A activity will be followed by a surge of deal-making. Yet, numerous studies have shown that roughly two out of three corporate acquisitions fail, as measured by the performance of the stock of the acquiring company. What if those odds could be flipped? What if it were possible to succeed two times out of three and just fail a third of the time?
Our research suggests this is possible. A 20-person team that spent two years investigating 2,500 major corporate failures from the past 25 years found that almost half stemmed from ill-conceived strategies that could have been headed-off early, before millions, if not billions, had been lost. Applying the lessons derived from that research can help executives dodge problems and reshape strategies in ways that greatly increase the chances of success.
Acquisitions usually fail because, in part, decisions have to be made fast when an opportunity arises. Something is for sale. Do you want it? Well, do you? The clock is ticking. (BofA CEO Ken Lewis decided to buy Merrill after less than an hour of negotiating, for fear that he’d be outbid if he didn’t act immediately.)
The other main problem is that deals can happen in an echo chamber. The senior executive team, trying to please the CEO, can censor objections and gloss over problems. Even the best investment bankers and consultants become too optimistic. Boards can spot problems, but directors can be reluctant to speak up because they don’t have as much information as the CEO and seldom have as much background in the industry. In addition, vetoing a deal is usually a bring-on-the-next-guy decision, so, when in doubt, boards tend to acquiesce. Even Warren Buffett has said that, while on the Coca-Cola board, he failed to challenge the CEO about an issue even though he was quite sure the CEO was making a serious mistake and was right.
To counteract these issues, acquirers need a way to get a fast, objective read on the potential problems with deals.
Based on our research, we have devised a process that requires as little as a weekend. The process is unbiased because it is led by individuals who have not been involved in the strategy discussions and because those individuals have no stake in any work that might follow an acquisition. The process can spot almost any problem because it incorporates research that has investigated every issue imaginable.
We call the process a “devil’s advocate” review, drawing the name from the practice that the Catholic church followed for centuries to safeguard canonization, by which the church declared someone to be a saint. Our review consists of three parts, as shown in Figure 1.
The first examines the potential deal against the lessons of past failures. We draw on our research to find companies that attempted something similar to what is being contemplated and failed. That way, we can see if a proposed strategy raises any of the red flags that indicated the others were about to flop. This part of the process differs from the norm because the tendency in businesses, as in business books, is to look at success stories and say, “Here’s how we can be like those guys.” We instead look at failures to figure out, “Okay, here’s how we can avoid being like those guys.”
The second part consists of a “last-chance” independent review that looks at any red flags, at any questionable assumptions, at all risks, etc. This review is typically done toward the end of the process but before it’s too late, before the CEO publicly commits himself and before momentum is so great that almost nothing can stop the deal.
The third part consists of working with management and, if appropriate, the board of directors to come to closure. A report on critical questions drives management’s final deliberations on the potential transaction, at which point a company might decide to kill a deal or, more likely, to fix problems or change negotiating tactics.
Even a cursory review can spot all sorts of problems. Look at Bank of America’s $50 billion acquisition of Merrill Lynch. Or look at private-equity fund Bay Harbour Management’s decision to buy the Steve & Barry’s retail clothing chain out of bankruptcy proceedings for $168 million last year, only to announce three months later that it would liquidate the chain. Based on our research, we identified both those deals as flawed at the time they were announced, but it was too late for BofA and for Bay Harbour.
The time to get things right is now, not when the deal pipeline starts to fill. In helping companies spot and avoid bad deals, we’ve found that, once a deal is in the works, it’s hard to stop, even when it’s clearly a bad idea. Companies need to agree ahead of time on the sorts of quality checks and process safeguards that will let them strengthen weak ideas and stop bad ones. In other words, executives can take advantage of the current lull to make sure that, when the deals start flowing again, they can have those two in three odds, not the one in three that have historically prevailed.
