Let’s talk about what are some of the largest inefficiencies faced in the industry and how do you help your clients overcome them?
I think that most inefficiencies arise from a misunderstanding about when to involve the integration experts. I feel strongly that the right time to do that is right about the time the letter of intent goes out.
The reason that I advocate for such an early involvement of the integration resources is that I have noticed that neither attorneys nor investment bankers typically have any business operations experience.
What are some of the considerations that often get overlooked when it comes to integration?
There are two pillars in regards to that. The first is what goes in deal agreements.
Purchase agreements and other documents that are being created by attorneys are forming the basis for the deal because what you include there in terms of language and what you omit, can really have a material impact on whether or not the integration can be done efficiently, how much it’s going to cost and how long it’s going to take.
This is particularly true if you have any kind of long-tail on the transaction, such a s an earn-out agreement, a joint operating agreement of sorts, or a divestiture.
The other area would be in the actual deal model. What a lot of corporate development or investment banking resources will do is put in an estimate for integration costs that’s roughly what it was on the last deal or a percentage of the deal cost.
Neither one of those tends to be a good estimate of what it’s actually going to take to do the integration, which is why both the attorneys for the deal agreements and the investment bankers for the valuation can greatly benefit from having the integration personnel involved early.
It seems like there is always a separation between corporate development and integration. Has there been anything that you’ve done to drive that type of partnership?
More and more serial acquirers are pairing the two together, they are structuring the performance objectives and the incentive compensation to help the two work together. If companies incentivize corporate development on doing deals, they may do deals, but these may not be good ones.
You want to make sure that they are incentivized on doing successful deals, which gives them the incentive to partner with the integration team and helps them do it much more collaboratively because it changes their driver.
What are some of the strategies you’ve implemented with your clients to create more successful deal outcomes?
I typically use a three-tiered strategy. The first one is the value-driven target operating model, where we take a look at the deal rationale and we stay focused on that throughout everything that we are doing. The second strategy and the third are tied together and these are the toolkit and staffing.
Most consulting firms use what I call the pyramid model where they will bring one to three experienced resources and lots of very inexperienced resources to create that pyramid, having the most experienced person on top of it. That does not work in M&A and you can’t use a rot toolkit.
The toolkit and staffing I am talking about are very flexible and adjust to the different target operating models and strategies that the company might want to deploy. It can change based on the parameters of the transaction and the specific industry.
The staffing model is something I offer full-time, part-time, ad hoc, and I also use agile staffing when I bring in experts when they are needed, so I can get the right person on the right puzzle much faster and more efficiently than large firms are able to.
This is a big shift from the traditional consulting model, and it seems like a trend that’s occurring as well. Maybe we could contract that difference a little bit because I think a lot of companies are identifying some of these challenges as well. There seems to be a lot of challenges in terms of information chasms and some of the structural issues.
We’ve got a three-way convergence going on in the industry, where you’ve got more and more skilled professionals going out there and making themselves available to the public, so you can get their services much faster than before.
Some consulting firms are starting to appreciate all the inefficiencies and problems that you mentioned and they have begun actually hiring the experienced resources as subcontractors, so if you hire a big consulting firm you may get several resources, even those near the top of the pyramid, who are, in fact, independent contractors.
Another area of convergence is that firms are growing more comfortable with hiring directly and picking the contractors themselves and we have big companies hiring small contractors directly.
The third leg of the convergence is companies realizing that they can use contractor versus employee models more extensively than they have in the past and they are growing comfortable with that.
I would like to hear more about how you would contrast the traditional consulting model with how you work with companies.
What my “two in the box” model means is, instead of having the consulting lead at the top of the pyramid being the point of contact for the lead and the client, there is a consultant paired up with the functional leads one in one, and that does two things.
One, it allows the function lead to be in more than one place at a time because they can send their delegate to meetings, and two, as the pair works together, the expertise that the consultant has is transitioned to the in-house resource.
Eventually, you can roll the consultant off and the internal resource is ready to stand on their own, and on the next transaction, they can get started much more quickly because the knowledge stays in-house with the company’s resources instead of transitioning back out with the consulting firm as it happens with the pyramid model.
You’ve also led and authored strategies and divestitures. Can you explain some of the common divestiture challenges and how your approaches seek to overcome them?
There’s a lot of challenges in the legal agreement structuring, particularly in the negotiation and execution of any transition agreements.
If you’ve got more than one country involved in the transaction, if it’s a large multinational, you can almost count on tax authorities requiring a separate agreement for each geography, priced in the local currency, subject to the local invoice requirements and done in accordance with the local law.
You mentioned earlier about transition services, but it seems like those tend to be very complicated to negotiate as well.
Companies may be tempted to postpone that part of the work, that transition negotiation agreement until after they got the purchase price nailed and the APA, but there are very critical components of the transition agreement that need to go into the APA that go beyond just referencing the master services agreements.
You are going to want a really good master services agreement and the TSA schedules, not only to get the APA done correctly, but it’s also important from the pricing and valuation standpoint.
What are the challenges you see when it comes to actual execution?
You really want to watch culture in a divestiture. One of the things that make that challenging is legal and compliance reasons, and you also really have to watch the separation and make sure that it’s not commingling post-close. You want to keep people engaged, keep everybody on the same page, and feeling the right way about it.
You want to start communication really early and have a really good cultural assessment and a really good communications plan in place. You want to make sure you offer things like incentive compensation or work arrangements that incentivize people to feel like what you are doing is the right decision for them.
You’ve created a predictive model for integration. Can you tell me more about that and how that relates to the actual cost drivers of the deal?
We talked a little bit about why percentages don’t work.
If you are a publicly-traded company and you are required to meet information security compliance, financial, and tax compliance and you are going to need to put the company on your ERP system, it costs a certain amount to do that, even if the company is small.
There will be some differences with regards to scale, but what companies overlook and get frustrated about is that there is that flaw. You will need to rebadge a certain number of employees, sign them up for benefits, integrate their data into your ERP system and that is going to cost a certain amount of money.
Sometimes companies also want to over integrate and in this case, they need to ask themselves whether they will achieve additional cost synergies if they do integrate more and if yes, will those come at the expense of revenue synergies or not.
There’s a lot of variables that are involved.
One area where we could talk about key cost drivers would be staffing model. There is an acronym called SQERT, which stands for scope, quality, effort, resources, and time.
The scope is how much you are going to do, quality is how well you will do it, the effort is how hard you will work, resources stand for how many people you will use and time stands for how long it will take.
There is a rule that nobody can do anything about and which is that if you choose one element of SQERT, you will probably change at least one other and if you change two of them, you’ll probably change all.
Staffing is one of the big cost drivers for integration because it will help you make sure that you’ve got good coverage with regards to SQERT and that you’ve got 85 percent of your experienced resources’ time dedicated to the transaction. If you want to mitigate those costs, you can put a centralized staffing model.
You can also do a “two in a box”, as well as what I call “uplift and backfill'', which is when you promote everybody temporarily into their boss’s job as far down in the organization as you can and then backfill at that level. It's a good thing culturally and a good way to save money. You can opt for the “ad hoc” option as well.
It often feels like, especially in private equity, that there are additional milestones to consider as well. Could you maybe give me a quick overview on that?
I will do a 100-day plan and you really want to look at that plan in terms of major initiatives. There is a lot of value to be captured upfront and you do absolutely want to burn up the road. You want to have the organization design done, you want to get people on board, make sure they are equipped to work.
You want to do as much of the data work as you can so that the tools are up and running. These are the things you want to set up front, but the question is, how much of that work will be done in 100 days?
Kelly, what do people do wrong in diligence and integration?
Underestimating integration is a big one - not costing it out so that you really know what it is you’re signing up to do, who's going to do it, how much it’s going to cost you.
Overlooking compliance, information security compliance, PII, finance, and tax compliance are all costs that affect the deal value and people need to know what these are. They also assume that smart people have more than 24 hours in a day.
What are some of the biggest innovations you currently see transforming the M&A industry and how will those changes impact operations in the overall marketplace?
I think we are going to see more industries begin to acquire innovation than we have in the past. Part of the reason for that is the pace in which the technology is progressing, and cryptocurrencies are an example of that. Artificial intelligence is another area where we are seeing a lot of development.
There will be a need to look at some of the technologies that are being developed by the AI startups and find what they need to buy that will actually bring AI into their organization and help and optimize some of their business offerings. Early mover advantage is critical in all of this, as it will allow getting a competitive advantage.
I believe we are going to see more acquiring of these cutting edge technological capabilities and bringing them inhouse.
What’s the craziest thing you’ve seen in M&A?
There was a transaction I worked on where a company had had a cash cow, a successful product which they sold for years, however, because another company started giving a substitute product for free, their cash cow had no market value anymore.
They wanted to solve this by getting a new product in their portfolio that they thought was complementary and create a bundled market offering with this complimentary product.
They went out and did an acquisition and brought me to look at the integration. What I found out looking at the material, it turned out that the reason for buying the company they bought was that their core product had recently encountered a readily available free substitute.
They doubled down on the problem of having products with absolutely no market value. To make everything worse, the customer base of the company they acquired had more than 80 percent overlap with their existing base.
Their stock price had significantly declined and most of their executive team has resigned and they are now looking for a buyer in a distressed sale because they can’t cover their debt.
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