Large companies vs. small companies
Large and small companies are very different. Even at large companies, you end up doing small deals. All of them have unique aspects, but one thing that's different is that established firms build out a group of functional leads. The integration leader's role is a bit more strategic but with less program management.
At smaller companies, where you're working with volunteers from the functions, you have to do more program management. So that's the distinction between them.
Changes in integration
Twenty years ago, high-tech firms, mostly on the West Coast, corp dev groups would do deals and just turn them over to the business and people would be recruited as volunteers to help.
And most people didn't want to help because there was no organization, best practice, or retention of learnings; it was very frustrating.
So about 20 years ago, I was at Sun and they decided to create a formal acquisition integration team. Cisco and IBM were ahead of everybody else and Cisco was very generous with Sun and gave them their playbook.
Sun modeled Cisco's program after that, and now we've started to have formal integration programs. But they were very lean. We had an integration lead, a dedicated person in HR and finance, but everybody else was a volunteer. Because of this, the role of the integration management team was very program management oriented. People who volunteered embraced it because you said you would make life easier for them.
After a few years, companies started doing more deals, and they wanted more formal program management. It was around 2005 to 2015 where heavy program management came in. Heavy tracking tools were used and you have to have many program managers to keep track of everything.
You could justify that in a complex deal, but we often applied that to deals that weren't that complicated. And so it was a lot of overhead, particularly for the functions.
And at the same time, functions are getting better at their jobs and gaining more experience, so they resented the heavy-handed program management of the detailed level of their plans. They knew they didn't need it, they just wanted to know 5 to 10 milestones of the project, and they will keep the management posted.
They wanted the process to lighten up, so a lot of companies did. When this happened, the IMO now had some bandwidth and tried to be involved earlier in the process to get closer to corporate development and the business units and try to influence the deal. That came out positive.
So in the last five years, a few things I've seen have a logical progression.
One of them is that many integration teams have taken over program managing due diligence. And personally that's a great place to manage due diligence. But, due diligence is a process and I'm not certain if corp dev people and legal people love doing program management, whereas integration people, that's what they do.
It's an excellent group to give the assignment of running due diligence. We're pretty neutral and it seems we're well suited to that. That's one thing that's changed.
Another thing that's changed is that people are looking at less cookie cutter, more Agile, and more revisiting the plan as we go along.
For example, I know several companies have been acquiring gaming studios over the last few years. Well, you can't integrate a gaming studio like you integrate a software company where you're going to embed their technology.
Gaming studios are artistic endeavors and they have their own cultures. It's very collaborative and the way they work. Even their business model is very different. So you'll see companies saying we're going to treat that very differently than we treat others. You're seeing more diversity in the approach.
Another trend I've seen is around diligence, prevalent from 2020 to 2022, where it was a seller's market, and they wanted fast due diligence.
There were deals where one potential buyer was favored over another because the one buyer had a shorter due diligence list, and the certainty of the deal conclusion was going to be higher. So the risk to the seller was less, and some companies could adapt to that.
Other companies got their 300-line DD list and they want every single one of those things answered regardless of the risk that the line item represents.
But some questions are very hard for large organizations to answer, or the answer is problematic.
Shortening the diligence is a hard sell to lawyers. But you just have to pick out those things that are either:
- Critical because there could be a legal suit
- The key to the value proposition of the reason you're buying it.
Those things you cannot short-change.
Another thing about progression, a tech company enters today, it won't have to go through 20 years and five stages like it did before. It's only going to take them 3 or 4 years because they're going to hire someone into that first lead role with tons of experience, and they'll skip a couple of steps. They'll go through those stages much faster.
Auction vs. Proprietary Deals
Definitely, it's harder when there are other people in there because there's a lot of pressure to move really fast. It's a time-pressure thing. You can take your time with a small proprietary, privately held company where it's not an auction process.
Not that it's a great idea to spend lots of time. Because with a small deal, there are probably two or three people preparing the diligence, it would be painful for them. So don't take forever. Still, try to be selective in questioning and move it along as quickly as you can.
Also, when you have more time, you can diligence less and spend more time learning about the two companies. When you're condensed, you're not going to get permission to spend time getting to know each other. So by the time you get to signing, you don't know much about them.
So now you have much catching up to do, especially if the closing is tight because there are no regulatory approvals. You better be focused. So now you have to pick what has to be done for closing, and the other stuff has to wait.
Doing a deal with a company that the team has been partnering with for years is great because they're not going to suggest that we acquire
them if they dislike or find them difficult to work with.
And it's usually very positive. There's a high preference for doing deals with companies that you already knew the people.
During COVID for those two years, people couldn't go out and meet with the other folks to have dinner and have a more relaxed, non zoom kind of thing. So you were more comfortable with that because you didn't have the opportunity to really get to know them, while Zoom is not the same as getting to know someone face-to-face.
Another example is there was a firm where we're in the process of acquiring it. Actually, it was one of these cases where we knew that company pretty well. However, as we were candid with the CEO about how the org was going to play out after close, he decided that there was too much integration for his taste and that his role was too diminished so he soured on the deal.
Meanwhile, we've written him into the LOI as a key employee but the HR person seems to think that he doesn't want to do this while his VCs are certain of selling.
So eventually the engineering business lead just had a heart-to-heart with him and told him that they could work out another arrangement, or he could just go. It would've been easy to keep going and bring that CEO on. Fortunately, we're lucky to have the head engineering guy and HR tell us that they think the CEO doesn't want to come, and it would not be in their best interest to bring him in if he doesn't want to.
Advantages of Involving the Integration Lead Early
Corporate development must engage the integration lead early in the process, certainly before the letter of intent, or even before you make the first formal approach to the target.
And the reason is that the integration leads usually have done dozens of deals. Corp dev probably does it once a year or once every couple of years. The business unit person who sponsors the deal may never have done a deal.
The person with the most experience is the integration person and they can bring to the table in those early discussions some of the learnings from the past, or some things that often get said that can impact the long-term success of the deal.
Some corp dev people or business unit executives commit and makes promises such as:
- Nothing will change
- You'll still be in charge
- We're not going to integrate you.
And these aren't intended to be misleading. They're probably what the person thinks about during that time. But then, three or four weeks later, they'll figure out that they need to integrate the acquired product. And before they can do that, they all need to be on the same network and using the same tools.
And now they want to back out from communicating with the target leadership because they just promised nothing is changing.
The integration lead can help a lot there; they can provide some realistic insights on how the people might feel or how long the engineering activities will take. These things are very valuable to have early on, including timelines and expenses.
There's one area in particular for large companies with a strong brand acquiring younger companies.
For the larger company to release the younger companies' products, these products have to be up to the standards of the larger company. These days, there are standards not just internally, such as developed standards, standards for quality, regulated standards, standards for privacy, standards for security and many others.
It can take a lot longer for acquirers to release a product from an acquired company under their fully sanctioned brand because there is technical debt. Technical debt means getting the target company's security and privacy up to the buyer's level so that they don't trip up GDPR and things like that.
It's much work, and that's something that you learn in integration, but you might not necessarily encounter it in your business, because in the business, that's all taken care of. Running the business at the big company is all up to security and privacy standards. But if your team has some good technical people in your diligence team, they will be able to provide a quick assessment of what that looks like, but not all companies have that level of caliber of people available to do the work.
When to Involve the Integration Lead
Before you send them the preliminary diligence questions, things like P&L and the number of employees, there's no reason not to include the integration lead.
There are people who don't want to waste the integration lead's time, but I believe an integration lead would love to spend an hour walking through it and talking about those things that can be challenging, especially if you have a couple of candidate companies.
Let's say you have two possible sources for this particular technology, and one of them is in a country where dealing with personnel is pretty straightforward and easy, and another one is very challenging. They both have a hundred people, but you don't need their sales team and marketing. You just really want the engineers.
If your business model takes those 50 engineers and lays off the other people, you can't do that in certain countries. You're going to have to pay significant severance benefits to them. So you have to go with the country that allows you to do something different. There are lots of implications that you need to consider.
As soon as I get involved, I want to know
- Where's the location?
- How many people the target company has?
- Why buy the target company?
- What are the software tools they use?
- Which cloud provider are they on?
- Is the integration easy to deal with?
All these lead up to time or money. So we don't usually impact the preliminary due diligence, unless there's something about the deal that really jumps out.
Integration's impact on the Valuation Model
In general, a letter of intent doesn't have much in it. But corp dev sharing that bare-bones letter of intent with HR, finance, and go-to-market can make a difference. There can be a specific nature of the deal that HR might want you to word one way or the other.
One of the teams I worked with was adamant about not wanting to get trapped in identifying a specific dollar amount for post-close retention.
Sometimes the buyer will say they want us to provide $30 million retention for the team. And HR would disagree with that because we don't know anything about the employees. We haven't done any diligence, so we don't know the caliber of these people.
We don't even know how long they've worked for the company. What if you've closed the deal and found that out of a hundred of their employees, 80 of them were hired last year? Do you want to spend 30 million on retention? That would be frightening.
So It's not a bad idea to have the letter of intent, particularly for those functions in technology, HR, and finance who would want to weigh in on how you're wording it.
Value of Synergy to the Company
In high tech, particularly in software, where most of my expertise is, the only synergy is the revenue. There really aren't many cost synergies. You might have some procurement volume discounts that can be applied to the smaller firm, but in general, you're not going to find many cost synergies.
You're actually going to find some cost increases because you might have a higher salary or more expensive benefits than they have. So it's all about the revenue.
The challenge is that the company's price is based on what it's worth to you but also on what it's worth in the market. And the market has a pretty big dictate over what that price will be.
You have to look at your P&L and see if it is close to what the market says they're worth. Sometimes you have to take a bit of a gamble and do it anyway. People are sometimes uncomfortable with a revenue number that is really ambitious to make that purchase.
Most serial acquirers view M&A as a portfolio play. They're going to buy many companies. Using baseball as an analogy, some are going to be strikeouts, some are single-bases, and then get that home run.
You might never do a deal if you're strict with your synergy modeling. You've got to make those trade-offs where you're going to be very optimistic at times about the potential, but that's because you're making a few bets. Some of them are going to be brilliant, and others are less. It's a hard discussion to have most of the time.
Now that you've got the letter of intent signed, you'll dive into real diligence. Most deals go through. You might find some things along the way that are less or more favorable than you thought they were. But the vast majority of deals that get to the LOI get to close.
You'll probably have an idea whether you will face some hurdle for deals with regulatory issues since you've factored that into your thinking.
But for most deals that don't have a huge regulatory factor, once you get to LOI and then due diligence, if you think there are things that could cause the deal not to go through, get on those fast.
Go as fast as you can and as deep as you can into those particular questions. Because if you do have to walk away from the deal, you, you owe it to everybody to do that fast.
Killing a bad deal is as worthy of praise as closing a great deal. You shouldn't feel like you didn't do your job.
Walking Away from the Deal
There's only one justification for walking away: when the company represented itself differently than reality. They represented that they could do something, and then we found out that they can't do those things. Or that their financials were this way, and we dug into it, and it's not that way.
Buyers can't just walk away because they found something they didn't like. It has to be material. There has to be a basis for a big discrepancy.
It doesn't happen often, but there are other cases where you or integration had doubts as early as pre- LOI. They saw the writing on the wall, and it would be very challenging to work around, but at the end of the day, integration isn't driving the deal. Sometimes we have thoughts about it and decide to go for it anyway.
It's our job to make it the most successful we can be. We can't go into integration with a grudge. We got to do our best even when we didn't like the deal.
Due Diligence Surprises
An unfortunate surprise I've seen during due diligence that comes up quite problematic would be a lack of quality or security in the technology. That's like a big, painful thing and could be a deal breaker potentially.
On the post-close surprise, every once in a while, you'll find out that a key person in the deal is not how they presented themselves, that there's a problem of leadership, or maybe the ethics are not what you thought.
And what's even more surprising is that no one else mentioned that. No one mentioned that the boss is a bad boss. The seller wanted the deal to go through, and if they had talked about it, it might not help the deal.
When it comes to the financial side, a lot of things will surprise you. And they have gotten pretty good at figuring out what those are.
Back in the day, I would always ask the finance people to tell me what percentage of sales went through the channel each of the last 12 months before we got to where we are right now.
And the reason I asked that question is, let's just say for the sake of argument, that 50% of the sales went through the channel for the first six months of last year, and in the last six months at an ever-increasing rate, a larger and larger percentage went through the channel.
Well, that could mean the seller is stuffing the channel to make their revenue number look better. Now, I haven't seen that in decades, maybe because finance just looks at that right away. So people don't do that, and it's illegal.
But on the people's side, someone would have to say something for you to necessarily know if there was some hidden issue there.
An interesting thing you can do when you send your team in to do due diligence is remind them that in addition to their tactical diligence, they're also there to get to know the target team. They're your ears on the ground.
Send the engineers in to talk to their engineers or the finance people to talk to their finance people or HR to talk to HR. And you're going to get a good feel for that company through those day-to-day workers and those day-to-day interactions.
Cultural fit is a great thing to know. Doing a deal with a company that the engineering team has been partnering with for years is great. They're not going to suggest an acquisition if they dislike them or find them difficult to work with.