Do Big Companies Destroy Small Ones in the M&A Process?

More often than not, small companies acquired by big companies are either destroyed in the process or fully absorbed and disappear.

I led a recent conversation with Carlos Cesta, Vice President of Corporate Development for Presidio and Jeff Desroches, Vice President Strategy & Corporate Development for VAT Group, who shared his thoughts on the perception that big companies destroy small company value. Why is that? Is it true? If so, how can it be prevented?

It isn’t uncommon for large companies to totally absorb small companies. Shareholders of the small company may feel good when they get a nice payout, but other stakeholders including employees and customers may feel differently.

Large companies might consider partnering or making an investment in the smaller company. But companies often feel they need to own and control the asset. It might be due to a technology that the acquirer isn’t able to develop internally or it could be skill acquisition. Said Cesta, “This is a recurring theme when companies aren’t able to develop these things organically so they go buy them. That's not always the most efficient way to achieve a goal.”

There is also a dynamic that big companies buy small companies because there are more of them out there, and you aren’t betting the farm. The sheer volume of deals feeds the checkered history. Said Desroches, “Boards and shareholders are more comfortable making smaller investments. That’s not to say these aren’t viewed as highly strategic, but there isn’t as much of a risk that if something goes wrong it could take the whole business down.”

How does value get destroyed? Small companies have to adapt to the new company and, in order to gain efficiencies, abandon systems and processes. Yet these systems and processes may have been what made the small company a unique and desirable target in the first place.

Some acquired companies might limp along after not meeting performance targets. “It isn’t uncommon for an acquirer to bring a small business on board and, when it doesn’t meet its objectives, it isn’t killed per se, but there are varying degrees of performance below expectations,” said Jeff Desroches.

Value and the deal objectives get missed when a company culture gets fragmented. More often this is accidental vs intentional. Said Desroches, “The change happens as soon as the deal closes. Before the close, the owner made almost every decision, but then post close they need to go through a couple levels of approval to buy a $400 plane ticket. This can cause some serious challenges.”

Regardless of strategy or industry, smaller companies are regularly killed by bigger ones. The reasons fall into several buckets:

• Bureaucracy – Intentionally or unintentionally, large companies layer in approval processes that can take much longer. While it makes sense to put these processes in place for larger companies, it doesn't necessarily make sense for smaller ones. Many large companies also apply an allocation of shared services overhead to an acquired business, costs that generally wouldn't be justified for such a small company.
• Integration – It is during the integration process where, when done right, companies capture the deal value, yet it is also often blamed for a deal’s demise. Lack of communication can destroy value. In successful transactions, discussions about integration begin before the deal is closed. An integration plan should be designed and shared with the seller so they know how the firm will be integrated and taken to market. Said Cesta, “The worst thing is not to discuss it at all. It will set you up for failure.” Instead, he suggests creating a memorandum of understanding that the buyer and seller both agree upon that identifies all the touchpoints of integration. “The buyer and the seller need to be what I like to call bridge builders. This agreement needs to include work streams, when they will transfer from QuickBooks to SAP, HR policies and all the things that will touch people’s lives and can be annoying.”
• Founders/Entrepreneurs - With the exception of a few serial entrepreneurs, most deals will be the first and only time an entrepreneur will go through the process. In addition to the business being their sole focus and perhaps carrying their family name, founders need to undertake an evolution in their thinking from being the primary decision maker to perhaps sharing decision making authority. Big companies focus on marginal efficiency and improving processes that flow to the bottom line. It is at the point when the entrepreneur meets professional management when most are unprepared.

How can small companies prevent being swallowed up and destroyed by a large company? Before entering into a deal, they should talk with other firms that were acquired by the company. They need to ask the hard questions, challenge assumptions and address concerns head on. They should know in advance the plan to integrate. It is important to get trusted advice from professional legal and financial advisors – not just family friends. Lastly, the seller must be completely comfortable.

How can small companies preserve their agility post deal? Here are a few best practices:

• Communication is the best way to preserve value. Be fully transparent in defining how the acquired company will fit into the organization and what roles the staff at the acquired company will play. Share these details in advance in writing.
• Negotiate the integration process as hard as you negotiate deal terms. Both companies should co-develop and tailor a plan so everyone is on the same page. This should be a high-level framework of how you plan to operate post-closing. Name the people who will manage the processes. Integration should be another work stream.
• Create a value capture team. Identify the value drivers in the investment thesis in order to prioritize the biggest impacts. Engage this team before you move forward.
• Take a nuanced and empathic approach to integration. Because integration tends to be painful, conventional thinking is that you should get it over with as soon as possible. But big companies may need to acknowledge and understand that the ways a smaller company approaches work can be beneficial and they can learn from them. Acknowledging the culture, the company’s accomplishments, and the emotional transition the acquired company is going through can be helpful to the employees and shows respect for what the company has created. Avoid an attitude of “we bought you guys so we’re going to show you the way that things are done.” Some things like payroll and financial reporting have to happen immediately, but there are other processes or protocols that can wait; not implementing a bunch of process changes immediately could help smooth the transition.
• Don’t underestimate the role of the lead integrator. This person needs to be CEO-like, know about operations and finance and deeply understand the issues. They should continue managing everything after the deal closes and navigate well back to the mothership when needed. Choose the right person who will not leave issues behind.
• Use deal templates that take advantage of Agile M&A processes. These are checklists that leverage the experience and lessons learned from similar projects. You don’t want to repeat the same mistakes. Templates include detailed check lists on diligence and integration project plans.
• Don’t succumb to deal fever. At the 11^th hour, the deal feels like a huge train coming down the tracks and it is hard to stop it. The pressure to get a deal done is immense. But often the signs that an acquiring company won’t be Agile come up repeatedly during due diligence. It is important not to let the fact that you’ve gone so far into the deal and paid the legal and professional fees push you to get a deal done you don’t want to do.

Kison Patel is the CEO and Founder of M&A Science.