So You’re Thinking About M&A
A Framework for Evaluating Whether you should Pursue an Acquisition
- Buyer beware! M&A is inherently risky, quite often does not work out
- Companies with healthy organic growth (30%+) should not let M&A distract them
- Companies should not invest time and resources in M&A until:
- ROI from investing in M&A outweighs ROI from investing in organic growth
- They reach a scale where they can successfully absorb an acquisition
Leaders at companies we interact with – both within and beyond our portfolio – regularly express interest in M&A. They understand that M&A can generate tremendous opportunities, including vertical expansion, product enhancement, and market consolidation. However, it is also important to recall the risks M&A entails: distraction from the core business, failure to realize synergies, inability to integrate products or technology, disruption of culture – the list goes on.
Top reasons why M&A transactions have not generated expected value
Source: Deloitte, “The State of the Deal, M&A Trends 2019“
Quite often, an acquisition will not generate the value expected:
M&A Return on Investment
Source: Deloitte, “The State of the Deal, M&A Trends 2020“
Accordingly, we caution our companies against pursuing M&A until the time is right.
As investors across 50+ companies – several of whom have completed multiple acquisitions – we have developed a framework to help leaders determine when and how much time, energy, and resources they should devote to M&A opportunities:
|Company Size & Organic Growth||EITHER:
|Emphasis on home market and adjacent markets (probing competitive opportunities & threats)||Consolidation and
adjacent market entry
|Typically in company’s
|CEO/CFO/Board of Directors, Relevant business unit head||CEO/CFO/
Board of Directors,
full time M&A leader
|Frequency of Internal Alignment
as-needed, depending on importance of competitive threats
Explore buy/build/partner decisions
Selective tuck-ins for product gaps (<5% of platform revs)
Build M&A integration capability
|Increase scale of business
Growth EBITDA with
Our framework is centered on the size and growth rate of a portfolio company’s core business. Why? As growth equity investors, we fundamentally believe that organic growth creates more equity value than any other factor. There is an opportunity cost to M&A; effectively pursuing M&A opportunities requires the investment of significant resources and dedicated time and attention from the management team. Our framework discourages pursuing M&A until organic growth diminishes (<30%) because as long as organic growth remains high, we expect a greater return on investment in the core business than acquisition targets. We also recommend putting off M&A until a company reaches a certain scale ($20m+), such that it can absorb an acquisition target without meaningful disruption to the core business.
Once a business reaches a scale and organic growth rate outlined above, the opportunity cost to M&A diminishes – there are more resources available to invest and less risk should the acquisition fail – and the potential to create value increases – there are greater potential synergies and acquisitions can supplement declining organic growth.
In summary, corporate development and M&A activities can be hugely accretive to your business; by equal measure, they can be hugely distracting. With a thoughtful and deliberate approach to this category, a company can have a well calibrated level of market awareness and be prepared (a) when opportunity arises and (b) when the company and market is ready for it.