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Value Creation Blog

Why Most Acquisitions Fail

Posted by Josh Patrick

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I’ve been involved in selling and buying businesses for almost 35 years.  For the first part of my business career I did it for my own companies.  For the past twenty years I’ve worked with other business owners helping them make wise decisions around acquisitions.

Over this time I’ve seen precious few acquisitions work out well.  It’s one of the reasons I hate to see sellers provide seller financing or have a large part of their sale based on contingencies.  Buyers will often blame the seller when things don’t go well.  It then becomes easy for your buyer to stop paying the note…..Then what do you do?

It’s all about culture.

When I did my first acquisitions I never even knew what the term corporate culture meant.  I never realized that other companies would do things differently than we did. 

When I bought my first business I was 24 years old.  Our company did things one way and the company we bought which was much larger did things very differently.  I thought that logically they would of course adopt our way of doing things.  Boy, was I wrong.  What happened was a minor disaster.  It took me several years and to get the people at the company we bought to adopt our methods of doing things.

At the end of the day, the buyer will always control what the culture will be.  If the culture isn’t compatible, the chance of a successful acquisition drops…..the amount depends on how skillful the acquiring company is at merging cultures.

Buyers are more optimistic than they should be.

This was certainly true for me.  When we bought our first businesses we thought that tons of expenses would disappear.  That never happened.  In fact, most of the time when we did an acquisition, during the first year or two expenses would go up.  We spent a lot of time and money getting the businesses we bought up to our standards.

If you’re about to buy a business understand that there will always be things you didn’t expect.  If you don’t budget for the unexpected you just might find yourself short of cash.  It happened to me and it could very easily happen to you.

Then there’s behavioral finance.

I call this my restaurant story.  I was in the food business and decided we should keep our catering staff busy by opening a restaurant.  We found a spot and I just kept negotiating with the landlord and before I knew it I had put so much effort into making the deal work that I wasn’t about to back out.  I rationally knew there was no way this was going to end well and yet I kept negotiating….

As you might expect, it didn’t end well.  After leaving my $50,000 deposit I ended my adventure in owning a restaurant.  This can even be worse when you go to buy someone else’s business.  You have to have a trigger for when you’re going to walk away.  You need to have someone who is going to remind you when the trigger his hit.  Then, you have to listen.  If you don’t you’re going to fall prey to what’s called sunk costs…..that is when you’ve put in so much effort, you just don’t want to walk away.

Watch out for your ego.

I recently was involved with a client where one of the leaders of the company decided that acquisitions was the way to grow.  No one else at the firm was interested in pursuing this strategy.  He kept at it and wouldn’t back down.  Eventually, he had to leave the firm because he lost all support from others.

Let’s face it buying a business is good for your ego.  It’s fun to buy a business.  Too often I see a bidding war start between two buyers.  All the players decide they “need” to own the company they’re after.  They let their ego get in the way and before you know it, they’ve bought a business where they’ve paid way too much money.  Don’t let this happen to you.

Finally, there’s deal structure.

By deal structure I mean the real cost of the deal.  You see if you pay someone $1,000,000 for their business you’re going to end up paying them more than that.  If you buy stock the price will likely be closer to $1,800,000.  That’s because you have to earn enough to pay taxes before you actually pay for the business. 

Even if you do an asset sale you’re likely going to have a tax cost that you don’t recapture for years.  This is especially true with good will.  Even though you get to deduct good will, you have to take fifteen years to do so.  You’ve already either paid the seller or the bank back using after tax dollars before you get your deduction.

This is when owner financing becomes especially dangerous.  Too often I’ve seen sellers not factor whether the buyer can afford to pay them.  Too often the seller decides to provide owner financing.  You know what happens when cash is tight…..the buyer will just stop paying you.  And, I bet you don’t want that to happen.

All is not lost.

Here’s the deal.  Acquisitions can work.  You need to think about problems you’ll have.  You have to learn to say no.  You have to learn to walk away from the deal when it’s not in your favor.  You need to have a thinking partner who’s going to help you in this process.  If not, you’ll end up with my early acquisition results.  And this is not something I want you to achieve….it’s just too painful.

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Topics: starting a business

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