M&A Deal Failure: What Drives M&A Deals to Fail and How to Fix It

The process of merging companies is expensive, time-consuming, and fraught with danger. Despite 70-90% of all M&As failing, smaller deals continue to be made at a brisk pace, although mega deals have seen a recent decline. 

2021 proved a banner year for M&A with $2.9 trillion in transactions. M&As may be a risky bet, but the willingness of top business leaders to continue executing M&As at a breakneck pace suggests that the benefits of a successful M&A are sufficient to outweigh the overwhelming likelihood of a costly failure.

Careful analysis of M&A deals gone wrong reveals a series of patterns underpinning many of the most egregious M&A failures. By a similar token, common features driving M&A success have emerged. 

What Causes M&A Deal Failure?

Numerous factors play into why deals fail. We’ve compiled a list addressing seven of the biggest problems companies undergoing M&A face today.

Business case studies have turned up a number of common threads tying together most failures:

• Misvaluations by third parties
• Overbidding
• Unrealized synergies
• Information asymmetries
• Cultural incompatibilities
• Poor integration
• Undisciplined execution

Read on to learn more about the top reasons why M&A deals fail.

Misvaluations by Third Parties

During the M&A process, you should ensure that the valuation accurately reflects the sale’s worth. As Finance Professor Nuno Fernandes advises, think like an investor, but don’t hire investment bankers. 

In an article he wrote for the Harvard Law School Forum on Corporate Governance, he implores businesses to ignore the starry-eyed valuations dreamed up by investment bankers who are incentivized by their compensation structure to maximize sale price to the detriment of both parties. In the words of Professor Fernandes:

“Investment banks are good for roadshows and financing, but they should never be used for valuing or negotiating the deal. Because investment banks receive much larger fees when the deals are closed, bankers are always on the side of the deal, not the company’s side. Whenever possible, companies should develop valuations in-house or with the aid of third-party advisers who are less likely to be biased.”

Overbidding

Many M&A deals fail simply because the buyer paid too much — not because the companies failed to integrate or synergize, but simply because the cost paid exceeded the benefits accrued. Why do companies overpay for companies?

Dubbed the ” Bidder’s Curse,” there’s a strong body of research that suggests bidders in an auction setting are prone to irrational behavior and over-valuation. Hubris and ego all too often exacerbate this problem. C-suite executives and other top brass may view an M&A project as a means of expanding their prestige. Overconfident leaders may exaggerate their ability to profitably integrate a new company.

Take a step back and pretend to be a disinterested party. What is the maximum amount you would bid on this business based solely on this impartial analysis? This is your walk-away number. In the world of M&A, discipline beats heat-of-the-moment decision-making every time.

Unrealized Synergies

One of the top reasons why businesses choose to merge or acquire another company is to achieve a result greater than the sum of its parts, or in other words, synergy. In some deals, value projected from potential synergy opportunities can account for 30 to 70% of the acquisition price. 

There are multiple ways to achieve synergy. Here is a short, non-exhaustive list detailing some common areas in which synergy can take place during an M&A:

• Cost savings such as reducing staff, office space, and equipment made redundant by the M&A
• Increased productivity through cross-selling and cross-training opportunities
• Cost savings through economies of scale
• Increased contract negotiation leverage against smaller vendors

At a glance, it’s easy to see how an overly optimistic acquisition team could inflate the projected value of potential synergies. Ensuring that buyers use the correct discount rate and subtract the costs of integration and dis-synergies when creating a valuation is key to avoiding paying an excessive price tag. 

Information Asymmetries 

With so many variables informing your valuation, it’s vital that your information be as accurate as possible. Unfortunately, two big obstacles stand in the way of buyers as they seek to create an accurate valuation of the business they’re buying:

• A lack of institutional knowledge about the business they’re buying
• Incentive structures that reward the seller for misrepresenting the desirability of their company

Both of these factors can obscure otherwise rigorous and clear-headed valuation processes, and as we noted earlier in the article, valuations and bidding are often tainted by irrational exuberance and unwarranted confidence. A large-scale 2008 study examining more than 1,600 M&As between 1985 and 2006 came to the conclusion that greater opacity was linked to higher sales prices. 

How to mitigate this risk? The same study concluded that bank-financed acquisitions experienced lower failure rates, likely due to greater diligence and stricter standards. Other risk mitigation strategies include contractural remedies such as bonus payments if certain KPIs are met. 

Alternatively, warranties protecting against fraud and misrepresentation can indemnify a buyer fully or partially for a deal gone sour while serving as a potent deterrent against malfeasance by the sellers.

Cultural Incompatibilities 

The destructive power of an M&A between mismatched cultures is a key reason why it’s so important to assess qualitative factors as well as quantifiable data. Culture shocks have been the driving force behind some stupendously unsuccessful M&As. Amazon’s 2017 acquisition of Whole Foods is one such example.

On paper, it seemed like a logical move and a classic case of vertical integration. Both Amazon and Wholefoods are retailers, and Amazon’s growth plans included an expansion of its grocery offerings, an area in which Whole Foods would make a natural partner. 

What leaders failed to take into consideration, however, was how badly Whole Foods’ bourgeois sensibilities would clash with Amazon’s ethos of Spartan efficiency. Reports of crying workers and cratering morale began shortly after the M&A’s conclusion.

This is why it’s important to identify potential cultural mismatches before a deal is signed. This gives you time to gauge risk, ask questions, and strategize solutions for the seamless integration of teams.

Poor Integration

Poor fit goes beyond culture. Often, M&As fail to integrate the two organizations comprehensively, leading to gaps in data, communications, and activities. This can be disastrous for the merger in the long run. 

To avoid integration failures, you should create a clear, well-researched plan of how to create post-deal synergies. Also, discuss and delineate the responsibilities of everyone in the integrated teams. Not only will this avoid failure, but it will help you realize the full value of the deal.

Undisciplined Execution

Often, leaders fail to identify latent capabilities or underutilized assets of the combined companies. This can be fatal to the M&A deal.

According to Harvard Business Review, buyers may not properly consider “enterprise edges,” or assets that can serve the business’s core function:

“Who besides a competitor would pay to access my assets?” This thinking helps identify new revenue streams for a business by challenging where else assets that have been assembled to serve our core business could be utilized. To test this framework in the M&A context, we ask, “In the absence of a deal, would the acquiree pay for access to my assets?” 

Applying a rigorous and clear-minded test to acquisitions prior to purchase will prevent you from being saddled with cumbersome nonperformers further down the line.

What Can I Do?

As noted earlier, discipline, clear thinking, and a solid process are all necessary components to achieving a successful M&A. This is why it’s so critical that your team has the right tools to guide your M&A from start to finish. 

When choosing software to manage your next M&A it’s important that you select a comprehensive system that allows for easy collaboration and cross-team functionality. With our performance-enhancing solutions, you can minimize human error and irrational exuberance and take ego out of the equation. 

Devensoft has assembled every component of an M&A into one easy-to-use product. Perform analytics, create a due diligence list, and collaborate with your legal team, all on the same platform. With Devensoft’s synergy tracker, you will receive a rigorous third-party analysis free from irrational optimism.

Contact one of Devensoft’s software experts today to learn how we can elevate your next M&A into the coveted top 10-30% of successful deals.