10 Best Practices for Your Middle-Market M&A Transaction

10 Best Practices for Your Middle-Market M&A Transaction

September 18, 2023

Mergers and acquisitions (M&A) transactions are complex. To ensure successful integration, companies should follow best practices that cover every aspect of the transaction.

From leveraging diligence findings and involving the integration team early on to establishing a clear governance structure and retaining key personnel, companies need to pay attention to all the critical details.

In this article, we will cover ten best practices for your M&A transaction that can help you maximize the value of your investment while minimizing risks and challenges. These lessons apply if you are a corporate buyer completing a deal that expands the scale or scope of your business or a financial buyer looking to expand the business of an existing portfolio company.

#1 Icon1. Involve the integration team early on.

Your integration team can offer valuable insights that can impact the valuation of a deal, such as identifying areas for potential synergies, operational efficiencies, and cost savings. Plus, the team will be able to help develop a clear understanding of the process, system, and organizational changes that will be needed to successfully deliver on the deal thesis and execute on synergy opportunities. The team can also help avoid surprises by identifying what potential investments will be required to combine the companies.

However, if a deal is handed off to the integration team only after signing, delays and misunderstandings in the integration process could arise since the team may lack the context for understanding the rationale behind the deal, the strategic objectives, and the key value drivers. This could lead to unexpected costs and delays in combining the businesses.

Knowing this, leadership must clearly envision what full integration will look like. For example, does “full integration” mean that everyone is operating on the same system? Or is the final goal to operate as two separate teams? Integration leaders should communicate that vision so that everybody involved can make decisions based on that common goal.

As an example, a company that has just acquired a software development firm may need to loop in their integration team quickly so that the team can assess the existing software systems and evaluate compatibility with the acquiring company’s infrastructure. They can then work closely with the acquired company’s development team to create a roadmap for integrating the software products, aligning development processes, and leveraging shared resources.

#2 Icon2. Establish a clear governance structure.

Integration governance must be established to manage the integration process, identify and mitigate risks, ensure teams are aligned with key objectives, and communicate effectively with stakeholders. A siloed approach by each function can lead to miscommunications and a lack of alignment between functions that may undermine the deal.

A well-defined integration governance structure will provide clarity around the decision-making process and will allow for cross-functional coordination on key integration decisions and for managing and tracking progress against key integration objectives. Establishing an Integration Management Office (IMO) to manage the process and implement the governance structure can lead to better deal outcomes by keeping the integration focused and on track.

While there will be limitations before the deal is completed, involve the acquiree in integration discussions as much as possible. Early involvement of the target company in the integration program is essential to establish realistic timelines and to take a target’s unique business requirements into account. Ideally, the governance process should be established from the day the deal is announced to manage communication effectively.

What might this look like specifically? Imagine a corporation that has just completed a high-profile acquisition of a manufacturing company. To establish strong governance, an IMO is formed, comprised of key executives and leaders from both organizations. This committee takes charge of setting strategic direction, making crucial decisions, and monitoring integration progress. Supported by a dedicated IMO, they hold regular meetings to review plans, address risks, and maintain effective communication. Cross-functional integration teams are also formed, responsible for specific workstreams such as IT systems integration, employee onboarding, cultural integration, and customer transition. Under the guidance of the IMO, these teams report progress and challenges, ensuring coordination and alignment throughout the process.

#3 Icon3. Use momentum but manage the pace of change.

The time immediately after the deal is announced presents the biggest opportunity for staff members to be motivated, coordinated, and focused on successful integration. Leaders should remain conscious of using that momentum to create early wins following the deal.

But utilizing momentum must be balanced with a reasonable pace of change. A transaction brings significant change to an organization, and much of that change happens extremely quickly: leadership changes, new reporting requirements, deal synergies, system migrations, and more. By strategically pacing out those changes, integration leaders can keep people focused on executing the integration well without drowning them in an overly ambitious transformation timeline.

As an example, think of a company acquiring a telecommunications provider. First, they focus on improving the customer experience of the acquiree as an early, easy win. They hold joint training sessions and collaborative efforts so that employees from both companies can build. Then they carefully pace out operational synergies, system integrations, and reporting structure changes to avoid overwhelming employees over the next year.

#4 Icon4. You bought this company for a reason. Keep that reason top of mind.

The integration team needs to understand the deal thesis so that they can focus efforts in the most important areas. For example, understanding a deal’s purpose will inform whether efforts should be centered on maximizing commercial growth or maximizing cost savings.

Some mistakenly believe that acquiring a company means that they are allowed to impose their will on the newly acquired business, but it’s vital to respect and appreciate what makes the target company valuable to you as an acquirer and how it complements the existing business. If an acquirer is not careful, decisions made during the integration may undermine the value of the company they bought.

For example, imagine a company that conducts most of its business through wholesalers. Leadership decides to purchase an acquiree that focuses on retail to expand in that market. But then management forces the acquiree into a workflow designed for a wholesale model. They have forgotten the very reason they bought the company. In the worst circumstances, the acquiree’s retail business may be put in jeopardy.

In an ideal world, the acquiring company would recognize the unique strengths and expertise of the acquiree in the retail market and foster an environment that supports and nurtures its retail operations. They would understand the importance of preserving the acquiree’s established workflows, customer relationships, and retail-specific strategies.

To achieve an integration where the value of the acquiree is preserved, involve individuals from the target company into the integration process. The employees of the target company may have unique knowledge about their business, and their input is valuable to avoid gaps in the integration plan. Understand how their business creates value, how it’s different from the acquirer’s business, and then respect and protect it.

#5 Icon5. You’ve paid a lot for valuable reports. Use them.

During the M&A process, a company obtains various types of due diligence reports, including tax due diligence, financial diligence, legal diligence, and environmental diligence, among others. These reports can contain critical information and insights that can help guide a successful integration.

For example, tax due diligence can uncover potential tax liabilities and risks associated with a deal, such as tax exposure from previous transactions or incorrect tax reporting. Financial diligence can provide insights into the financial risks and opportunities associated with the target company, such as revenue recognition issues, unusual expenses, or contingent liabilities. Legal diligence can reveal potential legal liabilities or disputes that the target company may be facing. Environmental diligence can identify environmental risks associated with the target company’s operations.

Integration leaders need to ensure that they have access to all due diligence reports and understand and address the implications of the data presented in these reports.

#6 Icon6. Take acquisition accounting seriously.

Accounting is a critical area that will be closely scrutinized during an acquisition. Auditors will review acquisition accounting conclusions, journal entries, and other accounting aspects to ensure accuracy and compliance with regulations. Cutting corners or making mistakes can have significant financial consequences, such as restatements, penalties, and legal liabilities.

Companies must be prepared to address any discrepancies that may arise. For example, preliminary acquisition accounting estimates may not always be accurate, especially if a detailed pre-close analysis was not conducted on the anticipated impact of depreciation and amortization expense due to step-ups in acquired fixed assets and identifiable intangible assets.

During an acquisition, the net working capital of the target company becomes a significant consideration. Buyers need to evaluate the target’s working capital requirements, analyze its historical trends, and assess any potential risks or discrepancies. Understanding the target company’s net working capital helps the buyer determine the amount of working capital required to maintain its operations effectively. However, after the deal closes, the buyer and seller need to reconcile closing net working capital. Typically, the buyer only has 30-60 days to submit their calculation of closing working capital acquired to the seller and often must use the same accounting methodologies that the seller used. This will take up time and attention shortly after the deal closing.

Additionally, a deal’s structure can drive unexpected accounting results, especially when earnouts are tied to continued employment post combination. This may affect a company’s EBITDA or adjusted EBITDA, and grasping those implications is especially crucial for public filers that may experience a dip in stock price due to restatements. Private equity firms may focus more on non-GAAP measures like adjusted EBITDA, but they still need to pay attention to U.S. GAAP financial statements.

#7 Icon7. Proactively identify and address IT integration challenges.

IT is considered one of the most complex components of a transaction. While a key enabler of synergies, IT is typically the largest cash outlay of an integration. IT must balance demands of providing data to leaders for integration decisions, enabling critical communication protocols by Day One, and facilitating the consolidation of systems and processes post-close — all while enabling synergies across the company. Moreover, IT needs its own strategy to ensure that risk is mitigated across the environment, one-time and ongoing cost impacts are contained, and technology is positioned effectively to enable business success.

IT should be involved during diligence to understand the technical capabilities of the target company and how IT should be aligned to the broader M&A strategy. Additionally, by including IT in diligence, companies can minimize the risks of important knowledge about the company getting lost as the cycle progresses from diligence to integration. Deal teams should have protocols for sharing findings daily through diligence, which will allow teams to make informed decisions about integration strategy. These early decisions can accelerate planning and maximize the time between sign to close to developing a clear plan that is understood by both the buyer and seller.

The rigorous design of the IT target state is of paramount importance, and it should include all technology systems and tools. The cost synergies need to be captured in the target state of the business applications, data systems, infrastructure, IT governance, and end-user computing. Additionally, all cybersecurity vulnerabilities and data compliance issues must be identified and mitigated to avoid future data breaches. The transition plan to the target state should be clearly defined, and it should focus on business continuity and minimum management involvement instead of forced technology decisions.

Business alignment is vital to ensuring the unique capabilities of the target are retained while the scale and resources of the buyer are used to accelerate growth across the platform. For this to be true, business leaders must share what is important about employees, customers, and strategic partners so that IT has the right context for technology decisions. Forcing an adoption of the buyer’s systems and process could have negative consequences to the target’s business and potentially alienate employees and customers.

#8 Icon8. Important acquiree knowledge can be lost. Protect it.

Integration leaders must identify and retain key personnel from the target company who possess critical client relationships, functional knowledge, and technical expertise and ensure that their knowledge is retained or transferred to the appropriate people in the acquiring organization.

For instance, when dealing with the valuation of intangible assets for the opening balance sheet, a lot of the background and importance of these items can be qualitative or inherent within certain key individuals, such as the historical importance of a particular patent or trade secret. Conversations with key staff members who have been working with these assets over the years are crucial in gathering this qualitative data to inform appropriate assumptions in the valuation process.

The same is true for the finance function or IT, where the loss of key individuals can cause major disruptions to processes and systems, especially for homegrown systems common in the middle market. These individuals may have been following specific processes for years, and retaining the individuals who built and accessed homegrown reporting systems can help avoid any significant knowledge gaps.

#9 Icon9. Take care with merging cultures.

Cultural differences can pose significant challenges during post-transition integration. For instance, one firm may have a highly centralized decision-making process, while the other firm may push decision-making down to lower levels. Merging these two cultures can lead to conflicts and confusion as people who are used to making decisions locally may now have to report to multiple layers of management. Integration leaders need to be aware of these cultural differences and work to accommodate each other’s ways of working. This may require changes to the organizational structure or decision-making processes to better align the needs of both firms.

#10 Icon10. Be prepared to integrate the target while operating your normal business.

Acquirers are often surprised by the cost of integration, which can include both hard and soft dollar costs. This includes the internal bandwidth required to manage the integration while also running the business, as well as support from external advisors that may need to be brought in. Acquirers may also underestimate the emotional toll that the integration process can have on employees from both the acquirer and the target organization as employees balance managing their day-to-day jobs with supporting integration activities.

The integration process requires high-level expertise and experience, which can detract from day-to-day operations or other initiatives that critical employees may have been working on. Integration leaders may need to put other initiatives on hold to ensure that the integration process is done efficiently and effectively. Striking a balance between integrating the target organization and continuing to operate the business as usual can be challenging, so leadership must take care in scoping out an achievable timeline for integration goals.

Making Your Own Integration Successful

Navigating the complex landscape of middle-market M&A transactions requires a strategic approach and adherence to best practices that cover every aspect of the process. From involving the integration team early on to balancing integration tasks with day-to-day operations, each practice plays a crucial role in maximizing the value of your investment.

For your own M&A process, these ten steps will help steer you toward a smooth and effective integration process, minimizing risks and challenges while paving the way for a successful and profitable integration.

Originally published in The Deal