A fundamental challenge when executing a transaction is ensuring that the deal creates value for the buyer. With multiple bidders competing for a specific asset, companies must ensure that they can extract synergies from the transaction to justify a premium paid on assets and to cover the transaction cost and deliver an above-average return to investors.

Throwing numbers into a financial model to help justify the proposed purchase price can create an impression that if the numbers work, the results are guaranteed. In reality, significant effort is required to ensure that the ideas developed during the deal process can be converted into reality through a concerted synergy process.

Here are eight best practices in realizing your synergies from a transaction.

  1. Synergy opportunities should be closely aligned with the deal thesis.

    For any deal, the deal hypothesis and the sources of synergies should correlate strongly. For example, transactions focused on growth and market expansion are likely to lead to synergy opportunities tied to cross-selling and sales growth. As another example, transactions focused on consolidation are likely to lead to synergies regarding operational and G&A consolidations and optimization.

    A clear deal thesis will direct the integration team on integration and synergy prioritization. For example, for deals focused on growth and cross-selling, it may not make sense to prioritize SG&A synergies, as this could detract from growth objectives. Or pursuing SG&A synergies may impact the firm’s ability to achieve growth by distracting the sales team or disrupting client service.

    By taking the time to understand the deal thesis, the team working on synergy estimation and execution can focus efforts on the highest impact areas.

  2. While initial synergy estimates can be top-down, it is best to develop a bottom-up view of synergies pre-signing.

    Typically, initial estimates will be based on a top-down analysis early in the deal process with limited access to information. While the lack of data may prevent a comprehensive bottom-up plan, using top-down benchmarks can establish a preliminary range. This helps determine if it is worthwhile to proceed with the deal.

    However, to increase confidence in a transaction, companies should build a synergy model based on a bottom-up approach, founded on the target’s and buyer’s financial data. As part of diligence process, companies should secure access to functional cost data, employee census information, headcount costs, vendor spend, and other financial information that will provide a solid foundation for estimating synergies.

    From our experience, the cost baseline for estimating synergies should tie back to the pro-forma financial statements, as validated by the financial diligence team. Working closely with the financial diligence analyst will allow the synergy team to get a better sense of functional costs that will serve as the basis for synergy estimation. In cases where synergies may also be realized in the buyer’s cost structure, these should also be considered as part of the cost baseline.

    If there is uncertainty around the ability to achieve specific synergy opportunities, these opportunities can be organized by their level of risk and likelihood of achievement. For example, opportunities may be classified as highly likely, likely, or speculative, and then can be weighted accordingly when considered as part of the valuation model.

  3. Involve the teams who will be responsible for execution in the synergy estimation process.

    While early synergy estimates may be developed top-down based on benchmarks and comparing costs between buyer and target, owners of specific opportunities should eventually be brought into the process to validate and commit to the estimated synergies.

    Bringing these individuals into the process can ensure estimates are grounded on a plan to achieve them. This can help develop a sense of ownership/accountability for those responsible for execution. These individuals can also highlight the challenges or investments that need to be considered for achieving the synergies. For example, this may require making systems or process changes to account for any unique business requirements of the target that the buyer’s current process cannot accommodate.

    Later in the deal process, acquirers should also consider including personnel from the company to be acquired in the synergy discussions, as they can help vet existing opportunities and potentially propose additional ones.

    In addition, these individuals can identify any challenges that may impact the ability to hit certain targets (for example, by identifying potential client impacts). While this may not always be possible due to confidentiality issues or anti-trust limitations, there are cases where both issues can be addressed, and this can accelerate the synergy realization process and help build buy-in for the synergy targets.

  4. Work with accounting to ensure proper expectations are set for how synergies will be reflected and tracked in financial statements.

    A simple estimate of synergy opportunities is insufficient for tracking. Deal owners need to understand how synergies will be reflected in the P&L so there are no surprises after the deal closes.

    For example, expected synergies are often offset by increased cost allocations to the acquired business. For example, if $1 million is expected to be cut from the target’s G&A cost structure, but the new parent allocates $300,000 in incremental allocation for corporate services, the target’s P&L may only show $700,000 of saving (the additional $300,000 will be reflected in other businesses that benefit from reduced allocations).

    Another common issue is differentiating between cash and non-cash synergies. While cash cost savings are reflected in the P&L, there may be some items (such as an increase in asset efficiency) that accrue over time through lower CAPEX and lower depreciation.

    Working with accounting to understand how synergies will be reflected in the P&L can prevent misunderstandings between the deal and finance team once the deal closes.

  5. Anticipate that some opportunities may not materialize, but new opportunities may present themselves.

    Some opportunities may not materialize, as not everything about the target’s business will be known before close. For example, buyers may expect to fold one of the target’s business processes into the buyer’s process (and merge the teams performing these processes) but later realize that the target’s customers have unique requirements that would be impacted by the change. In these cases, any expected synergies could be offset by a potential loss of customers.

    By considering the potential for leakage in the proposed synergy opportunities, teams should look for additional areas of synergies to potentially offset any opportunities that are not deemed feasible.

    After close, the process for identifying and executing on new synergy opportunities should not halt. Instead, as part of the integration plan, teams should continue to identify new opportunities as the buyer and target become more familiar with each other’s operations.

    Another approach to account for potential leakage is to build in some level of contingency in the synergy estimation process to compensate for opportunities that cannot be executed. While having too large a contingency could impact the potential price you are willing to offer, some level of contingency can protect against the unexpected.

  6. Ensure there is a concrete plan to execute on the synergies and link that plan to the broader integration.

    Synergies will not happen on their own. In our experience, when a company is not realizing the expected benefits of a transaction, there is often no continuity between the deal process and the integration. Time was not taken to develop a specific plan for translating the synergies in the deal model into a plan for execution.

    As the synergy/integration team begins to take over from the deal team and prepare for close, a synergy implementation plan should be developed. For example, the team should ensure there is a plan to engage with and negotiate new contracts with vendors where there are opportunities to leverage increased spend. Where systems are being rationalized, companies need to plan for systems implementation activities, execute on data migration, and cut over to new processes and systems.

    Once plans for achieving synergies are developed, they should be managed and tracked as part of the broader set of the broader integration program.

  7. Consider timing for synergy realization that aligns with the integration plan and investments.

    When modeling synergies, deal teams should consider actions that must be taken to execute on synergies. These may be organizational or systems changes, and they may require negotiation with vendors. The deal team should note capacity constraints in the organization and system limitations, as many of these actions could take time to execute. The integration team can help determine the timeline for these actions and synergy realization.

    Companies also must consider the investments needed to execute on synergies, such as the cost to implement system changes. Other large investments include severance and other costs related to employee actions, including the potential payout triggered by terminating contracts of key employees.

    The deal team needs to ensure that that these investments are secured and considered as part of the broader deal model, as well as considering the timing for synergies accruing to the P&L. When a deal is approved by executives, if the synergies are considered in the justification, it should be confirmed that the investments needed for the integration are approved.

  8. Leverage quick wins to gain momentum and set the tone for integration.

    Prior to close, identify synergy opportunities that can be realized in short order and with limited investment. These may not be the largest opportunities, but quickly demonstrating the importance of synergies sets the tone for the broader integration.

    Typical areas that can be acted on quickly include procurement / vendor consolidation and the elimination of redundant staff. In cases where there is a longer sign-to-close period, more planning can be completed prior to close to allow for synergy acceleration, especially in the case where the sellers are willing to cooperate and it does not violate any gun-jumping protocols.

Summary

Synergy realization has received much public attention recently, especially in high-profile cases where companies have overpromised in their synergies. However, with proper upfront analysis, planning, and an ongoing focus on synergies, companies can achieve the expected results and deliver value to their shareholders.