The acquired business’s principals and employees — and their willingness to continue working at the same pace and at the same level of performance — could be a deal’s greatest risk, more so than financial issues. Inexperienced buyers often underestimate the difficulties of integrating smaller teams into their infrastructure, notes Bartus. “You can manage liabilities with escrow, but you can’t address a situation where you acquire a team that won’t work in the [new] organization,” he says.
To keep a newly acquired staff interested, buyers might consider adding retention bonuses to earnout targets. M&A experts also suggest that buyers ensure a degree of autonomy for valued legacy employees, and recognize that those employees may expect more from the deal than a payout, however large. They will likely want their business — even when it becomes a small part of a larger company — to continue to grow. “The business objectives and the personal objectives of the ownership and key managers are often intertwined,” says Will Frame, managing director of Deloitte Corporate Finance.
Grab a Partner
To get a handle on the true worth of a start-up and minimize the risk of a mismatch, many corporate buyers rely on the practice of establishing partnerships with potential targets. By developing a relationship — either by becoming a customer, an investor, an adviser, or a joint-venture partner — acquirers can learn about intriguing smaller companies and discover any potential problems.
Partnering is a long-standing practice at Intuit, the software company that makes QuickBooks. In its constant search for possible alliances, Intuit invites some 40 entrepreneurial companies to its headquarters about once a year. “The goal is not to sign up 50% right away,” says R. Neil Williams, Intuit’s finance chief. “The goal is to develop relationships longer term and to let [the smaller company] know who to contact if [that company has] a good idea.”
These relationships should benefit both parties, executives say. This means that would-be acquirers should be frank with entrepreneurial partners should a potential acquisition lose its appeal or simply not make sense. “If people want to talk to us about washing machines, that’s not part of our strategic plan,” says Williams. “They appreciate when we tell them up front that it’s not something we’re interested in and they can move on and not waste time talking to us.”
Williams acknowledges that even at a nimble software company such as Intuit, “innovation and creativity can be a scarce resource.” The company continues to encourage its employees and engineers to come up with great ideas, and invests in the internal resources needed to turn ideas into products, but Williams says that many of the most promising ideas will come from the outside.
Will 2011 see early-stage deal-making continue at the same pace? With caution continuing to dominate CFOs’ outlook, a sudden return to giant deals seems unlikely. Yet according to the latest Duke University/CFO Magazine Global Business Outlook Survey, fully a third of the CFOs who responded plan to spend cash on acquisitions in 2011 — twice as many as plan to use cash for research and development.
So, while a strengthening economy and growing confidence may usher in some larger transactions, for now, small deals — especially if they lead to innovation and growth — are indeed beautiful.
Sarah Johnson is senior editor for strategy at CFO.