F&A Advisor: Growth is not free

By W. Hobson Hogan Principal, ZweigWhite Consulting In today’s environment, many firms believe that they must become more diversified and larger to compete. In most cases, firms turn to mergers and acquisitions as a way to fill this strategic objective. Merging with similarly sized firms has become the preferred path to achieve this strategic objective because it typically allows the firm to fill its need in one transaction, as opposed to finding several smaller targets over a longer period of time. With most firms coming off several down years in a row and the industry in a tepid recovery at best, a stock swap is a very compelling option for firms of all sizes because it does not involve cash flowing out of the coffers. In a stock swap, two firms can trade in their old stock for stock of a “NewCo,” which will own the assets of the two predecessor firms. Another option is simply to have one firm issue new shares that it will use as payment for the stock of the acquired firm. Typically, the acquirer is the larger firm; however, smaller firms may have some legal or accounting advantage to becoming the acquirer. The mechanics of the transaction are important, but the structure that investment bankers, accountants, and transaction attorneys come up with is secondary to finding a merger partner that your firm will be compatible with. Firms looking for merger partners typically start by searching firms that have capabilities they want in an attractive geography. Their strategy may involve adding services to their current footprint or extending services to new parts of the globe. Once they have targets that look attractive, then firms usually start probing into the target’s culture: Is it design centric, is it run by architects or engineers, are they client-focused? These are all important questions, though it is rarely the reason that firms cannot come to an agreement. The number one reason why firms cannot come together is price. A transaction not happening because of price? Shocking! I know this sounds pretty simple; however, it is a bit more nuanced than the greed or thriftiness of one side of the equation. When merging two firms, you have to merge two separate internal transition plans. The key indicator of whether a transaction will occur or not is how aligned or divergent the buy/sell agreements are. If one firm values itself very conservatively, it could find it difficult to pay a fair market value to a merger partner because it would dilute its current ownership. Conversely, a firm that has a culture where stock ownership is kept affordable, yet distributes a significant amount of its earnings every year, will find a firm that relies on capital appreciation as its primary return on investment to be incompatible with its corporate culture. The fact is that ownership is the most powerful of all incentive plans. When searching for a merger partner, finding a firm that “checks off all of the strategy boxes” is simply the first step. In a merger, both sides should determine very early in the process how the merger partner implements its buy/sell process. Two divergent views of how new owners are brought in and current owners are bought out will not likely be overcome in the negotiation process. Having the same accounting system, offices that you can consolidate, or complementary markets is nice. However, these factors are not typically what push a deal over the top. Two things are necessary to strike a deal – an agreement on price and terms. When the sky is a different color on the other side, the likelihood of coming to an agreement is pretty low. That is unless someone decides to pay cash. It is, after all, still king.