Just about every software executive has been involved in an M&A deal at some point in their career. Everyone has their own ideas about what tactics and best practices are needed to improve the chances of a successful deal.
After playing a role in dozens of software deals over the past 27 years – most recently as CEO of Mercury Interactive during the HP acquisition – I’ve got a new list to share: the biggest software M&A myths.
Think M&A is a strategy? Think your bankers will craft the deal? You’re wrong. By understanding the most common misconceptions about software M&A, you can significantly improve the return on your company’s next deals.
Myth #1: M&A is a strategy
Reality #1: M&A is a tactic – not a strategy
Whether public or private, a company’s strategy must be set far in advance of considering specific M&A deals. As you evaluate how your company will reach its specific goals and qualifications, M&A may present itself as a potential tactic for achieving a strategic goal – to achieve market share, geographic presence, revenue growth, and so on. “Let’s merge with Company X” and “Let’s buy Company Y” are not strategies.
As you go through the process of reviewing a company for potential merger or acquisition activity, it is critical to question whether the acquisition will help fulfill the greater strategy. When negotiations hang up – and they always do – over people, process, price, terms or something else, always loop back to the “strategy question” to remove the obstacle. This will allow for you to say, “This is really strategic,” and pay more, endure product overlap, fire someone or jump over whatever other hurdle may arise.
Myth #2: Product overlaps will work themselves out
Reality #2: Deals should aim for “zero” product overlap
Software mergers should not have competing product lines. Aiming for “zero” overlap greatly improves the chances of a successful deal. When Company A buys Company B and there is no overlap, Company A simply begins to sell Company B’s product and vice versa. Everyone can get behind the reason for the deal and its value is realized.
The problem is that product overlap is a source of evil in M&A behavior.
When product overlap exists, the need to “kill” products and fire people is much greater. And because those decisions are difficult, they encourage bad management behavior, such as maintaining two product lines and doubling up on support, R&D and sales costs. At this point, the economics of the deal are damaged to the point that it cannot achieve its strategic potential.
In reality, most mergers have some degree of product overlap but by aiming for zero, the chances of success are greatly improved.
Myth #3: Merged companies will find a hybrid culture
Reality #3: Successful deals must have a cultural “fit”
At the end of the day, a software company is really only as good as its people. That means culture is just as important as the products and services that are delivered.
If the cultures of two merged companies don’t mesh, you lose people. Many employees of the target company feel the dream – of independence or an IPO, for example – is gone. Dissatisfaction and disappointment spreads. Employees walk.
Having compatible cultures is important to a smooth integration – but it can work without a perfect match. In the HP-Mercury deal, we overcame the existence of two different cultures by readily acknowledging the difference and creating space between the two firms: Mercury’s aggressive-R&D, hard-driving personality and the people-pleasing “HP Way.” Additionally, the mismatch worked because new CEO Mark Hurd was in the process of accelerating cultural change at HP.
Myth #4: What’s good for the buyer is good for the seller
Reality #4: Both sides must feel they got a good deal
When M&A deals are in the works, economics dominate the conversation. What was the revenue multiple? How about the cash options? The lockup agreement? But as the deal moves forward, it is critical for both sides to regularly review whether the deal as it is being structured still fits the strategy that both vendors are pursuing in the market.
Again, if one side becomes overwhelmed or bullied or feels that they overpaid or were undervalued, the cultural dynamic shifts and good people leave when the deal is done.
Myth #5: The executive team and the board will support the deal
Reality # 5: Managing expectations is critical
As the CEO, you have to manage the dynamics of the board. Basically, the board has two responsibilities: to represent shareholder concerns and to hire/fire the CEO. It is your job to figure out whether the deal is the right deal and maximizes shareholder value. The board should advise you in that effort.
The way to improve the reception of a potential deal is to present it as true to the overall corporate strategy. By offering a deal as a way to accelerate the achievement overall strategy, CEOs can avoid spending all of their time focusing on the “why” of the deal. If clearly strategic, a good deal will sell itself.
But if you are being acquired, the top managers may feel hurt about losing their independence – they may look right past the strategic fit and start asking the “what about me?” questions.
A deal should never surprise the board or the other senior executives. Communication is key. Daily calls with the board and management are painful but necessary. Keeping the top management and board intimately involved in the decision is one strategy. But some CEOs want to keep the details of the deal confined to a tight group of key leaders. It is a finesse call and depends on the specific situation.
Myth #6: CEOs don’t need to pay attention to small M&A deals
Reality #6: CEOs on both sides need to be aware of all deals
It is critical that you are working directly with the dealmakers in the buying/selling company. If the deal is of any size or significant consequence to the acquirer, CEOs on both sides must have visibility into the deal. At the end of the day, the CEO is making the final decisions on deals and determining whether specific, strategic goals have been reached.
If you are working on a supposedly “big deal” and the CEO has no involvement with the deal, it is a bad sign. It is probably code for “this deal isn’t really that important to us.”
Sure, if your tiny startup is being whisked off its feet by IBM, Sam Palmisano may not be intimately involved with the negotiations. But Sam really should know about your company, and you should be working with a top IBM exec who is one or two steps below Sam, at most. We completed five or six small acquisitions during my tenure with Mercury. Did I craft each deal? No. But I knew the specific details of each one and how each acquisition was going to take us one step closer to meeting our goals.
Another benefit of CEO involvement: there is a better chance of quickly removing any logjams that occur as the deal is moving along.
Myth #7: Bankers will do all the work
Myth #7: The CEO and the CFO must drive the deal
Bankers do a tremendous amount of work on software M&A deals. They endorse the strategic fit of a particular deal, compile fairness opinions, gather the legal implications – lots of heavy lifting and hundreds of pages of documents. The result may be a deal with dramatic potential for cost synergies and market gains -
but who has to make sure those opportunities are realized?
As CEO, you cannot leave the responsibility of dealmaking exclusively to a third party. The CEO and the CFO should drive the negotiation strategy. Only the top execs know what concessions can be given and what tradeoffs need to be made, given the strategic context of a potential deal.
For some small startups, it can be essential for CEOs to lean heavily on the opinions and research of the bankers. But in large, public companies, these decisions cannot be outsourced. You have to be in the midst of the negotiations and making decisions together to ensure a strategic fit.
Sometimes, the bankers can take over the M&A process. The bankers and lawyers get to work, the deal gets rolling downhill and before you know it, it is done. Soon afterwards, the bankers and lawyers have moved on to other deals and management is stuck picking up the pieces and explaining why the P&L statement isn’t measuring up.
Myth #8: You can make the tough decisions later
Reality #8: Tough decisions need to be made at the time of acquisition
When companies merge, by definition, there is duplication of effort: two product lines, two people doing the same job, two departments with the same charter, and so on. As discussed above, aiming for low product overlap helps mitigate this duplication, but cannot eliminate it altogether.
Executives need to make the tough calls before the deal is announced. There is no better time.
Nine-out-of-ten execs surveyed about their M&A experience said that they wished they would have acted faster and made the hard decisions sooner.
In the past, I took part in a deal where we delayed killing a product line and it cost us later – in customer goodwill, people, profits – all to a degree much greater than the bankers and financiers predicted.
Myth #9: Retention will happen on its own
Reality #9: Direct action must be taken in order to retain key employees
CEOs caught up in the strategic potential of a deal often expect employees to be equally excited about it – so excited, in fact, that they won’t quit. For many reasons I’ve already discussed, this simply isn’t the case.
When deals are crafted, a specific, proactive program must be put in place to retain the right people. You need to let these employees know in advance that the deal is a great thing – and why that’s the case.
For many rank-and-file employees, their first question will be “Will my email address change?” Or perhaps, “Will my dental plan change?” Having the answers to these “what about me” questions in advance is another key to retention.
The longer that good employees don’t know what is going on, the better the chance that they will start returning calls from head hunters, and an exodus will ensue. And that’s death for a software company – regardless of how great the deal was in the first place.
Tony Zingale most recently served as president and CEO of Mercury Interactive and oversaw its $5 billion merger with HP.