Acquisition Of Entrepreneurial Companies: Top Realities Why They Fail

There are multiple reasons why the acquisition of entrepreneurial companies fails. Close to 80% of all transactions involve acquiring a company that is much smaller than your organization. These acquisitions tend to be valued at less than $200M and are usually conducted to acquire specialist skills, specialized products, technology, or a critical value-chain component. M&A as a strategy has been active for the last couple of hundred years, but its base has expanded rapidly in the SME (Small and Medium Enterprise) segment in the last 40 years.

Instead of spending thousands of hours of effort, time, and money to develop new solutions and that too, with a high risk of solution being abandoned mid-way during development and the accompanying frustration, who would not get attracted to acquire a company with a readymade product and a solution. If you can get the financing, the allure of acquisition is incredible.

What about the actual integration? How difficult can it be as you may ask?

Most people think that SMEs do not have evolved processes and structures therefore, absorbing them into a larger company should be an easy task. An acquired SME should be happily able to adopt the existing processes, procedures, hierarchy structure, performance management, and operations of the acquiring company in no time, right?

Wrong!

Companies often forget that while they may not have formalized processes and procedures like a large company and their functionalization may not be highly evolved, it does NOT mean that they do not have any practices or management structures.

And the journey of adoption is not from a vacuum to the processes of the acquiring company. If a company had nothing, then putting new policies and procedures can be relatively easy. But as the acquiring company has certain practices in place, it is far more difficult to transition. In fact, the whole acquisition may need to go through a proper transformation and must go through the journey of moving from an old structure to the structure of the acquiring company.

So, what failure points should an acquiring company specifically address when acquiring an SME?

Here are the Top-5 failure points!

MANAGEMENT FOCUS

The management in an SME is primarily entrepreneurial. The management team often is made of a handful of people with the owner doubling up as the CEO as well or at least, the CEO is also a significant shareholder. Most of the strategic decisions are either made by the owners or need the approval of the owners.

The management or the CEO’s focus is primarily around making the product or creating a solution and sell. There is an over-emphasis on selling the products and solutions compared to other operational elements.

The focus of an SME is on make-&-sell rather than market expansion, organic growth, internal organization consolidation, or cost-restructuring.

ORGANIZATIONAL STRUCTURE

As the SME tends to have small team sizes, it often ends up looking like an extended family where the CEO ends up acting as the family head. Everyone seems to know everybody else. Many of them also, end up extending their professional relationship in their personal space as well.

This is in contrast to what is prevalent in large companies. Formal structures, procedures, management mechanisms, hierarchy, and performance targets are a few of these elements that exist in these companies.

A significant level of informality and approachability exists in SMEs whereas as the size of companies grows, there is an increased emphasis on structured approaches and formal procedures.

Now, imagine when a small company with informal styles gets acquired by a company that has formal structures, how big will be the jump for people of the acquired company be?

TOP-MANAGEMENT STYLES

In SMEs, the top management styles tend to be very CEO-centric and everything else tends to be subordinated to that. In fact, the company culture demonstrated is often a reflection of the leadership style of the CEO.

What is the purpose of an organization? Why does it exist? It is the combination of a company’s mission, it is strategic outlook, its operating model, the goals it wants to achieve, it's brand and more importantly, how does it want to be seen by the customers, vendors, employees, markets, and the outside world.

Comparing the purpose of two companies during integration and combining it with the strategic rationale of the acquisition will tell you how to integrate. If an acquired company is going to be completely absorbed, then the acquired company needs to let go of the old purpose and adopt the new purpose.

SMEs often exhibit a level of market-centricity with product/solution dependency and thus, are entrepreneurial by the constitution. A lot of the activities is centered around engaging with potential customers, showing flexibility on pricing but also, flexibility on contract terms.

Larger companies on the other side would involve delegation, diffusion, and deliberation. Decisions often get made in teams and through consensus rather than individual positions.

With the amount of independence and entrepreneurial structure, SMEs often struggle to adjust to a delegated and consensus-based approach. Many SME leaders find the management structures often stifling and inflexible.

CONTROL SYSTEM

Performance measurement and management are usually reflected by market results in SMEs. In fact, apart from revenue generation, most of the other parameters including market engagement and discussion with potential customers are qualitative in nature and thus, not easy to measure.

The generated revenue is often, the main difference between survival and shutdown.

In SMEs, new strategic investments are directly linked to excess cash generated from revenue and investor funding. And employee salary increases are linked with the performance of the company and market inflation.

Large companies on the other side, are managed by P&L. While there is an emphasis on revenue generation, there is also a considerable emphasis on costs as well as strategic investments that are required.

Moreover, large companies have a process of setting long-term strategy, short-range outlook and operating plan, and goals and objectives (G&Os) being set up by divisions and functions. These G&Os are used to measure individual performances, career advancements and salary increases.

REWARDS AND RECOGNITION

In general, SMEs do not have formal rewards and recognition procedures in place. Depending on the level of seniority and the amount of invested interest, a reward can be ad hoc cash bonuses, title promotions, and in some cases, ownership shares of the company. In most cases, it is ad hoc and is normally approved by the CEO.

In larger companies, there are formal procedures along with management approval for rewards and recognition. The process usually involves nomination by line managers, approval by senior management, and then conferring the reward on individuals. The rewards can be in form of cash bonuses, increased perks, promotion with salary and responsibility increase, stock options, and profit-sharing.

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This was an overview of the Top-5 areas that can lead to failed integration of an SME by a large company.

It is important for large companies to acknowledge that SMEs do not have robust functionalization, formal policies and procedures, and sophisticated management systems. Unfortunately, a large number of acquisitions fail to notice and address these differences.

As we come out of the current pandemic crisis, there is going to be a substantial increase in M&A activities involving SMEs. The acquiring organization must think about how to create a transformational journey for each of the five elements that can lead to failure. Otherwise, it is best that the money is invested somewhere else.

This article is written by Anirvan Sen.

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The original article appeared on the Fifth Chrome website: https://fifthchrome.com/top-realities-why-acquisition-of-entrepreneurial-companies-fail/

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Strategy and Leadership Advisor | M&A Integration | Shared Services | Organizational Culture Transformation

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Anirvan Sen

Anirvan Sen

Strategy and Leadership Advisor | M&A Integration | Shared Services | Organizational Culture Transformation

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