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Consolidation Realities … A Guide Through the Minefields
of Building Companies
Through Acquisition
Bill Wade
The basic premise couldn’t be any simpler. Take a highly
fragmented industry facing technological change, customer upheaval or chronic
financing difficulties. Add in a few well-healed foreign firms or (worse) a
couple of previously unknown competitors from “outside the business”.
Since the industry leaders are probably family run
businesses (second or third generation) with limited succession strategies, the
next step to protect profit and continue growth is clear: Consolidate.
It can’t miss. The new company will start out life with the
best of everything – smart, entrepreneurial ex-owners as key managers … freshly
infused capital from public or private equity funds … savvy top management eager
to reap the “low hanging fruit” by combining back offices, systems, inventory,
purchasing power and expanded customer contact. Regional national or even
multi-national market dominance from day one … perfect!
Why then do consolidations (also variously referenced to as
roll-ups, MBO’s, buy-ups, build-ups or “poofs”) seem to be faring so poorly in
the public markets. Is the recent stock price trace record of these companies
simply reflective of a couple of widely publicized problem cases (Waste
Management, Republic Industries, Corporate Express, Physicians Resource Group,
etc.) or is there a special set of management hurdles facing these hybrid
corporate structures?
Both business owners thinking about selling and managers
thinking about buying need to realize that the management task upon which they
are about to embark is both different and more complex than those faced in
typical mergers … somewhat dangerous ground, since more than 60% of these vastly
simpler two party transactions are thought to be failures. What can cause
dysfunction as these well-funded groups of successful managers – most are proven
executives – ply their course to creating a single and focused company?
A study of several consolidations, both successful and
disastrous, points time and again to ten POMO’s
of misunderstanding. Not all are in evidence at all times nor universally
prevalent across the organization. However, a little organizational pathology
reveals components of these ten in nearly every instance of conflict.
As will become evident, the key to success seems not to be
bound up in valuations, EBITDA or financial engineering. Rather, it boils down
to a proposition articulated in a classic HBR article by Willard Rockwell, one
of the first large scale consolidators, in 1968: “What you acquire, first of
all, when you buy a company is its people. They are the precious assets that can
keep it imaginative, aggressive, inspired and dynamic. In my view, if you keep
this thought well in mind, you will not go wrong.”
This is certainly true, but the permutations of employee
misunderstanding and mistrust make the nurturing of this asset a real trial.
Let’s now examine ten problems peculiar to consolidation of multiple merger
situations:
1. A Consolidation
company is a corporation … not a club
Consolidation of an industry is a traumatic time for all
involved, and since there is normally more than one consolidator at work when
the craze strikes a segment, seller choice often becomes clouded (but rarely
overwhelmed by) non-economic factors.
The proposed transaction represents an irrevocable
investment decision for both parties. Since the driving force in the sale of a
family business is usually the ability to “take some chips off the table”, cash
or highly discounted cash equivalents end up ruling the day.
It is interesting to note, however, the language used by
sellers and outsiders (vendors, customers, etc.). Typically the terminology
revolves around “joining the group”, as though the decision was not equity
transfer but membership in a club. All publics need to be reminded of the
corporate nature of the new entity and the set of decision-making processes this
implies. Buying groups may “vote” on vendors, companies do not. Trade
associations may vote on legislative positions, companies do not. Clubs may vote
on rules (such as the handling of a trademark), companies do not.
Since this paradigm transformation is so critical, it is
imperative to begin creating a cultural basis of shared or common beliefs as
soon as possible (even before the closing), and to the greatest organizational
depth possible. There is one rule to maximize this crucial process …
oversimplify. The basic tenets of the new company’s approach to everything from
customer service to human relations has to be covered quickly and concisely …
and then has to be restated and summarized over and over. Compounding chaos will
do nothing to dissipate it.
Consolidation integration is often likened to “herding
cats” … and apt description. Nothing is more important to the pulling-together
process than common understanding of short-term direction. Managers should
prepare to over lead (not to be confused with over-managing). No nuance can be
assumed, and every expectation should be stated as specifically as practical …
and in writing if possible.
A major factor in the delineation of the “new deal” should
be the introduction of a formalized business planning process – no small change
to organizations that may not have even done budgets in prior years. Business
planning is an excellent opportunity to involve many levels of many functions,
and to forcefully demonstrate the depth of change being anticipated in the
organization and the industry within which it competes.
2. There is an enormous difference between “real”
business and family business.
A large part of the appeal of smaller family business is
the supposed lack of “corporate “BS” necessary to run the enterprise. Once
consolidated with others, these simple freestanding organizations find it
necessary (and usually difficult) to assimilate the tentacles of a corporate
structure into their isolated individual companies.
Formal organizational structure is essential (the plan
should be finalized even before closing), as this is the neural network that
will guide all future development. Note…it is not enough to simply draft a
bunch of reporting relationships…they must be rigorously respected. The
possibilities for chaos from continuing informal (and often contradictory)
structures can’t be overestimated. Remember that most previous intra-and
inter-organizational relationships were never really defined – but here this
definition becomes imperative to the success of the new deal.
Often the first real business exercise for the entire new
company is the preparation of a budget and annual business plan. Unlike the
case in the family setting, budgets are not merely suggestions…they become the
critical financial playbook. Most small companies put together a “bank plan”,
typically a super conservative annual budget that almost can’t be missed. Now,
perhaps for the first time, aggressive targets must be hit.
Managers of individual operations don’t have a history of
looking at a larger entity, nor their units’ effect on others. Another common
hurdle is the reliance on previous year results as an estimating basis…dangerous
since all the previous rules have just been changed. Owners forget that the new
investors are looking forward to pro forma cash flows, not backward to see
results vs. last year. Zero-base, activity based costing is the most effective
(if most painful) solution here.
Two last warnings. Never assume a common level of data
quality…it’s not there. Migrations from different charts-of-accounts, part
numbering schemes, product or vendor coding structures or process protocols are
just too much to overcome on the first pass. Define everything database-wise as
intricately and immediately as possible.
Secondly, be prepared for corporate naiveté on a broader
scale than anyone would guess. Behavior and communication patterns that seem
“normal” to large company veterans are foreign to these new comers.
3. Never assume that purchase price is the only monetary
issue.
Most sellers come from a background of extreme corporate
frugality – understandable since the company’s money was their money on nearly a
direct basis. Two interesting problems spring from this fact. First, every
cent will be fought over in post closing cleanup. Even though they may have
just received a check for $10 million for the purchase of the business, bruising
battles can break out over $100 car allowances. Personal is personal, and no
amount is too small to forgo. The best possible defenses against this
disruption:
·
Detail everything (even though deemed immaterial during
negotiations) in writing. No understandings go unclouded in the fog of
consolidation activity in the first 12 months, and it is not just mega-bucks
items that can paralyze the process later.
·
Limit post closing adjustments or any “earn out” types of
payment. These “on-the-come” valuations severely limit the ability to
consolidate or make cultural changes, and may actually cause a unit’s behavior
to be counter to the interests of the new company.
The use of re-investment (or purchase of a unit with the
stock of the new company) can be a powerful alignment tool when it comes to
commonality issues (vendors, policies, etc.). The expectations of control that
accompany the investment can create a minefield, however. Understanding the
underlying motivation of sellers is critical. Inclusion of previous owners on
boards of directors tends to be dangerous, as most consolidations are built from
multiple acquisitions. Inclusion on or exclusion from such boards can be a bone
of silent (but very real) contention. Once again, written detailing of mutual
expectations is a must to avoid these pseudo-control hiccups.
Executive committees or management / operational committees
are often substituted for “real” board seats. Without careful delineation of
authority, these can cause management cross currents as well. Remember, under
no circumstance can the company become a democracy, and “voting”…especially
showing deference to individual age or organization size…rarely optimizes
decision-making. If used at all, consider communication the prime objective of
these constructs.
4. Never confuse former owners with communication
channels.
In established corporate structure, overall communication
patterns evolve over time, but basically follow established “level A to level B
to level C” formats. As the consolidation company comes together, it is
especially tempting to suppose that similar channels would arrange themselves.
Surprise – they won’t.
Regardless of claims of inclusion of employees in the
running of the previous company, family management and other entrepreneurial
types had made a living (literally) by not telling anyone anything…a practice
that probably counts its roots among “whistle blower” tax code provisions.
Recognize the fact that in the past owners didn’t tell employees anything, and
without a lot of prompting, are not likely to start now.
Mass communication directly to all employees, through
paycheck letters or company newsletters, is the only way to be sure that the
entire organization hears the same thing the same way – with minimal editorial
comment on the side.
On the communications front, feel free to over do it,
especially early. Try to get to employee spouses to tell the big picture and
alleviate (if appropriate) fears about layoffs, etc. Don’t leave your vendors
out of the loop, as they are intimately involved in many aspects of the
company’s future. It has been interesting to note that customers seem to be the
group with the fewest concerns – perhaps an off shoot of American’s generally
over served markets.
It is imperative to recognize the real management players
as soon as possible. Family managers may have been out of the day-to-day
operations for years, and are therefore questionable sources of real field
input. The second tier is often the guts of the asset, so every possible effort
should be made to nurture and assure longevity for these key players.
Short-term employment agreements in the early stages will tend to tie these
managers into the process from the beginning, and help protect this key asset
from competitive raiding.
Day one is critical. Be sure to have as complete a
“welcome to the new company” package as possible available for all employees.
Don’t underestimate the average employee’s interest, knowledge of the industry
or curiosity about big picture strategy. Tell as much as you can as soon as you
can, but be careful not to leave much open for interpretation. Remember, the
entire structure is forming itself and questioning itself … but it may not yet
trust itself.
5. Personnel Evaluation…it’s tough to know your real
players.
One critical discipline often overlooked by small or family
business is in the area of personnel evaluation. Formalized systems are
normally non-existent, save some notes in the file regarding last pay raise,
etc.
Similarly, records on training accomplishments of selected
individuals are also missing. It is difficult-post-deal to determine exactly
what the talent pool looks like. Three common hindrances include:
·
“My people are great…you should pay them more.” Unfortunately in
only rare circumstances were many key second and third level managers included
in the distribution of the buyout pie. Often one of the first “crises”
encountered will be that of imminent loss of key people because they are under
paid. Comparable pay levels (if a deficiency truly exists) should be figured
into purchase price adjustments.
·
Sort out loyalty vs. ability. Long-term employees are usually
valuable, unless this was simply the only job they could get. Watch carefully
for undue deference (yes-men) when talking with key managers in the presence of
ex-owners. The ability should be evident…and is not to be confused with
loyalty.
·
Nepotism is not always bad. Evaluate “water tower kids” (their
name is up there) with as much fairness as possible…interviewing them alone
helps…and find out if they will still be interested in working there when
someone else is in charge.
In any employee evaluation, expect to hear what owners
think you want to hear. Try to sort out defensive evaluations, as they will
create serious roadblocks to true consolidation. Competence may not transfer to
new circumstances, nor may compatibility.
6. Estimate the limits of ambition of previous owners.
Anyone receiving a multimillion-dollar check for his
business has to take a moment to think what…exactly…the effect will be on his
life outlook. True, the experience is markedly different from winning the
lottery – you didn’t win the money, you (or your family) earned it.
None-the-less, sudden liquidity can have drastic social and psychological
effects, especially if the previous owner has most of his net worth tied up in
the company (and if he had personally signed for the bank loans).
Two primary business effects have been often noticed in
this regard. The first usual reaction is the evaporation (at least temporarily)
of the entrepreneurial “Bias Toward Action”. While former owners guided and
grew their business through often unbelievable financial and market travails,
unfamiliarity with requirements of the consolidation atmosphere may render them
afraid of their own shadow. Instant reassurance of management trust in their
judgment (while introducing new reporting and authorization forms) will make
this nearly universal system pass quickly.
Balance is the key here, for once comfortable with the new
rules, many “things we always wanted to try but didn’t have the capital” start
to surface like rocks in the spring. The discipline of capital allocation
systems must be installed (and enforced) from day one. Capital allocation is an
enterprise wide decision set, not simply a prioritizing process for individual
units.
One more nearly universal surprise…previous owners
unanimously report that they “Haven’t worked this hard – ever”. In a short-term
sense, this is probably correct – as most day-to-day operations have often been
turned over to second tier managers. Also, since they will tend to try to
control all information flow, they find themselves tied up by managing both the
questions and the answers. Re-insertion of the family can be very disruptive to
the real daily supervisors.
7. Ask for (and share) feedback, but beware of voting.
Multilevel field feedback, from employees, customers,
vendors or even competitors can be the most valuable source of research
available. There are several caveats regarding this process:
·
Be careful of the phrasing or orientation of the question. Don’t
ask for information in such a way as to indicate what you expected to hear – or
you will hear exactly that. Avoid phraseology that not only indicates
ignorance of the facts, but the inability to formulate a plan of action. “What
would you suggest?” is far different from “What should we do?”
·
Don’t assume answers are complete or that all-relevant information
is being volunteered. In this brave new world, information represents the
ultimate protective device. Lack of experience and lack of trust really curtail
the efficiency of fact finding. Therefore, count on spending days or weeks (but
certainly not hours) listening to all levels of input.
·
Carefully weigh the value of “the old days”. Since the
consolidation is actually changing the face of the industry, antidotes from ten
years ago may have limited relevance on a go-forward basis.
·
Pick your time to confront sensitive issues. Immediately
post-closing, the entire organization will have been rubbed raw, and
expectations are disorganized. This superheated sensitivity may be a bad time
for decisions that require understanding or trust from employees.
As for overall strategic direction, don’t wait for it to
magically appear from field input. Generally, consolidation strategy (and early
tactical solutions) can’t possibly come from committee work…but if this hasn’t
been pretty well thought out prior to writing checks, it may be academic anyway.
8. Familiarity may breed contempt, especially in the
crunch.
One of the most fascinating changes brought on by the
formation of a consolidation company is the metamorphosis of pre-existing
personal relationships among the principals involved.
Since the majority of these new larger companies is
geographically diverse collections of operations in the same base business, the
probability is high that many of the managers have known each other from trade
groups or advisory councils. There is an unbelievable difference between an
association board and being equity / business partners. Cliques and “shadow
cabinets” emerge in the new entity that only serve to complicate the true
consolidation effort. Friendship may get in the way of candor, and gossip soon
is confused with communication.
Large organizations of any type are combinations and
interactions of economic, political and social spheres.
The product of these interactions largely determines the
success of the combined enterprise, so each should be monitored…and managed if
appropriate. To the extent possible, these interactions must be contained within
the operating management of the company. Unnecessary or unstructured access to
advisors, lenders and investors should be limited, as “back-channel” information
can be disruptive to both ongoing operation and strategic development.
9.
Consolidation savings only count once you can spend them.
Great ideas are never in short supply when a bunch of
entrepreneurs, who all intimately know the industry, get together in a
consolidation effort. Operations, sales tactics, tax tricks and training tips
all come out quickly once a modicum of trust among the new management team has
been established. However, prioritizing which will be the “next great thing”
may be the first opportunity for hurt feelings and dissention.
A couple of common problems surface in this effort. Due to
the local nature of most small businesses, the fact that many operational
innovations will not thrive equally in all geographic or industry sub segments
must be considered. Care should be taken, however, as geographical or customer
differences are often merely excuses to be sure that “change is what happens to
the other guys”.
Consolidation benefits typically count on communization
opportunities, which have to be pushed much harder than most anticipate. The
tragedy of commons (what is good for the whole may not be good for each
component) is the strongest single factor responsible for pulling buying groups
and cartels apart…it must be managed closely here.
As previously mentioned, closely held information is the
best shield for the status quo. During discussions of emotional points
(including selection of vendors), watch for the “secret deal” that is usually
revealed only after consensus is reached. Long term, this “gotcha” mentality
must be eliminated…and this may require fairly wrenching personnel decisions.
Public executions have a way of getting everyone’s attention.
10. Technology should have no personality.
Many areas of operational improvement will be dependent on
an examination of “best practices” of the individual units as they are added to
the consolidation company. Two that probably shouldn’t be included in this
evolutionary process are accounting standards and an overall IT strategy.
Absolutely nothing is as disruptive in the formative stages
of a consolidation company as non-common charts-of-accounts. Consolidation of
results and analysis of component units (or prospective add-on acquisitions) is
nearly impossible without a common lingua franca. Fortunately, newer data
mapping and data warehouse tools allow for uniform understanding at the home
office level without disrupting branch operations or daily customer service
related systems. Use of this solution allows a little breathing room in the
field, while providing banks and investors timely and meaningful analysis up
front.
Utilization of this all-important accounting short cut
depends upon very early adoption of a focused IT strategy. Flexibility must be
built in, as no more than three-quarters of any buildup is likely to be
operating on the same system (much less same release). While tempting at the
corporate level, installation of enterprise wide systems (ERP) within the first
two years of company formation is almost certainly a train wreck in search of a
crossing.
The ability to manipulate field data…remember our earlier
caveat regarding data quality…is critical to control of four pivotal working
capital accounts: cash, receivables, payables and inventory. Even extremely
similar operations on the same system will have wide variances in coding
structure and nomenclature. IT has to be able to deal with this “dirty data”
from Day One. Without this capability, forget those heralded, “back office
savings” much less any E-commerce capability.
Note also that other “technical” aspects of the
transactions – EPA, OSHA, etc. – will be magnified at the time of a sale.
Prepare key employees for “due diligence depression” as soon as possible…the
questions and document requests will be unbelievable, and not anything most
people are used to.
Conclusion
Both the rate of consolidation and the concentration of
industries are reaching the highest point in American economic history – some
108 years after the trustbusters chased Rockefeller and his original gang of
consolidators. Computer and communication technology is the single driving
force, and almost no US industry will escape the consolidation microscope.
Consolidation companies created from multiple
acquisitions…either serial or of the “big bang” school of development…require
feverish attention to detail. In all spheres (economic, social and political)
of the combining enterprise, the challenges extend well beyond those encountered
in the two party deals.
It is absolutely essential to pinpoint objectives –
operating, financial and personal – as precisely as possible for all involved.
Concentrating on ideas that provide two-way payoff (both for buyer and seller)
will accelerate the true consolidation.
Once again, it is worth paraphrasing Willard Rockwell’s
thoughts from 40 years ago…at which time Mergers and Acquisitions
magazine gushed: “If current trends continue, one of every three American
companies will merge in the next ten years…”
The merger (or consolidation) route can be all that its
most enthusiastic proponents claim it to be – if the reasons for merging
are right, if the pre-planning is sound, if major pitfalls are
anticipated and if the CEO is a stark realist.
Hopefully, we have provided some insight to eliminate some
of these if’s.
About the Author:
Bill Wade has been involved in the automotive
business on both the manufacturer and distributor sides for over thirty years.
He has written and spoken extensively on the evolution of buying groups and the
effects of distribution consolidation.
In 1999, he founded FleetPride by combining nearly 30
family companies. Today, FleetPride is the largest truck parts and service
distributor in the world, with 180 branches and over $500 million in sales
He recently formed Wade&Partners, a marketing
services company specializing in issues such as unexpected growth opportunities,
strategic development, startup and turnaround counsel and brand building and
restoration.
He is a graduate of the University of Notre Dame and holds
a Master of Management from Northwestern’s Kellogg School.
Note: Additional articles are available at
www.wade-partners.com.
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