When the rescue becomes more expensive than the problem
“Don't throw good money after bad!” This quote from stock market legend André Kostolany has stuck with me – somewhere between a failed dot-com investment and a glass of red wine. And it immediately popped back into my head when a private equity fund presented me with one of those very special ideas: fixing through acquisition.
The story went something like this: there was a portfolio company that just wouldn't perform. Sure, the algebraic sign before the result were still positive, but the number behind it? Miles away from what had been imagined in the business case. When I asked about the likely causes, the partner in charge promptly replied: “The processes are the problem.” The solution? Already at hand. They simply wanted to buy another company in the same industry, one with functioning processes, take them over, and presto, the business would be up and running.
Admittedly, Kostolany's warning does not apply entirely here. His advice is aimed at passive investments, especially stock purchases. But in the case of a private equity fund, one is anything but passive. One can actively intervene and make things happen. And the proposed acquisition would be just that: active intervention. So it is definitely worth examining the matter thoroughly instead of dismissing it outright.
First step – understand the problem...
There are no blanket solutions, neither the knee-jerk reaction of “just don't pump any more money into it” nor the optimistic “it'll be fine.” In M&A business, you need a keen eye for detail: identify problems precisely and uncover causes consistently.
What does it mean in concrete terms when something is not running smoothly? Is there a lack of effective access to the market? Are the quality of products or services insufficient? Is the level of automation too low, which in turn prolongs process times or causes personnel costs to skyrocket?
Let's be honest: saying “it's down to the processes” doesn't get you very far either. Processes run through the entire value chain at a wide variety of points. Which processes exactly are causing problems? Why can't they simply be adapted? Is the IT application landscape blocking progress? Is there a lack of digitalization?
In fact, sometimes there is simply a lack of the necessary scale to achieve economies of scale that competitors have long been exploiting. Even then, however, an acquisition is no guarantee of success, as the Getir/Gorillas transaction three years ago impressively demonstrated.
...then step two – select the solution
The question “What should the target look like?” could be answered very simply: it simply needs a tailor-made solution for this specific problem. But how can you really recognize this? How can you know that what the target brings to the table is actually the right solution that will ultimately get both companies back on track?
Let's take sales processes as an example. Even if both sides sell the same products, that doesn't guarantee that the sales processes will also work in a different market. And that different market doesn't even have to be a different country. Just think of B2B versus B2C. And just because a target group falls into the B2B scheme by definition, that doesn't mean that everyone there thinks like a huge corporation.
The deeper the solution is anchored within the organization, the more difficult it is to transfer. An interesting case: The company provides services to consumers. Branch-based, very labor-intensive, short interaction time with the customer. The processes for service provision work well in principle. Quality and efficiency are right. The problem: the necessary service mindset is lacking – not so much in the branches, but in the rest of the organization. Even with a perfect target, this mindset cannot be acquired. It always requires a persistent transformation process.
No matter where the problem lies, anyone who does not consider subsequent integration when selecting a target should take Kostolany's warning to heart. The question is therefore not only whether the target has the right solution, but also, and more importantly, how can the solution be transferred from the target?
Merger of equals or reverse integration
The second detail from that conversation? The sentence: “So it's a merger of equals.” Wrong! The companies are anything but equal. One is running smoothly, the other is faltering. Anyone who labels this a “merger of equals” is setting completely false expectations.
Let's briefly recap the situation: a solution to the problems has been found. This solution comes in the form of an add-on acquisition. The decision is made to pursue the acquisition route. It would then be downright absurd to pretend that both organizations can now negotiate on equal terms how they want to merge.
Reality completely turns the tables. This is rather a case of reverse integration, because the target company clearly has the superior structures. To put it bluntly, the buyer is being integrated into the target company. The appreciation that is usually accorded to the target company in traditional constellations is now due to the buyer.
Hence the clear recommendation: do not acquire the target directly through the original portfolio company. Instead, conduct the transaction through the acquisition vehicle. This way, both companies are at least on an equal footing, and the target's organization does not inadvertently become subordinate.
Without sufficient buffer, restructuring becomes an ordeal
A sufficient buffer is the basic prerequisite for the success of fixing through acquisition. The starting point: the original company is not exactly shining in terms of profitability. All too often, a barely positive earnings situation tips into the red. Then liquidity becomes the bottleneck, and time becomes a scarce commodity.
At the same time, unforeseen events always arise. These consume at least additional time, and usually additional money as well. Take, for example, the introduction of an important IT system that entails further migrations. Although the production processes can be implemented on the existing machinery, logistics suddenly faces an unplanned challenge.
If such developments lead to a restructuring, the desired transformation must take a back seat. This can quickly take up a year or two. Unforeseen events are part and parcel of any M&A transaction, but in this case the consequences are much more serious.
No experiments during a crisis
There is no time for experiments during a crisis. This raises the question of clear exclusion criteria. The filters from the long list to the short list are already extremely narrow and allow hardly any targets to pass through. The requirements for a suitable target for restructuring through acquisition are extremely tough.
If the original company is undergoing restructuring or is even in acute danger of insolvency, there is one ironclad rule: stay away from complex fixing through acquisition.
The shorter route could be the better one
Sometimes the direct route gets you to your destination faster. Anyone seriously considering tackling restructuring within the existing company should ask themselves: Why not implement the necessary transformation there directly? The risk remains manageable, and the capital requirements are significantly lower.
In any case, in order to select the right takeover candidate, you have to thoroughly examine the problems and their causes and identify them with razor-sharp precision. Otherwise, there is a risk of choosing a target that looks excellent but misses the actual problem.
Once the problems and their causes have been clearly identified, the solution is almost always obvious. And the organization has to go through the transformation process anyway, even if it is being restructured through acquisition.
Courage or recklessness?
Fixing through acquisition — it sounds tempting, but it is anything but a silver bullet for struggling portfolio companies. Anyone who takes this path will quickly feel the enormous pressure that such a transaction entails. After all, it is not just a matter of two organizations, somehow, somewhere, sometime growing together. No, growing together is the essential prerequisite for the castling to work at all.
Anyone who thinks that fresh capital for the transaction and acquisition is all it takes is greatly underestimating the situation. The real challenge comes afterwards: the transformation of the company. And this is precisely where a question arises that must be answered honestly: Why not put all your energy directly into restructuring and transforming the original company?
So before rushing ahead and possibly throwing good money after bad, it is worth taking a crystal-clear look at the actual situation. First understand what is really going on – then decide.
