One plus one equals three. No, it’s not new wave ‘common core’ math. It’s actually an old school M&A strategy that’s found new favor in the private equity environment, particularly as company valuations reach all-time highs and organic growth has been stifled by a low-growth economic environment.
Private equity firms are spending increasing percentages of their $842 billion in dry powder on add-on acquisitions, hoping that the sum of the existing portfolio company plus its complementary investment will be greater than its individual parts. Of course that’s the hope - that buying companies in like industries will lead to synergies that lower costs, increase returns and create more profitable businesses with better dividend recap opportunities and exit options.
But then there’s that tricky math that’s rife with non-numeric, difficult to account for, pitfalls of the human talent variety. Without diligent pre-and post-close planning, acquisition talent integration can be the variable that throws off what appears to be a simple equation. The consequences of miscalculating the talent challenges that accompany the process of integration can be the difference between a successful add-on, and one that simply doesn’t add up. And while it’s true that the best laid plans of mice and men often go awry, scenario planning is particularly critical in an add-on integration where people will be critical to success, but assumptions about their behavior will be inexact, at best. In order to more effectively do the talent math correctly, add on buyers must:
1. Consolidate the equation
Decentralization is at the root of all integration failure. This often manifests itself in the simplest, yet most overlooked, of ways: hiring freezes wherein certain groups within the organization continue to hire or bring in outside consultants, reducing cost savings. Step 1 of any human capital plan must be the creation of a centralized Integration Management Office (IMO). And, step 2 must be empowering that office, by finding someone within the combined organization who is senior, well respected, and has the necessary bandwidth (and credibility) to spearhead merger integration efforts.
2. Calculate the people problem
The IMO will then be responsible for doing the right people math. Retaining key employees (throughout and following the merger process) is an exercise in and of itself, particularly in the case of employees within the corporate cost-center functions: finance, corporate development, HR, and IT. Because their jobs are typically most at risk during a merger, they may quickly seek outside opportunities. It is therefore incumbent on the IMO (working in conjunction with relevant departments) to do the talent identification, categorization and engagement heavy lifting - identifying flight risks and categorizing talent based on a tiered integration timeline: people key to long-term success, those who are needed in the medium-term for knowledge transfer, and those who are non-crucial contributors. Creating individualized plans to engage with talent based on that tiered matrix will help buyers retain valuable people while recognizing cost savings from real redundancies.
3. Follow the formula
The IMO must further develop a mechanism to track synergies that will help them stay accountable and support timely and comprehensive reporting. When it comes to labor synergies, the tracking mechanism should get granular on capital management and reduction plans across the organization: include costs per department, milestones by integration stage, payouts and severance packages, and labor arbitrage by relocation of jobs to cost efficient locations. And, critically, in order to maintain the necessary discipline on headcount to realize expected synergies, the tracker should name names. Of course, the formula can’t be a fixed one. The company will need the flexibility to recalculate on the fly – against initial savings goals - based on the unexpected human capital challenges that always arise (the critical manager requesting a more significant retention bonus, the unexpected departure who is considered a valuable asset and must be replaced or enticed to stay with a better compensatory deal).
4. Multiply the softer stats
There is no greater human capital variable to the success of an add-on integration than the choice of CFO. While it may seem obvious (if formulaic) to select the CFO of the acquirer, there are social metrics that should be calculated to arrive at the right candidate: fluency in the sector, particularly for more specialized industries, experience working in a private-equity backed environment, track record navigating a successful exit, etc. PE-backed CFOs tend to come and go much quicker than other employees. Leveraging a strategy that accounts for softer variables can help elongate their stay with the company, and can contribute to the success of both the integration and the long-term growth of the newly formed company.
Add-ons are an important, and growing, part of the private equity playbook. Well-managed integrations can lead to growth, expansion and higher valuations. But poorly managed integrations, wherein the talent variable is not properly accounted for, monitored, and navigated won’t in fact, add on, they’ll just subtract from.
Bolaji Lawal is a vice president with Accordion, a private equity consulting firm, focused exclusively within the office of the CFO.