New research reveals some of the primary reasons for deal failure
Despite the best intentions, sometimes acquisition deals aren’t completed. In fact, the current deal failure rate is up, at 7.2 per cent, which is above the 5.7 per cent average measured between 1992 and 2016. A new report from the Cass Business School and Intralinks looks into the causes of deal failures and, below, we examine each of these reasons.
If you are looking to buy a business, or indeed sell a business, it’s sensible to be aware of the factors that could lead to a deal falling through. Failed acquisitions can have a major financial and long term reputational impact on all parties involved. Those who are aware of some of the factors that may predict a failure can take action to try to protect their deal.
Deals involving larger targets are more likely to fall through
Deals involving a larger target business fail more often than those involving a small target business. The researchers found that when an acquisition target is much larger than an acquirer, the deal is more likely to break down than in a situation when the acquirer is larger and the target is smaller.
The failure rate among all deals involving a private target, as opposed to a public target, is around 3 per cent, but when the target business is around 25 per cent of the size of the acquirer, the failure rate is just 2 per cent. This acquirer-to-target size difference is seen to be optimal for deal success. As soon as the acquirer-to-target difference starts to reduce, the chance the deal will fall through increases. So, when a target becomes larger than the acquirer, failure is much more likely. In fact, some 8.3 per cent of deals fail when they involve a target that is more than twice as large as the acquirer.
So, the advice to those looking to buy a business is not to aim too big. Buying a business that is smaller than your current operation will increase the chances of the deal being completed. For sellers, it’s wise to look for buyers who are significantly larger than you in order to optimise the chances of a deal succeeding.
As well as financial security, deal experts claim that larger buyers have more success because sellers feel more secure in their hands. Psychologically, they feel that larger entities are more experienced and that the transaction is more secure than if they were selling to a smaller buyer.
The more liquid the acquirer, the better for the deal.
As well as size, the liquidity of a buyer, in terms of its current assets to current liabilities ratio, is a significant influencing factor as to whether an acquisition is seen through to completion.
The researchers found that deals with an acquirer whose current liabilities were half that of their current assets had a failure rate of just 4 per cent, which was around average for the whole sample. However, once they started looking at deals involving acquirers with far less liquidity, the failure rate shot up. For example, among deals involving acquirers whose liabilities were four times that of their assets, failure rates rose to 9 per cent.
It’s not surprising that deals fail more often when purchasers have poor levels of liquidity. However, sellers can easily overlook such factors when they are desperate to find a buyer. Examining the liquidity of a prospective buyer is vital to maximising the chances of success in selling a business.
And a cash buyer is more reliable than an equity buyer…
Acquisitions where the buyer is offering cash for the business are more likely to complete than deals where equity is offered as all or part payment for a business. Experts interviewed by Cass Business School claim that this is partly due to the fact that it is difficult to value the equity part of the deal. “There is more uncertainty in equity, so there are fewer chances of success if you offer equity and not cash” stated one private equity firm executive from Norway.
Have great advisers
Lastly, getting great legal and financial advice will help you through the process of buying or selling. Research shows that deals where those involved retain a number of experts to advise on various specialist aspects are more likely to succeed to completion. “If you have key experts in each area where you need advice, then this will lead to a better result,” stated one legal expert that Cass Business School consulted.
In addition, many suppose that major political events will reduce the likelihood of a deal being completed as those involved will get cold feet. This latest research shows that this simply isn’t the case. While financial shocks, like the collapse of Lehman Brothers, which preceded the global economic downturn, resulted in an increase in deal failures, the September 11 terrorist attack had no such impact. It is then, largely down to those involved to take steps to maximise the likelihood of deal success.
To sum up...
Being involved in a private merger or acquisition deal is an advantage in itself when it comes to ensuring that the deal does not fail. The average deal failure rate worldwide between 1992 and 2016 for public business acquisitions is 11.1 per cent, while the failure rate when the target business is private is just 3.7 per cent.
Aligning acquisition and target interests, whilst ensuring that the acquirer is liquid, cash-rich and is larger than the target will minimise the chances of a deal falling through.
Failure is rare, but being aware of the above factors when embarking on your deal will minimise the risk even further and help you achieve the best results for everyone involved.
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