7 ways an M&A fails
and the solution.
These cognitive biases make VC, PE and BD teams fail
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When the stakes are high – as in M&A transactions – we tend to take refuge in detailed analysis, in the comfort of precise processes, in the archives of experience, ending up throwing the doors wide open to error. It’s not analysis paralysis. It’s information overload.
Worn out by the effort, our brain looks for alternative ways to make the decision on its own, unconsciously adopting sub-optimal fallback solutions – when it goes well – or being led off track by the counterparty to our detriment – when it goes badly.
But we can do better – as the latest findings in behavioral economics explain.
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“Flavio, for us you have been – how can I put it? – a midwife…”
A midwife? Up to that moment I had been called many things: psychologist, professor, confessor … but “midwife”? Never.
And yet, for my client, the owner of a long-established aerospace components company, the journey we had taken together over the last 4 years had had the effect of a rebirth.
The entire long-term company strategy had been redefined, repositioning the business from the energy sector to defense, culminating in an overseas acquisition that opened a new market and turned a family-owned company into a successful international group.
The decision to pursue a diversification and internationalization strategy through a strategic acquisition had been a struggle.
Not only was the acquisition significant in value, on the same order of magnitude as the company itself, but it also involved a radical change in the operating model and business model, the failure of which would have put the entire group at risk.
This tension was palpable when speaking with all the key players in the transaction.
My client as the owner of a historic company and responsible toward a large family clan; as CEO of a group on which the well-being of a few hundred families in an Italian province depended. The head of the M&A team hired to support the search for the target company, conduct the due diligence and the final negotiation, who had put his own reputation on the line with a new client. And myself, who at General Electric, a few years earlier, had seen almost all the M&A transactions carried out by the Business Development team end up proving over-ambitious, if not an outright disaster to be swept under the rug.
In hindsight, the problem was not the complexity of the project.
The team – ultimate decision-maker, experts in acquisitions and divestitures, management on hand – was made up of outstanding professionals. There was no lack of experience, or of the ability to gather and analyze information – even non-verbal – or of clarity, analytical strength, and synthesis.
The problem was getting the final decision to surface, buried as it was in an ocean of information, parallel decisions to make, explicit interests and hidden interests.
Nobel Prize winner Herbert Simon shows us that in these situations we are no longer able to evaluate all possible combinations and identify the one that leads to the optimum. When it goes well – that is, when we don’t abandon the idea to retreat into our comfortable status quo – we take the first solution that seems to stand up and we settle.
Daniel Kahneman, also awarded the Nobel Prize in 2002, tells us that our brain actually does worse. When it is overloaded by the effort of making complex decisions, it looks for alternative paths, analogies with similar situations, and borrows their conclusions, making do with them this time as well.
In contexts such as M&A transactions, private equity projects, and venture capital activities, the decision is always complex and the stakes are high.
When the brain runs away from its responsibilities:
on the one hand it protects itself by looking for the answer in alternative decision-making processes (how alternative is explained by behavioral economics, which has identified at least 200 cognitive biases – substitute models used by our brain to make decisions on its own, without us realizing it and without our validation),
on the other hand it becomes easily manipulable: by ourselves, when we steer the decision toward what is more convenient for us – and it could be as simple as being in a hurry to go to lunch… – and by others, who use psychological levers to push our brain into alternative paths that are not in our interest. In fact, that are against our interest. One name above all: Charles Ponzi, who won the trust of his fellow countrymen in New York by steering their decision away from a “rational” process into a “relational” one, where investing in his pyramid scheme was not based on facts, but on a shared social root.
Letting our brain choose the decision-making process to adopt easily leads to sub-optimal outcomes for the transaction.
You settle for having obtained an acceptable price – not: the best price; for having closed the deal before competitors snatch it away – not: in time to beat competitors; for having limited the loss of intellectual property – not: for having maximized the acquisition of new capabilities.
Once the transaction is completed, you end up realizing that the expected conditions have vanished in the waiting time or due to the loss of key people. And worse: you have also put yourself in a situation you can’t go back from.
We can do something better. Keeping in mind the lessons of Cialdini, Kahneman, Simon and other deep experts in how our brain works under stress.
This phase answers the question: why? Why move toward an inorganic solution to the company’s strategic development. It is in this phase that the fundamental assumptions are defined on which the expected value creation of the business strategy scenario rests, which led to the idea of an M&A. Based on these assumptions, the criteria are defined that set the perimeter within which the transaction can succeed, and those that must serve as a guide to warn of a likely failure.
The success of an M&A transaction is largely decided in its strategic phase. The risk of deciding on instinct and building justifications afterward is extremely high. But the thinking models that brought you success – within a known framework and defined baseline conditions – are not automatically winning if the strategy involves a change of context and new business models. Personal ego, underestimating complexity, and failing to involve colleagues are just some of the factors that give birth to a poorly founded strategy.
Behavioral economics helps us identify more than 200 cognitive biases that distort our ability to decide rationally – and we cannot correct them on our own. Among these:
• We tend to deal only with people who confirm our ideas
• We tend to stick to the same group of people
• We tend to rely more on past experience than on our ability to plan
• We tend to manufacture confirmations that justify our past actions
• We tend to assess risks based on the severity of consequences, not probability
• We tend to give more weight to losses than to gains
• We tend to reward ourselves in the present rather than wait for future rewards
• We tend to reason by comparing differences rather than evaluating in absolute terms.
With clear ideas, you proceed with a selection of possible targets for the transaction, filtering them based on preliminary information until you identify a shortlist. These must then be made concrete through the first contact, which must confirm the interest in exploring further, in a confidential manner and on a formally agreed basis.
The egos in an acquisition transaction are at least two. The seller’s ego is at least as large as the buyer’s and defends its status against any real or perceived threat. Assuming that the approach to the counterparty is a bureaucratic act, governed by rules, often causes enormous emotional damage that puts the transaction uphill from the start.
Cialdini proposes an influence process that goes through three phases: creating the relationship, creating trust, creating motivation. We cannot expect others to use our head to think. We must help them use theirs, with gentleness. Gentleness is at the root of persuasion. A word that comes from Sanskrit per-suavis: through – the gentle: “the sweet” – in Sanskrit.
If there is a shared alignment of intent, it makes sense to estimate the financial commitment required based on industry multiples and discounted cash flows, and the expected returns, based on the level of strategic alignment achievable with the desired scenario. If it is feasible, on this preliminary analysis you proceed to grant or not the approval to submit a non-binding commitment.
When you fall in love, everything looks rosy. In preliminary valuations, the same often happens. You see the strengths, you look for them, you amplify them; you forget to look for the flaws, what doesn’t work. We are not only in love with the potential counterparty, we are also in love with our valuation methods, our multiples, our analysis tools.
Leonardo da Vinci said: “it is easier to resist at the beginning than at the end.” Cialdini codified this in our tendency to give greater value to things the more we are involved with them – it is the principle of consistency, from which it is not easy to break free.
The indicative, non-binding offer serves to define the perimeter within which you intend to move and allow the counterparty to move. A time validity is defined, a basic structure of the financial agreement, the requests for exclusivity, openness and confidentiality, what is in and what is out of the agreement.
The “falling in love” analogy works very well to explain the fundamental difference between the parties at the time the preliminary offer is presented. The proposing party has invested time, resources, reputation. The receiving party has done none of that. The proposing party already has sunk costs that heavily influence its willingness to obtain the result compared to the receiving party, who is free from any prior investment in the relationship.
With Cialdini’s 7 Principles of Persuasion, the asymmetry between the parties can be reduced by bringing it back within the respect of Reciprocity, structuring it as a scarce opportunity not to be missed, offering the right reference points rather than letting them be chosen by someone who has not immersed themselves in the problem.
Every aspect of the operations of the company being acquired is subject to an in-depth investigation aimed at confirming the remaining assumptions, gathering information that can expand the perimeter of the strategic scenario, and generally reducing financial, legal, tax, commercial, operational, ESG risks, on strategic information, intellectual property, key human resources and, if possible, value and cultural alignment. If the assumptions are confirmed and the boundary conditions have not changed, a final valuation reference is made and the green light is given to negotiations.
Here there is what I call “data room syndrome.” Put a bunch of techies to comb through a mountain of information, all looking for confirmations, nobody looking for disproofs, and you forget about coffee. You forget to take a walk to the coffee machine. Down in the workshop. Up on the top floors where the secretaries hang out. Over here where customer service answers. Over there beyond the wall, in that little bar in front of the main entrance, where in reality everyone passes every single day. And if you don’t get out, you don’t realize that in the meantime things have changed. Not only do you fail to rise above the data, not only do you miss the weak signals, but your brain also starts rejecting logic and making decisions on its own.
Weak signals come through when people feel appreciated, safe, part of a tribe. With Cialdini’s principle of Unity we can reduce distances and increase belonging; with the principle of Authority we can break down resistance. The unwritten reality begins to flow.
For the final valuation of the transaction, two parties must agree. If convergence is found, it is endorsed by the ultimate decision-maker and the documentation is prepared. The agreement must be structured to account for the corporate structure (Share Purchase Agreement), any last-minute price adjustments due to cash and working capital variations, and include formal statements on the accuracy of information – especially tax-related – and possible compensations if some information later turns out to be incorrect.
Signing an agreement is a revealing moment.
On the one hand, the psychological pressure to close makes you forget that you can also walk away with no deal. On the other hand, signing a commitment brings out the ultimate decision-maker’s “X factor.” Until now, analysis and mediation have followed a clear mandate and shared instructions. The signature involves a mediation that takes place inside the ultimate decision-maker’s head, between declared criteria and personal, private decision criteria. The “X factor” cannot be put on the table, but it is decisive for finalizing the agreement.
Knowing how to recognize how others influence our decision by derailing it from our interests can be decisive to maintain the right priorities. Cialdini’s 7 Principles not only help us influence others ethically and respectfully, but also to recognize when someone uses these techniques with bad intent – against us.
Closing marks the moment when the agreed conditions are met and ownership is transferred in exchange for the payment due. Control of the company is acquired.
If you assume you have done the job properly, the closing moment holds few surprises. Typically, problems come from communication that does not take personal sensitivities into account out of carelessness rather than method. You miss the opportunity to leverage the emotional tension of the moment to shape expectations.
I have collected 13 resistances encountered in my career:
1. Low appreciation of value
2. It’s not how we do things here
3. Fear of the unknown
4. Lack of training and reference points
5. Previous mistakes
6. Not invented here
7. Fear for vested interests
8. Lack of control
9. Embarrassment
10. Denying the existence of alternative viewpoints
11. No one is a prophet in their own land
12. Commitments made that cannot be revised
13. Not in my backyard
All can be overcome through a correct use of behavioral psychology.
From this moment, control changes hands: it must be clear how the transition happens, what activities must be carried out in the first period to take the reins of the company again, aligning direction with the new organizational and cultural guidelines.
A poorly planned start can only bear bad fruit. It’s true that energy runs out, that there is a change in company leadership and the inevitable misalignment of corporate cultures, but there is also the issue of drafting a new relational pact with the workforce. In an M&A transaction we make sure everything is done according to the agreement and that people respect contracts, but the relationship between workforce and leadership has a non-contractual component that a change in leadership resets. Starting out assuming everyone will do their duty is naive if part of that duty is based on an unwritten pact through which the previous leadership obtained performance today in exchange for future promises that can no longer be claimed.
A new social pact cannot start with a debt. Cialdini’s principle of Reciprocity teaches us that being generous can create that network of relationships and obligations on which organizations manage to achieve goals that are unattainable for an individual.
After 5 years, the company acquired by my client grew from 16 to 160 employees. The group doubled. Today it stands firmly on two legs: one domestic and one international. The business model is no longer tied to the energy market but has diversified into defense. Management has been strengthened with international-level people of different nationalities. It went well.
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