When to Walk Away from a Deal

The Idea in Brief

Is your company prone to "deal fever"--getting so excited while pursuing acquisitions that it skimps on due diligence? Caught up in the thrill of the chase, many firms use due diligence to justify the deal rather than to uncover potentially serious problems.

To introduce discipline into your due diligence, Cullinan, Le Roux, and Weddigen recommend putting potential acquisitions' strategic rationale under the microscope: Probe for targets' strengths and weaknesses, and dig for unreliable assumptions. Be prepared to walk away.

Asking four questions can protect your company from ending up with a bad bargain:

• What are we really buying? (What would the acquisition bring, in terms of customers, competitors, costs, and capabilities?)
  
• What's the target's stand-alone value? (Your purchase price should reflect the target as it is, not as it might be once acquired.)
  
• Where are the synergies?
  
• What's the most we're willing to pay?
  

The Idea in Practice

Cullinan, Le Roux, and Weddigen offer these guidelines for evaluating a potential acquisition:

What Are We Really Buying?

Instead of relying on information provided by the target company, build your own view of the target by gathering information on its:

Customers: Who are the target's most profitable customers, and how well is it managing them? For example, how do its customers' profitability or vulnerability compare with those of the target's competitors?

Competition: How does the target compare to rivals in terms of market share, revenues, and profits--by geography, product, and segment? How might its competitors react to the acquisition?

Costs: Is the target performing above or below cost expectations given its relative market position? Why? What's the best cost position you could reasonably achieve by acquiring the target?

Capabilities: What capabilities--management expertise, technologies, organizational structures--does the target have that create definable customer value?

What's the Target's Stand-Alone Value?

The vast majority of the price you pay for an acquisition should reflect the business as it is, not as it might be once you've won it. To determine stand-alone value, strip away tricks used by targets, such as stuffing distribution channels to inflate sales projections.

Send a team into the field to see what's really happening with the target's costs and sales. If the target's hesitant or hostile about your investigation, steer clear.

Where Are the Synergies--and Dangers?

Assess the value of the acquisition's potential cost and revenue synergies by:

Estimating how long they'll take to achieve. You can gain some synergies (such as eliminating duplicate functions) quickly. Others (such as selling new products through new channels) take much longer.

Assessing the probability of success. Some synergies (such as combining facilities) have lower success rates because they involve complex personnel and regulatory issues.

Considering integration costs. Anticipate post-acquisition events that can sap revenues or increase costs, such as defections of talented employees.

What's Our Walk-Away Price?

Your walk-away price is the top price you're willing to pay when the final negotiation is conducted. When establishing your walk-away price, give most weight to the current worth of the target company, and don't overestimate synergies' potential value--which may not materialize. Assemble a team of trusted individuals, less attached to the deal than senior management, who can provide an unbiased examination of the target and hold everyone to the walk-away criteria.

Copyright 2007 Harvard Business School Publishing Corporation. All rights reserved.

• Purchase the full-length Harvard Business Review article here.
• Visit Harvard Business Online.
• See more on Strategy and Execution at Harvard Business Online.

Further Reading

Articles

Acquisitions: The Process Can Be a Problem

Harvard Business Review

March 1986

by David B. Jemison and Sim B. Sitkin

The authors provide additional insights on challenges that can arise during the acquisition process. For example, in many acquisitions, analysts with specialized skills and contrasting goals present fragmented perspectives on the value and potential problems of the proposed deal. General managers may find it difficult to integrate these different perspectives. To address this problem, include operating managers on the negotiating team. They'll help everyone to stay focused on the most important overarching issues (such as the fit between the two organizations), to keep financial and operational considerations in balance, and to ensure managerial continuity if the agreement ultimately goes through.

Are You Paying Too Much for That Acquisition?

Harvard Business Review

July 1999

by Robert G. Eccles, Kersten L. Lanes, and Thomas C. Wilson

This article takes a different position on whether or not to consider the value of potential synergies in your offer price for an acquisition. In today's market, say the authors, the purchase price of an acquisition will nearly always be higher than the company's intrinsic value--the price of its stock before any acquisition intentions are announced. To arrive at your price, determine how much of that difference is "synergy value"--which will result from improvements made when the companies are combined. This value will accrue to your shareholders rather than the target's. The more synergy value a particular acquisition can generate, the higher the maximum price you're justified in paying.

Making the Deal Real: How GE Capital Integrates Acquisitions

Harvard Business Review

January 1998

by Ronald N. Ashkenas, Lawrence J. DeMonaco, and Suzanne C. Francis

This article presents lessons GE Capital has learned from its extensive experience with acquisitions. In GE's view, the thinking about integration should start well before the ink is dry on the contract. For example, during the preacquisition phase (due diligence, negotiation and announcement, and close), GE Capital begins assessing the two companies' cultures, identifies barriers to integration success, selects and integration manager, assesses the strengths and weaknesses of business and function leaders, and develops a communication strategy. Owing to this level of discipline GE Capital has achieved valuable business results from its acquisitions--such as doubling its net income during the 1990s.