If I’ve learned one thing in my career, it’s that there’s an enormous difference between perception and reality. In the case of an acquisition, the complexity and dynamics are exponential. If you’d like to understand what it’s like representing the “buy-side,” let me take you on what’s hopefully an interesting journey.
The difference between the pursuer and the pursued.
With 20+ years of agency experience leading strategy practices, solving complex client challenges and serving in the C-Suite within agencies and management consultancies, being on the acquisition due diligence side is a different beast. Let me start by giving a few insights.
- When an agency is being “packaged” for sale, they partner with a number of companies to take them to market. Sell-side investment bankers and advisors such as GP Bullhound, CG Petsky Prunier, Houlihan Lokey, etc. work to ensure they present the financial “picture” and the capabilities of the firm as an opportunity unlike anything else available in the market. On one hand, it’s an exercise in forensics in order to avoid liability while on the other, it’s the equivalent of P.T. Barnum’s extravaganza.
- As a member of the team of buy-side advisors including Jeffries, PWC, etc. my company, Trade, brought a combination of expertise. With Partners representing 50+ years in industry leadership roles, coupled with agency “re-tooling” expertise and business advisory role within the Society of Digital Agencies (SoDA), Trade was selected to lead a deep analysis of each aspect of the business in order to determine the viability of a post acquisition strategy.
- Companies are packaged to look exceptional. A great analogy is the car salesman that convinces a person that a SUV is rugged and built for off-roading. On the surface, it seems like the perfect purchase — until you take your new purchase off the beautiful paved highway into the woods and find that you can’t even clear a low rock and absolutely don’t have the ability to navigate a muddy road. Although being the pursued is a distraction to day-to-day operations, the reality is it’s the responsibility of the sell-side firms to spend their resources, including financial, effectively to create the right scenario for a purchase. In this particular case, the objective was to find multiple suitors in order to drive the multiples.
- There’s a lot of “wining and dining”by the pursuer coupled with flights, video conferences, spreadsheet after spreadsheet and in the end, expensive resources dedicated to finding the hidden issues and associated pitfalls. In the end, depending on the sense of urgency by the pursuer, the internal battles between C-suite functions become their own collective war.
When it’s competitive, what changes?
There’s a fundamental shift in priorities, and you feel it from every angle when multiple companies are pursuing an acquisition. This shift gets exacerbated when a previous acquisition pursuit was unsuccessful resulting in a loss to a larger competitor. The stakes are higher when it’s competitive, and the C-suite politics become wildly compounded. As a third-party advisor with fiduciary responsibility, the pressure is significant. So what changes?
— Competing factions within the C-Suite want specific answers. So, what does this mean? People want the due diligence to tell a very specific story. If you find an issue of concern, depending on an individual’s role, the issue is directed to be “overlooked.” If the issue is a positive for the acquirer, the insights / data are to be “played up.” What’s to serve as a neutral role in the due diligence process effectively becomes a navigator of politics and pressure.
— The pressure to overlook items, avoid conflicts and close out analysis early is a daily occurrence in a competitive bid situation. On the other hand, the reality is simple. As the due diligence lead, you have a legal obligation to present the insights in an unbiased manner with the final responsibility of decisions being placed on the acquiring firm, their Board of Directors and their finance partners.
— Bundling — The sell-side firms work over a defined period of time to bundle competitive offers to present to their client. In the case of highly competitive scenarios such as this one, the requirements for the offer become more complex.
What’s the process like?
Let’s dig in a bit here. In this particular instance, Trade was engaged to address a number of key work streams. These included:
- Financial forensics — Because of our extensive backgrounds in the industry, coupled with the fact that our Economics practice lead managed the annual SoDA financial trends analysis, our understanding of rates, utilization, realization, gross margin and net margin by offering and functional role was critical to understanding the Big 3 audit firms’ findings.
- Offering analysis — Key to any acquisition is a deep analysis of parity vs. proprietary. In this instance, the company being pursued was a roll-up by a well known PE firm. With an amalgamation of “parts” through acquisitions, the key was finding out whether any of the parts were uniquely valuable within the competitive landscape and what the trend indicated by capability / offering. Our goal was to determine whether the offerings were in demand, experiencing growth or beginning to experience market attrition. If market attrition was noted, our focus was on whether it was driven by commoditization, shifting technologies, or quality of offerings. What became evident in the process was the sell-side wanted to limit any “deep” analysis. The single most controversial aspect of the due diligence, which nearly derailed the acquisition, was our insistence on meeting with the creative leadership across the agency and reviewing the client strategy that informed the creative output. In the end, our buy-side client acquiesced to the demands of the sell-side to not allow for an extensive evaluation. This was a big red flag for our due diligence team that gets covered below in who’s listening and who’s not.
- People, Process and Culture — By understanding the industry exceptionally well, the process of evaluating talent is a straight forward exercise. BS doesn’t fly in this process. There’s always talent in an organization of this size, but the key is understanding the depth and breath. This exercise is also called the “weakest link.” The process analysis was fascinating in this scenario. Here’s a bit of an inside look. When a PE firm rolls up an agency as a holding company through acquisitions, they typically focus on 3 elements. First; cost-out. Anything that can be reduced as far as redundancy is effectively on the chopping block. This applies to people, offerings, technology, etc. Second; do very little. What does this mean? In essence, don’t spend time, which is money, or invest in any efforts to improve the acquisition. An example, in this instance, 5 firms were rolled into 1. That meant 5 different time tracking and accounting systems. Investing in consolidating systems and processes is expensive; but, in the long run, it’s essential to the agency to operate efficiently. By not investing, the pain of the inefficiency was temporarily transferred to the employees, while maximizing profits. The idea of reducing expenditures and eliminating capital investments was key to the firm achieving its highly above industry benchmarks performance. Imagine working on a client project that crossed 3, 4 or all 5 of the businesses, where setting up time codes across each system, reconciling time entry, and tying out what revenue and costs are applied to which business unit. It’s a bit mind numbing. Third; speed to market. In this instance, the longer the PE firm held the company, the higher the risks. There’s a sweet spot of timing that was focused on a window in which the PE firm knew it had maximized the efficiencies it had gained before requiring investment in people, product and process. The process evaluation was complicated. Each of the 5 operating companies within the roll-up had a different methodology with some having little to no consistency in the application. With process being key to client value and quality, this was a significant “red flag.” Lastly, the culture issue came through in the interview processes. As much as the firm wanted to present itself as a single culture, it was evident that little had been done to create a common vision and supporting tone and style. With this in mind, one item was apparent. The leader of the company was dynamic, intelligent, experienced and personable. This person was balancing building a leadership team from existing leadership out of the acquisitions while subsequently managing the process of building a firm and serving the master aka, the PE firm.
- Client and Market Perception— This exercise was the most insightful of any aspect of the due diligence. The sell-side wants to ensure you get the best perception possible in any element of the due diligence process. When interviewing customers, it’s like speaking with a reference for a job candidate. The process has to be nuanced. The sell-side provides restrictions on which clients can be spoken with and who within each client can participate. There’s actually a science to this that involves a quant and qual exercise, resulting in a detailed scorecard. The research process was extensive with a framework consisting of economic decision maker and day-to-day clients (e.g. business unit lead, functional leads, project management leads, technology leads, analytic leads, etc.). The client portfolio was aligned to fee spend trends by agency capability (distinct agency acquisitions rolled up by the PE firm). This analysis included former clients in order to understand the basis for client attrition.
This is essential in any due diligence. If you’re on the sell-side, you have to understand that it’s hard to hide anything if the firm that’s conducting the due diligence understands the industry exceptionally well and has no bias within the exercise. Beyond the exercise of financial forensics, offering capabilities, people, process, culture, etc., the questions that have to be asked include post-acquisition cultural fit, financial expectations (revenue growth, profitability, R&D investment, etc.), IP value and employee retention. In this instance, it was made clear that a number of individuals in senior leadership roles would not remain with the firm post-acquisition as their earn-outs would provide an opportunity to explore new opportunities. This was another red flag in the Do You? or Don’t You? assessment.
Who’s listening and who’s not?
We clearly earned a lot of frequent flyer miles with this due diligence process. Week after week we spent on a plane — of course this was pre-pandemic. Each trip and, candidly, each call with the buy-side leadership team was surreal. When you’re talking about spending hundreds of millions of dollars the stakes are relatively high. The reality is quite different from what you’d expect. For some people, it was all about the win. Having previously lost an opportunity to acquire a highly recognized agency to a Big 3 management consultancy, it was a bit like a breakup rebound. Each meeting with the sell-side was significant “pomp and circumstance.” These meetings were highly coordinated with an emphasis on perception. On the sell-side, the leadership team, including the investment bankers, etc. were listening intently for the “buy” signals and any risks to the potential sale. On the buy-side, the only group that was intently focused was the legal team. Once the financial forensics were completed and validated, it was clear that the sell-side was throwing off a level of profit well beyond industry standards, but it wasn’t sustainable without consolidation and investment. The Finance M&A team viewed this as “not their problem,” rather the responsibility of the post-merger leadership team. In any acquisition, there are individuals on the buy-side that don’t listen intently; instead they focus on what they want to hear. Honestly, it’s no different in many other aspects of business and life. In the end, my company, Trade, presented our recommendations and concerns to the Board of Directors.
What does it mean to “win?”
The entire process came down to a risk vs. return exercise. In the end, the buy-side elected to invest $295MM in acquiring the agency. We’re now a number of years out from the acquisition and it’s clear that the issues that were “red flags” were accurately identified. Unfortunately, as is the case in many agency roll-ups acquired by management consultancies, the resulting synergies are challenged. Sometimes, the desire to “win” is so strong that the fear of losing becomes the only motivation.
You can reach me on Twitter — @digitalquotient or on LinkedIn — https://www.linkedin.com/in/bobmorris/