Protecting Valuable (Customer) Assets In The M&A Minefield

Harry Cruickshank

A series of reports produced by various firms over the last 10 years show that the average success rate of M&A deals is 20% or less. Most of them talk about “shareholder value destruction”.

Two primary areas of risk are sub-standard intelligence on, and management of, employee and customer relationships. Given that even modest operational changes, if badly managed, can negatively impact employees and customers, the potential for damage caused by the controlled chaos that is an M&A transaction is considerable.

But there’s a silver lining to these clouds. These are largely controllable risks and can be planned for and mitigated to avoid “self-inflicted wounds”.

Let’s focus on the customer angle.

Buyer Beware

Due diligence on customers provides the first opportunity to avoid unnecessary risks. As part of the deal, assumptions are made about post-deal customer behaviour, retention and loyalty. This is understandable, as a component of post-deal value predicts revenue gains from base growth. The issue is the extent to which these assumptions are tested. In one M&A deal where we were involved, the assumptions made about customer retention were horribly awry.

What data are assumptions about customer retention and growth based on? Assurances from the target company? That assumes that they are intimately acquainted with their customer base and that those relationships are solid and dependable. But the reality is that companies rarely have that data. They may gather information on “customer satisfaction”, but it has been known for over 20 years that satisfaction is not a reliable predictor of loyalty or customer behaviour.

Interviews with sales leaders? There’s little incentive for them to be anything other than positive. PE and corporate M&A consultants will have ground through detailed metrics on salesforce effectiveness, sending a shiver through the sales team from the CSO down. The resulting nervousness opens the door to salesforce attrition and the knock-on effect with customers.

In B2B markets, customer retention and growth are especially critical, given the typical concentration of value within the base, with a relatively small number of key accounts representing the majority of revenue and profit. Here, the risk of customer attrition within those key accounts could have a significant impact on growth forecasts and projected value.

Sellers Take The Lead

Proactive sellers can mitigate this risk, present a stronger pitch to prospective buyers and, perhaps, elevate the deal value. Vendor or sell-side due diligence, actioned prior to the sales process, is an opportunity to highlight customer-related issues and fix them before the transaction begins.

An effective approach is to measure and analyse customer expectations and the company’s current performance against them. This should be done across a suitably wide sample of the customer base (or all of them). This yields detailed, actionable insight to help the leadership team take remedial action to address any obvious issues. When combined with data about competitor performance against customer expectations, it can support (or rebut) the seller’s assertions regarding market position and areas of competitive advantage.

At the very least this will surface potential problems, which may up to that point have been invisible to the seller. At best it demonstrates a positive attitude, a willingness to provide buyers with high-quality data on the customer base and the ability to highlight how well the seller is outperforming competitors in key areas.

Typical due diligence doesn’t achieve this level of insight because of how it’s conducted. Another challenge is the time allocated to it. To do a proper customer assessment takes several weeks, if not months. If insufficient time is set aside, then vital decisions are made regardless of weak or missing data. Ideally customer research should take place before due diligence.

We have seen M&A transactions in which the buyer missed out on critical information about customers simply because they failed to ask the right questions, or dig deeper into the initial feedback.

It Cuts Both Ways

The above points also apply to the acquiring company’s customers; assuming that they’ll take a wholly positive view of the deal is dangerous. Businesses know that acquisitions tend to take senior leaders’ eyes off the ball and lead to operational disruption. Unless acquirers have the same level of deep insight into their own customer relationships, those are also at risk.

Running the expectations analysis process for both the acquirer and the target will reduce risk and open the door to more effective post-deal value creation to secure sustainable growth and keep competitors at bay.

We hope that PE firms, corporate M&A practitioners and business leaders who have experienced the downside of deals, where prospective value has been undermined by customer-related issues, will see the high value in an expectations-driven approach.

At the very least it would confirm, and perhaps reinforce, accurate assumptions relating to a deal.

In a world dislocated by the pandemic where great prizes await smart investors and the painful, expensive outcomes of bad deals lurk in the shadows, what have buyers, sellers and investors to lose by trying something different (that works)?