While deal successes often get the most attention, Ramzi Hermiz, a partner at Atlas Holdings, said at the Detroit Smart Business Dealmakers Conference that there's a lot more to learn about de-risking from challenges and failed deals.
When he was president and CEO of Shiloh Industries, he says he made six acquisitions, a majority of which went really well. But a couple of them went poorly. The reasons why?
"We went in with a plan and then you get kind of caught in the momentum," he says. "And I'd say this is a big thing in strategics versus some of the PE firms; PE firms are a lot more disciplined. And I think when you're in a business you get wrapped up in, we can find more synergy. We can grow sales greater than they did. We can launch a product, a new technology faster. And you convince yourself to pay a little bit more."
Additionally, he says the acquiring team buys in, thinking that they can sell more and add customers. One counter to that, he says, is to reflect on prior deals and look at what you have typically achieved. Then take a step back and spend time on what could go wrong and what assumptions have you made, and how do you go back and challenge those assumptions?
As the leader of the business, he says there's a point you change and become the counter voice in your company. Then you start challenging your people — for example, why does the sales team think they can be so much more successful than the owners of the business?
"That was the biggest thing that we've learned is that we overestimated our capabilities based off of success — you did three great deals, you can do a fourth great deal, a fifth-great deal — and you get caught up in it yourself," he says. "A little bit of arrogance can be a negative — positive sometimes, but it also could be a negative."
Doug Shinkle, vice president of Lorient Capital, says de-risking a deal, from a buy-side perspective, often comes down to having conservative underwriting.
"Keep the growth rate low, set up a purchase price such that ultimately you can either engineer a return through how you structure the deal, which is ultimately a function of what your debt-to-equity mix is and what type of debt you put on the business," Shinkle says. "It also depends on the type of equity that you're investing, whether it's a standard equity, whether it's preferred equity; equity could have a series of tranches behind it that have distribution thresholds, which are functional performance of the business. So, you could basically come in and invest at a certain level and you're de-risking your equity position as a buyer because you're first money out, or maybe you're required two or three extra turns before the common or the next level starts getting paid out. So, from an institutional buyer's perspective, that's how you would potentially de-risk from an underwriting perspective."
Buyers, he says, are looking for the ability of the target company to drive organic growth. If they don't have the capability to do that, it's a fool's errand as a buyer to think that could be manufactured. In some circumstances it can be part of the equation, but typically, when that's the assumption going into a deal, organic growth isn't necessarily realized or the culture may not align.
"Synergies were underwritten to that ultimately weren't realized, post-close," he says. "Or, let's say you're baking those synergies into your purchase price, but in doing so you're paying for value that you're going to have to create in that business. And by factoring in the synergies, what you fail to incorporate are risks that are inherent to just changing workforce; it's human capital management across all these organizations and it's a delicate balance of who you're bringing into the company."
