Worst Case Scenarios by Dr Tom McKaskill

When acquiring companies, keep the worst case scenario in mind

Acquisitions tend to stretch most acquirers to the limit. Perhaps they tend to take on more than they should or maybe they are simply unprepared for the process, but what is obvious is that most buyers fail to achieve their investment objectives. Few anticipate the level of executive commitment required, the extent of disruption to their own business or the size of the project they are taking on. The timing of the deal is often outside their control and thus can come when the firm is already working at capacity. What they often fail to do is to work out what could go wrong before they decide to launch their acquisition bid.

Perhaps the most valuable tool in the armory of the acquirer is the worst-case scenario. Murphy’s Law is great technique for working out whether you have the capacity and capability to take on an acquisition activity. If you project that you can get through the activity when things go wrong, the chances are that you will come out the other end in reasonable shape.

When I was the President of a UK based software firm of 34 staff, I undertook an acquisition of one of my software suppliers in San Diego which had 57 employees. We agreed the deal, raised venture capital to finance 75% of it and used surplus cash and anticipated earnings to cover the balance. A US based national firm of accountants undertook the due diligence and gave the firm a clean bill of health. Three months after we took control, the same accounting firm undertook an audit and discovered serious irregularities with revenue recognition and inventory counting. As a result of these findings we took the accountants and prior owners to the federal court in the US. Over the next five years the business was severely disrupted, lost money most years, terminated about one third of the employees and drained the UK of cash. Both businesses were almost brought to their knees by the litigation activity.

The mistake we made was to rely on the profitability of the acquired firm to partly fund the acquisition and to assume that the change of ownership would require little attention from the UK executive team. Even though we undertook a proper due diligence, we were let down by our advisors. Basically, we had failed to build in enough capacity to deal with possible problems.

If you start the evaluation process by looking at what might go wrong and how you could mitigate the costs, delays and risks, you have a much better appreciation for what resources you need to have on call in order to get through the process. The worst situation to be in is to suddenly be confronted with an unanticipated problem for which you have no strategy. You need to plan for the loss of key employees, disruption of both businesses, a heavy drain on executive time, more time to bring the business under new management and a longer time to achieve investment outcomes. If you can still make a positive case for the acquisition under a worst-case scenario, you are probably looking at a very good investment.

Global serial entrepreneur, consultant, educator and author, Dr Tom McKaskill has established a reputation for providing insights into how entrepreneurs start, develop and harvest their ventures.