July 20, 2020

IN OUR OPINION, PERSPECTIVE #114 — JULY 20, 2020

(A Continuing Series for Leading CPA Firms)

LESSONS LEARNED: WHY MANY MERGERS/ACQUISITIONS FALL SHORT OF EXPECTATIONS AND WHY SO MANY DIE AT THE ALTAR

Failed culture integrations are often at the heart of

merger difficulties.”                     — Louis V. Gerstner

Principally because of the “post COVID-19 blues” and anticipated difficulty in growing organically at an acceptable rate and because of the ever-increasing number of baby boomer retirements, there is a sense that small and mid-sized firms will continue to merge at a healthy pace. To illustrate, in just the past few weeks, we learned about Anders CPAs + Advisors picked up Cummings, Ristau & Associates (both of St. Louis), Adams, Brown, Beran & Ball Chtd (Great Bend, Kansas) added Jonesboro, Arkansas office of EGP PLLC and Hancock Askew & Co. (Georgia and Flordia) acquired CAPA (Miami). These are noteworthy transactions and we believe that there are more to come.

Having said that, mergers and acquisitions are a tricky business and are not silver bullets to solving a CPA firm’s problem in achieving sustainable growth. To say the least, these transactions are extremely time-consuming, riddled with “sand traps” and full of opportunity costs but more than that they have considerable risk.

When we speak to CEOs and other senior management at the Top 100 and other fast-growing firms, it’s apparent that many, if not most, of these mergers/acquisitions, fall significantly short of growth and profit expectations. Some even wind up in divorce with costly break-up costs as morale drops, go-to-market opportunities fail to materialize, and key partners and potential partners leave for other opportunities. And for every transaction that actually does happen, it is also apparent that handfuls of potential deals die at the altar.

So, we thought it would be helpful if we took a deep dive into merger and acquisition difficulties and offered some advice. The following summarizes our observations as to why many mergers/acquisitions fall short of expectations and why so many more die at the altar:

• Irreconcilable culture clashes or differences at the two firms.
• Egos of senior partners.
• Different views on governance, autonomy and, accountability moving forward.
• Concern that it “may not work” so why take the risk.
• The larger firm decides that the pain to integrate is greater than the gain to be realized. The senior partners are not willing to invest the time and effort to make 1+1=3.
• Lack of effective leadership taking partners through the decision tree from initial transaction identification to transaction consummation.
• Too many partners are willing and able to torpedo the transaction (in many cases simply because it wasn’t their idea).
• Disagreement among the merged-in partners on how to cut up the practice payment (deferred compensation).
• Amount of retirement obligations at both the larger firm and the merged-in firm or at either firm.
• Dissimilar retirement and compensation plans at the two firms.
• Valuation and other deal considerations outlined in the term sheet.

You notice that we identify irreconcilable culture clashes or differences as the #1 reason why transactions run into difficulties and that valuation and other deal considerations are identified as reason #11.

While many people believe deals fall apart because of economics, we have found that while economics is clearly important, this conclusion is a myth. Here’s why. Financial considerations in a transaction are usually flushed out quickly. If there isn’t a meeting of the minds, deal discussions shut down. Little ventured; little gained. Further, we have found that valuation and other deal considerations most times can be successfully negotiated if the two firms believe that 1+1=3 and that they can have greater success in the marketplace if they are together rather than apart.

On the other hand, culture clashes or differences usually take considerable time before they bubble up to the top of the “we have an issue” heap. This is why culture compatibility is so important and without it deals fall short of expectations or never see the light of day.

Before we take a deep dive into cultural compatibilities and what can be done to deal with potential clashes, culture needs to be defined. To sum it up, a firm’s culture is the accumulation of shared values, beliefs and, behaviors that determine how partners and staff carry out day-to-day tasks such as managing and governing the practice, serving clients and attracting and retaining talent. Culture has three key prongs:

• The behaviors of the CEO, senior management, and staff.
• The capabilities and decisions about where and how to compete.
• A firm’s operating and governance models that are core to how it functions on a day-to-day basis.

We have found that when it comes to determining culture compatibilities, many firms talk a lot about a few cultural similarities as proof of compatibility but cheap culture talk fails to help firms navigate through the difficult task of dealing with potential culture clashes that will help improve outcomes and the probability that a combination will be a win-win.

In Our Opinion, an assessment of culture compatibilities between the larger firm and a merged-in firm should not be a gloss over or an afterthought when considering a possible transaction. We believe culture deserves a lot more weight in the due diligence process as a potential transaction is evaluated. Our advice is:

• Give mutual culture due diligence the same type of timely priority as financial, operational, and legal due diligence.
• Have the larger firm’s CEO and other senior management drive culture due diligence and subsequent integration. It’s that important! Don’t delegate this important task to the Human Resources Department or, worse yet, have it outsourced to an outside consulting firm.
• Use some simple tools to diagnose the potential problem. Two tools include:
• Observe different ways of working particularly when it comes to Quality Control.
• Hold key interviews and small group dinners to determine how the other firm interacts among themselves and if you would be proud to hold out the other partners at the other firm as your very own. This is commonly referred to as the “beer” test.
• Determine the culture you want to see as a result of the transaction. The larger firm usually has two choices here. It can assimilate the merged-in firm into its culture or it can create a blend of the cultures at the two firms. Depending on the facts and circumstances, either approach is viable.
• Develop a culture change plan.
• Sustain and measure progress.
• Be astute in developing transaction communications relating to cultural matters. Both the substance and timing of messages are very important. Senior management at both firms needs to be turned into managing expectations and anxieties while shaping workforce behavior in the desired cultural direction.
• Cut off further conversations and negotiations once you conclude that there are irreconcilable cultural clashes or differences. Better to call off the marriage than divorcing or worst yet, living together in disillusionment and frustration.

   IN CONCLUSION

Here are four questions that might help you assess your due diligence efforts regarding culture:

• Do you pay lip service to the importance of culture in mergers and acquisitions but then routinely fail to back it up with effort and dollars? Culture is the pauper when integration budgets are allocated.
• Do you gather culture data without a clear end game in mind?
• Is your cultural assessment an afterthought that is ad hoc, unstructured, sketchy, and haphazard?
• Do you turn cultural integration over to people who lack expertise in managing intense political dynamics and psychological complexities involved?

If you answered yes to any one of these questions, you need to pay more attention to the #1 reason why so many deals fall short of expectations and why so many die at the altar.

Cultural integration isn’t something that can wait until after a merger or acquisition is consummated. The Top 100 and other fast-growing firms usually flag possible cultural clashes or differences as an integral part of due diligence.

Buyers and sellers beware! Why did Dillinger rob banks? Because that is where the money is. Why should the larger firm and the merged-in firm make culture due diligence a priority when evaluating a potential transaction? Because that’s where most deals fall apart.

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After 47 years in the accounting profession (with responsibilities that included CEO of Grant Thornton and COO of CohnReznick), Dom Esposito, CPA, launched ESPOSITO CEO2CEO, LLC — a boutique advisory firm that consults to leading CPA and other professional services firms on strategy, succession planning, mergers, acquisitions, and integration. Dom, voted as one of the most influential people in the profession for two consecutive years by Accounting Today, authored a book, published by www.CPATrendlines.com., entitled “8 Steps to Great” which is a primer for CEOs, managing partners, and other senior partners. In Our Opinion, is a continuing series of perspectives for leading CPA firms where Dom and his colleagues share insights, experiences, and wisdom with firm leaders who want to “run with the big dogs” and develop their firms into sustainable brands.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and ESPOSITO CEO2CEO, LLC, its employees and its independent contractors accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.