For the M&A market, the corona pandemic initially meant one thing above all: downtime and short-term crisis management. While many companies successfully defied the Covid 19-related adversities, the question is what influences the situation will have on the “post-Covid” world in the long term. The crisis was and is a driver of digital transformation, and M&A works in the digital space.
“We cannot change the wind, but we can set the sails differently” – Aristotle
The M&A market is demonstrating encouraging resilience. For this reason, it is worth taking a closer look at the success factors of digital and virtual M&A for the “new normal”. In particular, considering the fact that half of the corporate acquisitions did not deliver the desired value add and therefore failed to realize the defined synergies. This was even the case before the crisis and digitalization is widely acknowledged as a savior.1
Along the M&A cycle, there are various reasons why a deal is often unsuccessful: from initiation without a defined M&A strategy and clear vision, to inadequate target screening and superficial due diligence, to unstructured post-merger integration. The interactive process, which was previously characterized by physical presence, is now digitized “end-to-end”.
The following section will describe the drivers that affect the M&A journey during the covid pandemic and the lessons that can be learned. The focus is on experiences and practical insights regarding digital tools, processes and methods. Specific recommendations will be derived that will facilitate successful operation in the new normality and thus systematically increase the added value of the acquisition.
M&A Market Analysis: Status quo
The upward trend in the capital markets in the 2nd half of 2020, strengthened by the central banks, is also being felt in 2021 and will continue.2 Investors continue to invest more in the stock market due to the remaining zero or negative interest rate policy. Moreover, even the macroeconomic forecasts no longer look as grim as predicted at the beginning of the pandemic. In its Winter 2021 Economic Forecast, the European Commission predicted that the EU’s gross domestic product would grow by 3.7%, bringing the EU’s economic output back to its pre-crisis level.3
The M&A market, which initially plummeted due to external influences, has shown an amazing “bounce-back effect” after a short interruption in 2020. After the initial market shake in the first half of 2020, the impact of COVID-19 was not as severe as feared. Deal activity in Q3 and Q4 (H2 2020) was among the highest in history. Numerically, in H2 2020, deals increased by 122% compared to H1, to a total volume of approximately €2.1 billion, with 16,700 deals transacted. The main driver was tech deals, according to “Merger Market – Cross Border M&A in 2021.” This sector accounted for 31% of the total deal volume. A second driver was the PE sector, which recorded 27% of total deal volume. The figures underpin the noticeable upswing in the M&A sector and illustrate that the initial reluctance of M&A professionals in the area of deal execution has no longer passed.
M&A Market Analysis: Outlook and Perspectives
Skepticism about the market development and digital feasibility of deals has fundamentally changed. At the same time, the extensive economic and social consequences of this pandemic cannot yet be assessed. Low-interest rates are creating enthusiasm among buyers to pursue M&A to expand their businesses or realign business lines. According to CMS – European M&A Study 2021, a shift from a seller’s to a buyer’s market can be observed.4 Buyers are increasingly able to enforce risk-sharing clauses that are more advantageous to them. Significantly longer limitation periods and higher liability levels can be identified. The economies should be able to recover gradually. In order to forecast the future, historical references must be used. Clearly, the resilience of the M&A market is surprisingly good compared to the financial market crisis of 2008. The market’s regeneration after the financial crash took several years, not just a few months, to return to baseline. According to Bain’s article “The Surprising Resilience of M&A” in M&A Review 2020, the focus will be on capability acquisitions, i.e., investments that focus on IP, know-how and competence enrichment as well as expansion of the current core business.5 There is a trend among many companies to invest in the area of digital capabilities (portfolio enhancement, e.g., via integration of technology start-ups to strengthen core competencies). Such deals have already increased strongly over the last five years and now account for 15% of all large deals (> EUR 850 million).
M&A in the digital and virtual sphere
M&A is manageable in the face of a pandemic
Working from home is the “new normal”. Physical and social distance defines our everyday lives. That’s why there have been and continue to be drastic shifts toward digital and virtual implementation of business practices. There will be lasting and substantial changes in business models, including the ongoing limitation of travel options. As there is also an increasing shift of deal activities in innovation countries, this affects the entire M&A industry.
In addition, state protectionism to protect against foreign investors has continued to increase – with the intention of not giving away the countries’ intellectual property. In a 2020 article, the Federation of German Industries (BDI) describes “increasing state controls on investment – in Germany and worldwide. In fact, not only China but also EU countries such as Germany or Spain have introduced regulations that increase bureaucratic complexity to create an investment barrier.6 Despite all the challenges, the market has realized that the crisis offers options for optimization. Shifting to a digital M&A process was inevitable. In fact, by incorporating new types of tools and methods, the change provides an opportunity to drive efficiency as well as effectiveness and sustainably shape the M&A success.
Digital support along the M&A journey: the three-phase model
Crisis periods often drive change. The M&A cycle has begun to be optimized, and it is essential to address success factors and experiences at an early stage in order to be best prepared for both new and familiar challenges. The entire deal cycle must be considered “end-to-end”.
A three-phase model consisting of pre-deal (M&A strategy), deal (due diligence) and execution (post-merger integration) can provide a structural framework for analyzing the entire M&A process. The process is identical to a certain extent for scale and capability acquisitions.
A.) Phase 1: Pre-Deal / M&A Strategy
It is the growth strategy of the acquiring company (question: how do I want to grow?) that should form the basis of the M&A strategy. This strategy is derived from the corporate vision (question: where do I want to take my company?). Both questions form the guidelines for a focused target screening as well as focused due diligence and a “lean” post-merger integration.
As part of the target screening, the buyer company creates a target profile. This target profile includes the various search criteria that are decisive for the buyer, such as industry, capabilities, region, and company size. The screening activities also include initial considerations of the business case and potential collaboration/integration scenarios.
Given the limited number of suitable target companies in the current prevalent investment environment of strategic and PE investors, target search can arguably be seen as one of the most significant points in the M&A process.
Apart from one’s own network, the use of digital information databases or also platforms for the purchase and disposal of companies are an option. Recent years have seen the emergence of an increasing number of solution providers who, based on search parameters, precisely search the Internet and databases linked to the relevant provider in order to generate the “best possible match”. In this way, the long list becomes more extensive but also more complete. The possible alternatives for achieving strategic goals can increase as a result.
To cover the multitude of possible targets, the development of a central deal flow management system is a good idea. A large number of solution providers are available for this purpose, but the lack of a continuous “end-to-end” process that takes various stakeholder interests into account is often still a problem.
B.) Phase 2: Due Diligence / Deal
In light of the pandemic situation, the planning and implementation phase of due diligence is becoming increasingly important. In addition to the usual examination of strategic and financial corporate planning in due diligence, the two areas of “IT due diligence” and “cultural integration” are moving more into the focus of the due diligence process.
The expectations of many companies at the start of a merger or acquisition process for seamless integration of legacy IT systems, software and data have very often not been met in the past. The IT architectures of the buyer and target are often incompatible, and the respective user interfaces are often customized and consequently usually difficult to integrate. These challenges were (and are) captured in the course of IT due diligence. However, especially in times of a pandemic and the associated necessary “working from home” activities, other important topics such as “cybersecurity” and “data protection” must be included in the (IT) due diligence process. In addition to necessary IT expertise, it is also advisable, due to the growing importance of digital business models, to increasingly subject the legal aspects of data protection to a detailed review during the implementation of the business model. Assessing the different corporate cultures was already an important but often neglected component of due diligence in the pre-covid 19 era. However, in times of the pandemic, this topic gains significance given the need for a “virtual merging” among the different corporate cultures. Therefore, an initial assessment of both cultures should be anchored in due diligence.
This assessment should also take the virtual capabilities of both parties into account. Furthermore, due diligence should be leveraged to define guidelines for the post-merger phase.
Covid-19 is reinforcing the trend to digitize due diligence activities. While various providers of due diligence data rooms already provided solutions for automated contract analysis or redaction of information in data rooms, the pandemic has spawned further product innovations or integrations.
Whether it be innovations that enable drones or robots to conduct tours of factories and spaces or product integrations such as traditional webinar and conference provider services to the data room, providers of transaction-supporting process management solutions can also be mentioned.
Using the various options in the right way offers the respective user great potential for time and cost efficiency during the due diligence phase. Several transactions can be carried out and completed simultaneously in the virtual and digital environment. Time and cost-intensive travel activities can be reduced to a necessary level.
C.) Phase 3: Post Merger Integration (PMI) / Execution
The framework for successful PMI should already be defined during due diligence. Providing relevant information and findings from the strategy and transaction phase in a structured and complete manner is elementary for effective project management of the integration. Because of cultural differences, negotiations and defining these starting conditions are of particular importance. Especially in virtual scenarios, sensitive negotiating is a difficult task. With a binding approach and the right tools, the foundations can be laid for rapid and successful integration.
Post-merger integration projects are characterized by uncertainty and incomplete information. These have an impact on strategic project planning. So the virtual space is helpful in bringing the necessary stakeholders quickly together. Proactive project management, collaborative workspaces and clear responsibilities must also be used to counteract the risk of long decision-making processes.
Once plans have been drawn up and agreed upon, execution in a virtual environment is often even more efficient because each participant can concentrate on his or her area of activity. This is another area where project management has a key role to play in identifying and moderating dependencies and overlaps at an early stage.
Interpersonal relationships, which are often one of the success factors of successful integration and collaboration, and complex training are considerably more difficult in a virtual context. Dedicated communication channels – also for private exchanges – and the commitment of experienced trainers are therefore required. Regular team meetings, virtual “coffee rooms,” spreading meetings over several days in a week, and using online collaboration tools are just a few examples of ways to simplify virtual collaboration.
There are various providers offering interesting solutions for a PMI, ranging from tool providers that provide complex transaction and integration scenarios with corresponding project management software, all the way to small digital stand-alone solutions that effectively measure the “pulse of integration”. The thing they all have in common is that they have come into greater focus in times of pandemic.
Returning to the metaphor mentioned at the beginning: The sails have been reset and the wind has been picked up by the M&A sector. Companies have quickly adapted to the new situation and recognize the potential offered by the crisis as a driver towards long-overdue initiatives in digitization. “Digital / Virtual M&A in the “New Normal” is manageable and in practice.
It is now necessary to compare current actions with those of the past and draw conclusions. Companies have to evaluate which activities may have become more effective and efficient through digitalization. Moreover, the value-maximizing impact on the phases of the M&A process needs to be assessed and thus should be considered the new normal in the post-COVID era.