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Cultural Fit Can Make or Break an M&A Deal

One of the most critical components for success -- cultural fit -- often falls by the wayside.

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Merger and acquisition activity has ramped up significantly over the past year. Even as the business world continues to grapple with the impacts of the lingering Covid-19 pandemic. For category leaders looking to expand market share across various sectors, businesses that aren't as well-positioned could make attractive acquisition targets in 2022.

Consolidation won't be as pronounced in some industries compared to others. But corporate and private investors might be increasingly prone to experiencing fear of missing out as deal-making picks up across the board. After all, that same mentality has recently fueled a technological arms race among companies that had been stockpiling capital at the peak of the pandemic. Business leaders are eager to spend on capabilities that might give them a leg up on the competition.

Related: Don't Even Think "Merger' Without Taking These 5 Steps First

The culture question

Of course, there will be plenty of companies feeling buyer's remorse in the coming months. When buyers approach technology investments and acquisitions without considering the implications for overall business strategy, such scenarios are inevitable. In particular, all M&A activity should be based upon a retained revenue assumption. Revenue equates to customers, subscribers or users. The success of a potential acquisition is arguably dependent on an acquirer's ability to keep those revenue sources.

Like other investments, acquisitions are ultimately aimed at bolstering a company's ability to retain and grow revenue. That is why all business leaders currently pursuing deals should be equally focused on the many other activities that are essential to driving growth.

Moreover, when evaluating M&A targets, prospective buyers must include cultural fit on the list of criteria that must be met before acquisition. Doing so ensures lasting growth is possible once a transaction has been finalized. Indeed, a failure to evaluate a target company's cultural similarities or differences during due diligence can significantly hamper long-term success (unless your goal for the acquisition is simply to eliminate a competitor).

Digging deeper

For companies looking to build synergies that can underpin lasting growth, it's critical to account for cultural fit in the financial models used to inform an M&A decision. That might seem simplistic, but in today's business environment, leaders who value an asset without conducting full due diligence often find themselves needing to reassess the transaction after a deal is complete.

Related: 4 Tips for Simplifying Due Diligence (and Why It's Even Needed)

Avoiding this scenario requires evaluating metrics that extend beyond financial performance — including risk management practices; the strength of the culture as it relates to employee satisfaction, talent acquisition and retention; and a company's alignment with environmental, social and governance principles (also known as ESG). In other words, buyers must develop a full-fledged, 360-degree view of the target company's strengths and weaknesses. And that doesn't come from merely meeting its CEO and executive team. Instead, it can be obtained by taking the following steps:

1. Evaluate operational culture

In industries such as banking and retail, better employee and customer experiences increasingly mark the difference between leaders and laggards. In the case of the former sector, buyers might pore over a target's loans and credit risk without properly assessing the behaviors and technologies that currently define that company's employee and customer experiences.

Does the bank have customer-friendly hours of operation? What expectations do the employees have regarding work-life balance and compensation? Is technology helping or hampering employee workflows and productivity? The answers to these and similar questions should be factored into a target company's valuation.

In the wake of the Covid-19 pandemic, it's perhaps even more important to understand whether a target's operations are aligned with your own. Businesses are now relying on a wide range of operating and workforce management models. Suppose your employees are back in the office and you're buying a fully remote company. In that case, you'll need to think carefully about how you'll convince key target personnel to return to a centralized workplace.

In May 2021, a Morning Consult survey of 1,000 U.S. adults found that 39 percent would consider quitting a job if their employers didn't give them the option to work from home at least part of the time. And since then, Americans have left the workforce in record numbers. When meeting with leaders of potential targets, ask them directly about the workforce model they've put into place and the expectations they've set with employees. If you find that their real expectations don't align with what you're hearing, that's a major red flag.

2. Scan the talent landscape

Businesses in every industry are increasingly fighting for the same shrinking pool of talented people. Banking leaders often look at acquisitions as the quickest, most effective way to secure critical personnel. However, if you rush through a merger to get more employees with key skills and expertise without checking for cultural misalignment, your new employees might quickly leave for other opportunities.

Related: Four Tips On Finding And Securing The Best (New) Talent For Your Enterprise

Consider, for example, Sprint's 2005 acquisition of a majority stake in Nextel Communications, which created the world's third-largest telecommunications provider. The entrepreneurial mindset that characterized the target's company culture didn't align with Sprint's bureaucratic approach. Nextel executives and managers quickly left the new company. Three years later, the acquisition was confirmed a failure when Sprint's Nextel stock was given a junk status rating.

3. Don't forget the ESG perspective

Although ESG investing has surged in popularity in recent years, these principles aren't often top of mind when corporate buyers consider potential acquisitions. That's perhaps partly due to the lack of standardized reporting requirements associated with ESG-related metrics.

However, those standards could soon be in place. In July, Securities and Exchange Commission Chair Gary Gensler said that voluntary disclosures on the climate impact of corporate activities led to inconsistent reporting. Gensler called for more robust guidelines on the way companies disclose these activities.

Even in the absence of comprehensive reporting guidelines, consumers have put more pressure on companies to get behind social and environmental causes — and increasingly, so have employees. Unionization efforts at big tech firms such as Amazon and Alphabet have shed light on toxic work environments and corporate disregard for human rights, underscoring the sense of purpose that often drives top talent.

If you hope to attract and retain valuable personnel in the wake of a merger or acquisition, you must understand what's important to them and ensure your mission and actions reflect those priorities. Consider sending employee surveys to gauge what ESG initiatives matter most to new team members so you can put plans in place to fulfill them.

Cultural fit is one of many factors to consider prior to executing an M&A deal, but it's certainly an important one. By applying the tips above, you can set yourself up for long-term success after a merger or acquisition, rather than look back and wonder where your evaluation went wrong.

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