Merge, don’t submerge – making better decisions about mergers

We’ve also seen up close the aftermath of mergers that weren’t handled properly – the impact of a poorly executed merger can be even more devastating than an ill-conceived acquisition.

To that end, we’ve spent plenty of time thinking about the best way to help businesses contemplating merger to test their rationale and prepare for execution by tackling the tough questions in advance. Our focus here is on the decision to merge (“should we or shouldn’t we?”), rather than the how-to of merging (we’ll discuss that important topic another day).

Definition

But first, an explanation of what we mean by merger, because it is an expression that gets used in many different, and often misleading, ways. When we talk about a merger, we’re meaning a transaction that leads to the creation of a new entity without much (if any) cash changing hands. In effect, it’s A and B coming together to create something that’s not A or B.

It can involve more than two firms¹, it can be among groups that are quite different in business scope², and involve businesses of quite different sizes.

Why merge?

So, why should firms be contemplating mergers rather than other methods of inorganic growth?

• In a highly competitive market for acquisitions like we have currently in the financial advice space, mergers offer a less contested path to growth
• Mergers will often offer the scope to bolt two like-sized businesses together, enabling fast-tracked growth compared to acquisitions
• As cash isn’t required outside transaction costs, a merger shouldn’t impact the merged entity’s ability to acquire other businesses
• Both cost and revenue synergy opportunities should be available, although it often cost synergies are less aggressively pursued than in an acquisition.³

Of course, there are additional risks/costs associated with merging: the importance of cultural alignment typically means a longer negotiation period (or at least it should!); as due diligence is mutual, transaction costs will likely be higher; getting alignment around corporate structuring, licensing, accounting approaches, shareholder rights etc can be time-consuming and hence costly.

As with any transaction, a clear-headed assessment of the relative costs and benefits will be critical for evaluating the overall merits of a potential merger.

When mergers go wrong – the Triple Trap of Mergers

If we accept the Wildean notion that “experience is merely the name men gave to their mistakes”, then, sadly, we’ve had plenty of “experience” when it comes to mergers!

When we’ve reflected on negotiations or actual transactions where we’ve had some engagement, and where the result has been sub-optimal (and at times calamitous), we’ve identified the Triple Trap of Mergers – three key mistakes that occur repeatedly:

1. Poorly thought through strategic rationale – this is relevant for any transaction, avoiding the “growth for growth’s sake” mentality that dooms many acquisitions; but too often it seems little attention is given to how a merger will make the merging parties more highly valued;
2. Misalignment on where the value lies – it’s very rare that in a merger you’re dealing with businesses with similar margins, growth rates, dividend payout policies, capital structures etc – too often, there is a tendency not to address the implications of these differences and assume it will play out in the wash;
3. Lack of day 1 vision – insufficient attention is given to what the merged entity will look like from day 1 – what the common operating model will be, who will have what roles, how decisions will be made – which can become a source of great friction further down the track.

Of course, cultural alignment and valuations will also be critical elements of any merger, but the Triple Trap of rationale, value misalignment and vision are the most important “elephants” regularly left to their own devices.

Merger myths

There are a few myths we see play out repeatedly in talking about mergers.

• Mergers don’t need the same rigour as acquisitions – often the merger parties have known each other for a long time. That makes sense: you should have a better understanding of whether you share values and objectives (although you definitely still need to have those conversations too). But the assumption seems to be this increased familiarity means that corners can be cut on due diligence – in fact the opposite is true given you are bringing the businesses together⁴
• There is no such thing as a merger of equals – it’s not so much that this is a myth, as that it doesn’t have much significance. If the strategic rationale stacks up, does it matter that the merged entity maintains more of the DNA of one business rather than another? The caveat of course is that the parties have had open conversations about the things that matter to them and the roles they’ll play post-merger
• All mergers are the same – there are many valid reasons to explore a merger, and so there are different ways that mergers may play out. Two dimensions in particular help to categorise merger types: pre-merger overlap of business models; post-merger level of integration.

A bit more on each of these:

• High overlap, highly integrated (HO/HI) transactions – the most common merger contemplated. HO/HI transactions should be looking for cost synergies of 20%, depending on the level of overlap and the expected growth trajectory of the merged entity
• High overlap, lightly integrated (HO/LI) transactions – there may be a sense of not wanting to “scare the horses” with this approach or it might just be a commercial decision to run two businesses side-by-side (for example, to target different segments). Merging parties need to challenge themselves that a decision to go for low integration isn’t simply a path of least resistance choice
• Low overlap, highly integrated (LO/HI) transactions – these will often involve adjacent business lines where significant revenue (cross-sell) synergies have been identified. A 20% uplift in revenues is probably required to justify merger costs
• Low overlap, lightly integrated (LO/LI) transactions – these are uncommon but an example may be adjacent businesses, looking for scale and industry coverage, but wishing to avoid the regulatory or other scrutiny associated with vertical integration.

Thinking in advance about the type of merger you’re planning can help you to better understand what your objectives should be.

The GBD approach to the merger decision (“should we or shouldn’t we?”)

We’ve designed a workshop-based approach to facilitate parties considering merger, to enable those discussions to be accelerated without sacrificing rigour.

The approach constitutes four phases intended to confront the Triple Trap of Mergers, often over-looked in more ad hoc conversations:

1. Foundations – ensure that there is shared context around the process and the objectives, and set the foundations for the workshop process (including addressing confidentiality, access to data rooms, project protocols etc).
2. Workshop 1: Strategic rationale – from understanding the competitive environment in which the parties operate, the strategic challenges the parties face, and the opportunities presented by a potential merger, we can begin to develop and test the strategic rationale for any transaction.
3. Workshop 2: Common operating model – assessing areas of overlap and complementarity assists to design the post-merger ideal common operating model and hence how value will be generated in the event of a transaction.
4. Workshop 3: Day one organisation – leaning into the governance and decision-making framework, as well as the pro forma organisational chart aids in confronting potential friction points.

Although not directly addressed in the workshops, the manner in which they are undertaken will help to uncover the information required to assess cultural fit and mutual valuations.

We find this approach, leaning on GrowthByDesign as independent third parties, promotes accountability and momentum, ensuring that go/no go decisions can be made with the right data points at the right time.

In turn, the outputs from the workshops should: accelerate eventual due diligence; deliver the framework for transaction documents and shareholder agreements; provide clarity for valuations; and set the ground rules and leadership for merger integration planning.

Summary

We expect to see more activity in mergers, especially as the private market funded buyers dominate acquisitions. There are strong arguments for mergers to play a prominent role in industry consolidation and the race to scale – but only if they are undertaken with the discipline and accountability they demand.

Our experience suggests that using an independent third party like GrowthByDesign can be a major contributor to facilitating growth that is deliberate, strategic and sustainable and avoiding the Triple Trap.

John Sullivan is one of the wealth management industry’s leading strategy commentators. He has been consulting to wealth managers, insurers, advisers, asset managers and many other industry participants, in Australia, throughout Asia, the US, New Zealand, South Africa and Europe since 1998. For the last decade, he worked with (and eventually led) Macquarie’s Virtual Adviser Network, where he worked closely with 100s of Australia’s leading advice businesses, helping them to grow – deliberately, strategically and sustainably.

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¹As it did in the recent Esencia Wealth merger: https://www.moneymanagement.com.au/news/financial-planning/4-advice-firms-merge-create-esencia-wealth
²Eg, the 2024 merger of Ironbark and Invest Blue: https://www.professionalplanner.com.au/2023/09/invest-blue-merges-with-asset-manager/
³And it’s the nature of the advice tech stack that there is less purchasing power available than might otherwise be expected.
⁴The good news is that time spent upfront on due diligence can likely accelerate integration if a transaction ends up happening.