Corporate history is littered with examples of large corporates acquiring fast-growing start-ups, only to see them flounder post-acquisition because of misunderstandings, unrealistic expectations and cultural incompatibility.
In the case of Myspace, various factors led to its demise. At one point, News Corp predicted that the site would generate annual revenues of US$1 billion when its takings were only a tenth of that amount. With such a large target to hit, Myspace installed aggressive advertising and pop-ups to increase revenues, but this compromised user experience and audiences moved away. The number of users on Facebook, by contrast, which was not focused on monetization early and had the space to be subtler with its advertising, continued to grow rapidly.
To understand how large companies can effectively integrate fast-growing but culturally different start-ups, Mergermarket on behalf of Toppan Merrill spoke with three experts for their insights.
Toppan Merrill question: What are the most common points of tension between a large company and a start-up after acquisition? What are the best ways of resolving conflicts when they arise? Leading industry experts weigh in...
Jamie Leigh, Partner, Cooley says: I am a broken record on this point. People are the reason that we do deals for the most part, and so aligning expectations with respect to integration is, of course, the number one, two, three, four, and five priority. So clear communication channels, clear reporting channels, clear integration and onboarding of employees are the main areas where we see hiccups.
There are sometimes simply just inevitable clashes between the way a former exec team wants to continue and the way the acquiring company sees the future; and sometimes you just can't know that until you actually start working together.
I think a healthy acknowledgment that not everything can be planned for or knowable up front, and having some confidence in the flexibility that it will take to get through that first few months of integration from a human resources perspective is really important.
Sometimes start-up companies are either way too optimistic or way too defeatist. Instead of bringing that really creative spirit and problem-solving mentality into the larger company, the attitude can be: "Well, I don't get to do my own thing anymore so I'm not even going to try” or "These people want me to do my start-up thing and also have 42 layers of reporting." Displaying some real tenacity and flexibility at this stage is crucial.
I think you also want to provide your people with some marketing tools to talk about the acquisition. What gets out in the street is hugely important for the buyer, the seller, the investors and the former stockholders. Everybody wants to be able to rally around the good parts of the deal. Thinking about the key talking points and putting these front and center for all participants is important.
Arnaud Leroi, Partner, Bain & Company adds: One big element is really the relationship between the top executives. What kind of relationship has the owner of the start-up maintained with the corporate team now that they are in control? If trust breaks down between the start-up’s senior people and the new company then you start to encounter difficulties, because those founders are the people who are going to be able to solve 90% of the problems during the initial period of integration.
The former owner needs to feel empowered to make strategic decisions, put forward ideas and recommend acquisition targets. If that channel of communication is not open, you can easily end up in a situation where the former owner checks out and does the minimum to secure the earn-out.
On the point about earn-outs, both the acquirer and the owner need to start the earn-out before there are deadlines. Earn-outs can be a barrier towards the execution of a better strategy. For the buyer, get on the front foot with earn-outs and be ready to renegotiate earn-outs, or pay them earlier, if you realize that keeping a former owner locked in is not helping the objectives of your company.
Dawn Belt, Partner, Fenwick & West weighs in: Buyers need to think about the existing workforce and how they feel about these “new kids.” They may have had big payouts as a result of the sale transaction. These new employees may also be seen as favored citizens compared to the incumbents – who are on different financial and incentive packages – and this can cause tension within the employee base. The parent company needs to make sure that everyone feels valued.
I also agree that earn-outs, despite being popular, can cause tension and leave nobody happy. Acquirers use them if they are looking to bridge valuation, but implementation does not always match expectation. The former start-up team may feel that it didn’t get enough backing from the parent company to achieve the earn-out, while the parent believes the team didn’t execute on it properly. The devil is very much in the details.