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Overoptimism in Mergers and Acquisitions

Harrison ZipkinAccording to Dan Lovallo and Daniel Kahneman’s article in Harvard Business Review, “Delusions of Success: How Optimism Undermines Executives’ Decisions,” most large capital investment projects do not live up to expectations; rather, they typically come in late and over budget. In fact, “Approximately three-quarters of mergers and acquisitions never pay off – the acquiring firm’s shareholders lose more than the acquired firm’s shareholders gain. And efforts to enter new markets fare no better; the vast majority end up being abandoned within a few years.”

How can we explain why more than 75 percent of M&A transactions never pay off? There are two likely reasons. First, today’s global economy depends on software. The prospect of capital losses or unplanned expenditures in a targeted asset, due to their software, has become more relevant to deal pricing, structure and performance. Anyone who has experienced the rigors of software project cost or schedule overruns, integration management problems or source code failure has dealt with the subsequent damage to the value of an asset.

Both the balance sheet and the P&L statements are affected by a target company’s dependence on custom software. If custom software is the embodiment of the target company’s unique business model and value, then there is real risk if the software does not support the financial statements, or is unduly expensive to maintain as an expense item.

In short, software needs to be a key consideration in any M&A transaction; if it’s ignored, the consequences are steep.

The second reason for failure? Overoptimism. As the article states, “Studies that compare the actual outcomes of capital investment projects, mergers and acquisitions, and market entries with managers’ original expectations for those ventures show a strong tendency toward overoptimism.”

This overoptimism is too often unjustified. “Many M&A decisions may be the result of hubris, as the executives evaluating an acquisition candidate come to believe that, with proper planning and superior management skills, they could make it more valuable. Research on postmerger performance suggests that, on average, they are mistaken.”

So what’s the answer? The first step is recognizing the valuable role that software plays in an M&A transaction. The second step is understanding if, and how, any software should be integrated into a new parent company’s software asset portfolio, which can be the difference between substantial capital losses and financial health.

This is where we can help, providing a quantitative and qualitative profile of the potential software risks and benefits you're facing. can include:

  • A profile of how the target organization relies on its technology.
  • An assessment of the risk involved in transitioning the target organization's software.
  • A profile of the return-on-investment for the acquired software, with an eye on the future.
  • An analysis of how to integrate the acquired software into the current environment.

Avoid the majority and set your M&A up for success. We can help you to avoid the mistakes of your peers and to assure the value of your transaction.

Read the article: Delusions of Success: How Optimism Undermines Executives’ Decisions

Harrison Zipkin
Director, VC-M&A

Written by Harrison Zipkin at 05:00
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