- Service: Mergers & Acquisitions
The recent presidential debates inspired our Mergers & Acquisitions team to engage in a spirited discussion about the relative challenges of integrating a merger of equals or carving a unit from its Parent company and standing it up as a new entity.
The debate features Brad Haller and Pedro Kroeff, specializing in merger integration, and Keith Campbell and Connor Kohlenberg, representing our team of carve-out specialists. Their combined experience spans more than 300 transactions across all major industries.
Who was more convincing? Well, follow along here, and you can be the judge.
MODERATOR: What is the one key factor that makes merger integration more challenging than a carve-out?
Brad: Integrations are harder due to the cultural implications of combining two companies. In a carve-out, the new organization (“NewCo”) is breaking away from the Parent company, providing the chance to get off and running without worrying about working through cultural differences. There is less insecurity about jobs. In a merger of equals, people at all levels are worried about job security because of redundancies—and it can be very challenging to retain key executives and employees.
MODERATOR: What is the one key factor that makes a carve-out more challenging than executing an integration?
Connor: A carve-out is more challenging because it is bound by the timeline of the transition services agreement (TSA). Sometimes we are not involved in negotiating the terms of the TSA or the Parent company has limited flexibility and, thus, we must work under extraordinary deadlines—for example, three months to stand up a new enterprise system or one month to hire a new HR director. I realize integrations have tight timelines for capturing merger synergies, but in a carve-out, TSA overage fees can go up exponentially if you can’t meet critical deadlines. Speed to execute is vital, and tradeoffs need to be made in regards to process optimization or cost.
MODERATOR: Brad and Pedro, do you have a rebuttal?
Pedro: I understand your point of view about the TSA—but that also creates a known sense of urgency. You can use that as a hammer to drive action. In a merger, must work harder to champion integration. Yes, there is the motivation of delivering on synergies, but there isn’t a “cut-off” date looming over your head. That can make the job harder.
Keith: But in a carve-out, we are relying on the Parent company for services during the transition period. Purchase negotiations can often strain the relationship between the NewCo and the Parent company, requiring us to rely on a third party with which it doesn’t see eye to eye. This can make it difficult to complete key tasks on schedule. In an integration scenario, both parties are working with the future organization’s leadership and are motivated to cooperate.
Brad: We’re losing sight of the importance of culture. A carve-out is like being “kicked out the door” and given the opportunity to run with less control. In a merger of equals, the acquired company is at risk of losing its sense of self. The merging organization requires new ways of business, new technology, and new culture. That requires a lot more finesse on the part of the teams involved.
MODERATOR: How about planning the scope of work? Is it easier to build an organization from scratch or start with an existing organization and improve on it? Keith and Connor, why don’t you start this time?
Connor: It seems like it would be easier to build from scratch, but that comes with a unique set of challenges. You must be methodical in your strategy and planning in order to “right size” systems, people, and processes for the new business. But there usually isn’t time for that. And every situation is different.
MODERATOR: Brad and Pedro, through experience, you have created playbooks for integrating organizations. Doesn’t that make it easier to plan?
Pedro: Playbooks are useful tools, but there’s never a “one-size-fits-all” approach. A straightforward integration scenario would be one where the acquirer and target are in the same industry, with similar customers and enterprise technology systems. But in reality, acquisitions come in all shapes and sizes. We see everything from a “tuck in” of a niche or regional player to a full-scale merger of equals. The one consistency among integrations is that they’re never as straightforward as they seem.
In a carve-out, you have the opportunity to design a new company the way you want—it’s like a wish list.
Keith: The concept of a “wish list” for a carve-out is simply not true. People may no longer exist. Tools that the business had used under the Parent’s ownership—for example, a travel and expense tool—no longer exist. Automated processes that used to exist are no longer available. And if you are working under a poorly negotiated TSA there are sometimes tradeoffs: for example, pay overage charges or go without a controller. Managing those tradeoffs can be critical to getting a new company off to the right start.
We usually have to deliver some tough messages; for example, “You may no longer have the budget to do that and you’ll have to calculate travel and expenses manually.” That adds to the complexity of communication and cultural change.
MODERATOR: Ah, back to the topic of cultural change. So, it is a big factor in a carve-out as well?
Connor: Yes, absolutely. You are building a new company with a new culture. That’s a great opportunity, but also a big challenge when rushing to put the pieces in place.
MODERATOR: From a technology perspective, is it harder to execute a merger or a carve-out?
Keith: In a carve-out, you typically start anew with about 80 percent of technology: new data center(s), new collaboration tools, new enterprise systems, new infrastructure, etc. You also have to work through the complexities of data extraction from the parent company’s source systems and transform that data into new formats of new systems. This requires a complete change that touches every employee. You have to train everyone on new tools—and typically new processes as well. And while we have the opportunity to be more diligent about cost, we also do more thorough cost modeling to ensure the buyer’s model is respected and deal drivers are met.
In a merger, you typically use applications and infrastructure from one side or the other, which means you only have to train a percentage of the people.
Brad: Most mergers that double the size of an organization also require substantial new technology. In addition, in most merger scenarios today, we look at moving more of the infrastructure to the cloud. So, while the core technologies may not change, processes do. As a result, we end up training the majority of staff.
Keith: Fair point, but based on my experience with integrations—and I do have a fair amount of experience—a good bit of technology remains intact. There is a footprint still in place. In a carve-out, we are building new servers and new data centers. That is more complex and takes longer.
Pedro: Generally, yes. But either way, the project teams are going through the same exercises—except in the case of a merger, there is not the same sense of urgency to comply with a timeline.
And one final point: In a carve-out, since you’re building from scratch, there are zero points of integration. Integration of systems and data sources always adds significant complexity.
MODERATOR: So, do we have consensus on which scenario presents a greater challenge? Let’s hear closing arguments.
Brad: I agree that building something from scratch is difficult. But I go back to change management as the bigger challenge: it is harder to convince people of the need to change to make people happy in an environment that feels like there are winners and losers. People want to know where they fit on the organization chart. If the new organization’s finance team comes from one company and its IT organization from the other, how well will they work together? How will you approach technology change if one organization is used to building in agile methodology and the other in waterfall methodology? If you put the two vice presidents of supply chain in a room and task them with designing a way forward, what will happen when they may be effectively competing for the same job?
Keith: Carve-outs face similar challenges. A supply chain executive may think that since the Parent company did it this way, then that’s the way the new organization should do it. But that way may not be right for the size of the new business. In a merger, the peers can work out the best way forward. In a carve-out, an executive with significant new responsibility but not enough knowledge can lead the organization quickly down the wrong path.
MODERATOR: What I’ve heard is that both are very complex and challenging in their own ways—and there is no definitive answer to the question of which is harder to execute. Cultural change plays a key role in both scenarios.
Either way, the rewards of a successful transaction can be very compelling—but realizing them will require careful planning and execution. Experience in dealing with these issues and challenges will be a key to success.
To learn more about West Monroe’s integration or carve-out expertise, please contact Keith Campbell, Brad Haller, Connor Kohlenberg or Pedro Kroeff.