Next year is shaping up to be a very strong year for M&A activity in the Knowledge Economy. In order to assist your preparation for 2021, take a look at our M&A Preview, in which we discuss the following eight key trends:
- The adoption of digital is accelerating
- Emerging technologies are being commercialised rapidly
- There is a convergence across the sector and delivery models are blending
- Private equity participation in the knowledge economy is increasing
- Next-generation technology platforms are emerging
- Vertical software solutions are playing an increasing role
- Buyers are returning to nearshore locations for access to new skills
- Shareholders are aligning expectations and addressing structural risks
Understanding the Synergy Opportunity for Buyers
Most acquisitions of businesses in the knowledge economy sector are driven by synergies, but what are they and what do they mean for buyers?
If a knowledge economy firm has approached you to make a potential acquisition offer, or if you are considering a sale of your firm to a larger knowledge economy buyer now or in the future, this article will help frame your thinking about what is important to knowledge economy buyers. We explore four key areas of consideration by knowledge economy buyers: Buy vs build, acquiring capabilities, intellectual property, and post-merger considerations. Each of these focuses on the key element of synergy value by knowledge economy buyers.
1) Build vs buy: Why do knowledge economy firms decide to acquire rather than grow in a particular area?
2) Acquiring capabilities: What is the landscape of capabilities, services and expertise that knowledge economy buyers typically consider?
3) Acquiring intellectual property: Why is it important for knowledge economy buyers and how does it represent value in a knowledge economy firm acquisition?
4) Post merger considerations: What are the key buyer considerations pre-deal for post-merger integration?
By reviewing these considerations of knowledge economy buyers, we provide an outline of how this category of buyer thinks about acquisitions of other knowledge economy firms. By doing so, we intend to further inform your approach to knowledge economy buyers and help you generate interest in your firm as an acquisition target by this type of buyer.
Build vs buy: Why do knowledge economy firms choose to acquire rather than grow a capability?
Growth is typically on the agenda for most large and mid-market knowledge economy firms. Given the high level of competition amongst firms and the ever-changing nature of the industries and specializations into which these firms provide solutions, knowledge economy firms have to continuously evolve in order to remain relevant. This can involve enhancing existing capabilities and offerings or entering into new areas of capability and expertise. This may also involve expanding into new regions or countries. More simply, some knowledge economy firms may simply need to gain scale in their existing organization to fulfill the demand from larger clients or projects.
Firms with a growth strategy and the capital set aside to fund that strategy need to think about an execution path that best achieves their growth objectives, and this typically comes down to a balance between growing organically and/or through acquisition. Each option has its share of advantages and disadvantages:
- Organic growth takes time and requires careful management of demand and supply in the new area. Hiring, training and marketing add costs to the business, but it is assumed that this investment pays off with new sales. There is a potential risk that the payoff takes longer than expected or does not happen at all. However, the upside is that the firm is in control of its own growth and the pace is incremental, allowing the firm to adjust to the growth at each step.
- Acquisitive growth, if successful, is immediately additive. Revenues of the target directly add to the top line of the buyer, duplicate costs are potentially cut out, and access to new clients, expertise and skills are present immediately. However, the tradeoff is that successfully selecting an acquisition target, structuring and executing the deal, and integrating the target into the buyer all involves significant short and long-term risk. There are well known statistics about M&A failure rate, and these are often the result of underestimated and ill-executed post-merger integration.
In practice, most knowledge economy buyers use a combination of organic and acquisitive growth. As many knowledge economy buyers are themselves people-based businesses, organic growth is often the natural choice and acquisitions are considered opportunistically, although each firm differs in their exact approach. Some knowledge economy firms prefer to carefully preserve their culture by avoiding acquisitions altogether.
Sellers of knowledge economy firms need to understand that knowledge economy buyers will always consider whether your business could be built internally quickly and effectively. It is worth asking yourself, “What am I actually selling?”, as the buyer will be asking “What am I buying?”. Therefore, you must demonstrate that your capabilities are rare in the market and additive to their own. Knowledge economy buyers these days are very interested in IP but you must show that your IP can be leveraged in their own business. Overall, a seller must demonstrate that an acquisition of their firm will be value generating, with some aspects of the business being immediately additive and others involving synergies going forward.
Acquiring capabilities: What is the landscape of capabilities, services and expertise that knowledge economy buyers typically consider?
Large, multi-disciplinary knowledge economy firms can be organized by both capability and industry. The reality is that strategy firms have historically organized themselves by industry expertise and most others have done so by functional or disciplinary capabilities. The reason for this is that in order to provide sound strategic advice, knowledge economy firms look holistically at business issues across functional disciplines and consider market dynamics within an industry (i.e. vertically). Other knowledge economy firms can focus on addressing business specific issues (supply chain) or on a functional area (operational, IT, financial, human resources). A focus on business issues or functions may exist across a number of industries (i.e. horizontally). Therefore, firms with expertise in these areas tend to organize themselves by these capabilities or service areas, in order to maximize the utility of this expertise across a broader client base.
An understanding of this helps us appreciate how buyers will look to fit you into their existing structure when evaluating your firm for acquisition. For example:
- If your knowledge economy firm deals with disparate business issues within a concentrated client group in one industry, you will be seen to have an industry focus (but potentially some potential risk in client concentration). Typically, acquirers highly value specialized industry expertise, particular if your business gives them a strong platform to enter a new market. They will also want to explore the portability of your solutions to their existing sectors to see if there is potential to achieve even greater synergies.
- If your knowledge economy firm focuses on specific business issues (IT, cost savings, procurement, change management) for clients in various different industries, you will be seen to have a capability focus, with some potential risk of lack of industry focus. The upside is that you are dealing with issues faced by many clients, but your lack of industry focus may mean that your firm may appear to be too generic.
The trick is to understand which knowledge economy buyers will be more attracted by your focus areas (capability or industry) and less deterred by areas where you may be more generic. Ultimately, buyers are looking to pay fair market value for your firm, but gain above average returns from their investment. The way to do this is by making acquisitions that have a high degree of synergy potential with the existing business.
Intellectual property: What is it and what value does it represent?
Intellectual property (IP) has always been an important consideration for knowledge economy buyers, but is also becoming increasingly important as the knowledge economy landscape changes.
IP is difficult to define and even more difficult to value. So sellers often want to understand how to define IP, whether what they have developed as IP is valuable to buyers, and if so, what is it worth? What we hope to lay out here is a framework for thinking about the IP in your business, as it is viewed from a knowledge economy buyer’s perspective.
IP comes in many different forms. The most understood forms of IP are software or IT products/solutions that are directly revenue generating as a standalone asset. The most abstract forms of IP tend to be methodologies or best practices that do not generate revenue, but better enable a knowledge economy firm to sell their expertise in a repeatable and consistent fashion. So it is worth considering IP value in terms of what it does for a knowledge economy firm as it grows. From this perspective, we can consider a few core groupings of IP in knowledge economy firms:
- IP that generates revenue;
- IP that creates operating leverage; and
- IP that enhances knowledge economy offerings.
Looking at IP in these categories, sellers can consider how a knowledge economy buyer may conceptually value IP in their business.
Revenue generating IP typically involves software, tools, or proprietary subscription databases that are standalone assets and that are sold in addition to or as a result of the knowledge economy work. This is IP that can be sold in tandem to or separate to knowledge economy work and that would be directly additive to a knowledge economy buyer’s revenue stream in addition to the seller’s knowledge economy fees. Buyers would assess this from the perspective of its scalability as a platform (can the platform scale with and adjust to growing client needs?) and its rarity in the market (how easily could someone create a similar product and destroy any competitive advantage?).
IP that creates operating leverage typically involves methodologies, best practice, approaches, etc. that provide a degree of standardization and consistency in the knowledge economy approach, such that the selling firm can more easily grow and train its own consultant base, while maintaining the quality of work delivered. This type of IP should help the buyer propagate the seller’s unique approach, methods and practices within its own organization, in order to replicate the acquired offerings and expertise across the knowledge economy buyer’s firm. Ultimately this should result in cross territory sales by its own, trained up staff.
IP that enhances knowledge economy offerings can be thought of as research, publications, articles, studies, etc. that act in symbiosis with knowledge economy work and expertise. This type of IP provides further depth to the insights that the knowledge economy firm can provide. Knowledge economy work may leverage previously generated research on a topic, and research from prior knowledge economy work can be consolidated and used to enhance the depth and insights for future knowledge economy work. This may allow a buyer to more deeply penetrate a given market area or use research to enable a level of expertise for new markets the knowledge economy buyer may wish to initially penetrate
Ultimately, knowledge economy buyers are looking to acquire IP that allows them to sell more or higher value knowledge economy work. The framework above may provide some clarity with which to consider what kind of IP you have and how buyers may find it valuable.
Post-merger: What to expect from knowledge economy buyers following an acquisition?
One of the main reason for M&A failures is down to poor integration, including pre-deal integration planning and post deal integration execution. The situation where a knowledge economy firm is acquired by a knowledge economy buyer is even more sensitive to integration failure, as integrating people is both the most difficult aspect and also the key to its success. It is worth running through a simplified acquisition process to highlight how integration can be considered at each step.
Time and time again, the critical factor of integration has proven to be the alignment of leadership objectives and defining successful integration as accurately as possible. However, as the acquisition of knowledge economy firms by knowledge economy buyers involves people based risks, such as attrition, most knowledge economy buyers mitigate this through a deferred payment or earn out in the deal structure, with upfront payment typically in the form of cash and shares (partnership with some knowledge economy firms). However, there is an ongoing dilemma for most knowledge economy buyers – how to measure the performance of an earn-out to ensure the acquired firm continues to grow, while trying to take advantage of the synergies between the two firms that often make standalone earn-out metrics difficult to measure. Some firms get around this by using top line earn-out metrics such as revenue or gross profit, while others stick to earn-out metrics for an initial period until the growth and integration is proven, then work collectively with the target to adjust objectives and take advantage of the synergy opportunities.
Ultimately, the integration of knowledge economy offerings and cross sell opportunities at clients command most of the air time in integration discussions, as this is where the money is made and where the opportunity lies. However, knowledge economy buyers more than others understand that a better than average alignment of people is required to make this happen.