At a glance39 percent of US CEOs are planning on an acquisition in 2014 according to PwCs Global CEO Survey. A PwC survey of tech companies found that76 percent of acquisitions focused on buying innovation met orexceeded expectations. With the right inorganic growth strategy, buyers in all industry sectors can apply critical success factors to their innovation-focused pursuits.March 2014Acquiring innovationStrategic deal-making to create value through M&A2 Acquiring innovation: Strategic deal-making to create value through M&ADeal-makerstalk deal-makingAs part of an ongoing series, PwC conducted a roundtable with a number of Silicon Valley corporate development executives to explore the subject of innovation-focused acquisitions. We drew the specifc topics of the conversation from the results of a survey of technology organizations conducted in the months prior to the roundtable. The corporate development leads from several technology-focused Silicon Valley companies participated in the roundtable. In this article, we draw on some of the key themes aired during the roundtable discussion and offer some perspectives on leading practice thatPwC has observed in the market. The discussion reinforced our view that innovation is becoming an increasingly important motive for M&A. As one roundtable participant put it, Acquiring innovation will continue to be a necessity for technology companies. Faced with a competitive environment that demands ever-greater speed to market, they have increasingly looked to M&A to complement internal research and development (R&D).Deals, however, are not assured of success, and innovation-focused M&A presents sizable and unique challenges that must be understood and addressed to realize the full value of a deal. If not managed appropriately, acquisitions can hurt, not help innovation efforts. The participants in PwCs M&A roundtable focused on some of the key challenges they face when undertaking innovation-focused acquisitions. Several key questions dominated the discussion, including:How do we educate and engage key deal stakeholders?How do we identify the right acquisition targets?How do we value and assess targets?How do we execute post deal and measure performance?The article accompanying this sidebar captures some of the most thoughtful responses to these questions, as well as PwCs own perspective, shaped by our extensive experience in the feld of technology M&A.3PwCStrategic deal-making M&A is clearly a potent sourceof growth if guided by soundstrategic direction. Tech companies,for example, are under relentlesspressure to innovate. They look to M&A to complement and enhance innovation via internal research and development (R&D). Done right, M&A can help these companies increase speed to market, outfank competitors, and relieve pressure from threatening disruptive market forces. (See Exhibit 1, Innovation as a driver of acquisition activity over 36-month period.)As one participant in a 2013 PwC roundtable on tech-company M&A put it, We will not be able to achieve our strategic intent in a timely manner by organic means alone. (See the sidebar, Deal-makers Talk Deal-Making.) Because of its reliance on M&A to fll its innovation pipeline, the technology industry can provide a model to other industry sectors for using M&A to invigorate, diversify, and accelerate their search for breakthrough innovations. By studying how leading companies develop inorganic strategies around growth themes, search and screen for target acquisitions, perform commercial due diligence, and integrate their acquisitions, senior leaders across all industries can use examples from tech sector M&A to better meet their own organizations need for innovation.Exhibit 1: Innovation as a driver of acquisition activity over 36-month period% of Deals0% 10% 20% 30% 40% 50% 60%InnovationChannels and market access Consolidation/cost reduction/market shareGeographic expansionVertical integration/supply chainDefensive 57%21%6%12%2%3%4 Acquiring innovation: Strategic deal-making to create value through M&ADeal performanceAccording to the 2014 PwC GlobalCEO Survey, 39 percent of US CEOs plan to initiate a domestic acquisition this year. To do so successfully, many CEOs are focused on improving their organizations ability to pursue M&A, joint ventures or strategic alliances. Thirty-fve percent of US CEOs are considering M&A improvement initiatives. Another 22 percent have change programs underway. The challenges of successfulM&A execution are no easier when making innovation-focused acquisitions. Creating value often entails monetizing the intangible assets of the target company, which may operate at a considerable distance from the acquirers core markets. Academic research confrms that, if not managed effectively, acquisitions can degrade the innovation output of both target and acquirer.1

Over the course of our work inthe technology M&A sphere,PwC has observed that small,tuck-in deals have a higher probability of success than larger- scale transactions. Management is better able to manage and controlthe post-merger integration process with smaller deals than with larger 1Journal of Marketing, January 2005ones, which are more complex andresource-intensive. (See Exhibit 2, PwC performance observations by deal category.) A large portion of these tuck-in deals involve technologyor talent acquisition.A PwC survey of tech-company corporate development and IT executives reveals that more than half of innovation-focused acquisitionsmany of them tuck-inshave at least met expectations. (See Exhibit 3, Innovation-Focused Acquisition Results Over the Past 36 Months.) But that performance has not come easily. Exhibit 2: PwC performance observations by deal categoryInnovativeTraditionalSmall (tuck ins)Large (transformational)12 43Note: Numbers represent observations ofdeal performance with 1 indicating likelihoodof high performance and 4 indicatinglikelihood of low performanceExhibit 3: Innovation-focused acquisition results over 36-month period % of Deals0% 5% 10% 15% 20% 25% 30% 35% 40%Far underperformed expectationsUnderperformed expectationsMet expectationsExceeded expectationsFar exceeded expectations11%13%36%35%5%5PwCM&A integration team, responsible for rapidly aligning the targets people, operations, systems, and processes with the acquirers corporate structure.Deal engineer, typically thechief technology offcer or other senior technology executive tasked with integrating the acquisitiononto the acquirers technology platform and resolving softwareand hardware incompatibilities.External advisors, includingthird-party advisors, investment bankers and legal advisors,to support deal execution and documentation. This teamthen draws on the skills ofspecialists who can assistwith all aspects of commercial, operational, and technical due diligence and integration.The deal teamIn discussions with tech executives, we learned that success depends on a dedicated deal team that owns the strategic development, acquisition and integration process and that is accountable for executing it on time and to plan. The optimal deal team brings a diverse range of skills, functions, and expertise to bearon a complex undertaking.(See Exhibit 4, Deal continuum:PwCs perspective on key evaluations necessary in each phase of the dealstrategy, execution, integration.) There are seats at the table for the following roles:Corporate development executive to develop and communicate the deals strategic rationale; orchestrate the interactions between buyer and seller; interface with the sellers investment bank; and set the deal structure.Deal sponsor, typically anexecutive from the business unitthat originally identifed and analyzed the target, who helpsmake the business case for the deal.Deal approver, often the CFOwho scrutinizes the deals economic impact on the company; this individual may also help arrange fnancing and will lead a robust review of strategic alternatives toan acquisition.Exhibit 4: Deal continuumStrategy Deal execution Value capture#1 Strategy assessment#2 Options evaluation#3 Deal evaluation#4 Negotiation and close#5 Integration #6 TransformationGrowth strategyMarket analysisInvestment hypothesisAlignment with corporate development initiativesAssessment of potential acquisition targetsCommercial due diligenceFinancial/ accounting, strategy, and tax considerationsDeal structuring (accounting and tax)Core diligence (IT, financial, tax, HR, insurance, operations)Regulatory and compliance, accounting/ financial reporting, SPAFinancial packs and operational issues in the TSA and SPAPreparation for capital raisingPost-closing purchase price adjustmentsEmployee agreements100 day plansTarget operating modelSynergy planningFunctional integration support and Integration Management Office (IMO) planning, setup and governance structureTarget operating modelCustomer, channel and product strategiesOperating improvements and cost reductionFinancial reporting requirementsPortfolio analysisBusiness performance analytics (operations, IT, and financial)Target operating model diagnostic6 Acquiring innovation: Strategic deal-making to create value through M&ATarget identifcation does more than just uncover possible acquisition candidates. The very process of exploring multiple channels and touch points acts as a powerful market-sensing tool that enables potential acquirers to collect valuable intelligence on competitor, market, and product trends. We speak with a number of players, one roundtable participant said, and it is a hugely valuable process whether or not we consummate something with them.Target identifcationSuccessful acquisitions begin with the right target, and executives explore numerous channels in their search for companies with superior innovation potential. Most tech sector executives place the most weight on internal channels, primarily corporate development teams and R&D and engineering teams. They are willingto explore unconventional channels, such as venture capital funds, to identify targets and increase dealfow. They also use existing alliances and relationships with other organizations to perform informaldue diligence on potential targets.(See Exhibit 5, Survey resultsidentifying and screening potential innovation-focused acquisitions.)As one roundtable participant said, You may want to do a licensing dealto get warmed up and see if they arethe target we think they are and getto know management better.Exhibit 5: Survey resultsIdentifying and screening potentialinnovation-focused acquisitionsCommonly usedSometimes usedRarely used Proactive pipeline development within corporate development team R&D/engineering team Venture capitalists/private equity funds Investment bankers Customers Board members/executive team Consultants/3rd party experts Sales teamWhile the above roles are adequate for smaller, quicker tuck-in deals that pose lower amounts of risk and complexity, larger transformative dealswhere offcers are betting the farmrequire more up front planning and scrutiny to succeed.Well before any targets are identifed, companies need an inorganic strategy that properly analyzes the macro and microeconomic markets, factoring trends and disruptive market forces. M&A is only a tactic to execute strategy. It is not the strategy itself. Companies need to have a clear, well-defned strategy for their specifc business vertical.And that strategy should be distinct from but complementary to the organic growth strategy.The inorganic strategy should identify areas of potential new growth to evaluate for market entry, product portfolio expansion, etc.M&A is only a tactic to execute strategy. It is not the strategy itself. 7PwCValuationValuation is a particularly thorny problem for innovation-focusedtech acquisitions. It is nearlyimpossible to apply traditional valuation techniques to companies in their early stages of development, when operating histories are briefand theres little or no historicalor predictable future cash fow.Acquirers therefore must resortto other measurements to buildthe case for a particular investment. (See Exhibit 6, Valuationtechniques ranked by relevanceand effectiveness.) Their executives typically consult internal R&D and product teams to determine thecostin terms of both time and moneyof building a product or service internally. Very often, the acquirer has the necessary capability, but the lead time to build the product or service is prohibitive, and an acquisition can signifcantly improve speed to market. I am confdent that in most instances our engineering team could build the solution, one roundtable participant said, but it is the time component that is criticaland makes M&A attractive.Less important More importantNPV analysisSelling party expectationsMarket comparables (public companies)Market comparables (similar transactions)Cost to build analysisEBITDA and earnings multiplesMost recent nancing round valuationRevenue multiplesOption value analysisExhibit 6: Valuation techniques ranked by relevance and effectiveness for evaluating innovation focused acquisitionsVery often, the acquirer has the necessary capability, but the lead time to build the product or service is prohibitive, and an acquisition can signifcantly improve speed to market.8 Acquiring innovation: Strategic deal-making to create value through M&APost-deal execution Integration of any sort of acquisition places signifcant demands on the acquirers capabilities and resources. But innovation-focused acquisitionsare a unique challenge. With innovative acquisitions, the real challenge comes post-completion, one participant in our roundtable said. It takes a signifcant level of commitment, patience, and ongoing investment to make these deals work. Indeed, such deals require commitment and focus from stakeholders that extend well pastthe frst 100 days following closing. Measuring the outcome of an innovation-focused acquisition requires the development of a scorecard that captures and quantifes the deals value-creation rationaleand enables executives to monitorthe targets post-acquisition performance. Because many targets have little or no revenue historyand may take several years to earnout, the scorecards metrics must include both fnancial yardsticks and a broader set of strategic milestones, such as product-development targets, talent retention, degree of collaboration, and the level of technological uptake. You can steer the deal off course if you place too much emphasis on revenue, one roundtable participant said. You may artifcially drive the business to produce short-term revenue that is inconsistent with the long-term strategic intent of the transaction. Because innovation-focused acquisitions tend to have longer time horizons and highly uncertain outcomes, successful acquirers build a great deal of fexibility and agility into their post-deal plans. Some go so far as to develop a range of post-deal scenarios to prepare for deal outcomes that diverge from the original plan. Other companies focus on criticalareas to improve the odds ofpost-deal success. Our surveyof innovation-focused acquirersreveals several of those areas.(See Exhibit 7, Survey results:Most effective strategies forcapturing deal value in innovation-focused acquisitions.)For a more extensive focus on M&A integration as it impacts the research and development (R&D) function, see the PwC white paper, R&D Integration: Unlocking product development opportunities in M&A.Exhibit 7: Survey resultsMost effective strategies for capturing deal value in innovation-focused acquisitionsClear roadmap Clarity of objectives and articulation of roadmap Dened yet exible product plan Dened go-to-market strategy from the beginning Team retention, integration,and alignment with BU Alignment of long-term strategic vision between acquired teamand acquisition sponsor High degree of involvementby acquisition product teamOwnership by sponsorshipStrategic integration9PwCM&A is an important weapon inthe arsenal of tech sector companieswhose success depends on producinga steady stream of innovationswhether those innovations occur in products, processes, or business models. As a result, the ability to identify and execute deals effciently and effectively is a critical competency well worth studying by executivesin other industries that dependon innovation for advantage, suchas healthcare, fnancial services,and retailing.The value of innovation-focused technology acquisitions is often predicated on the ability tomonetize intangible assets. Moreover, innovation-focused transactionsoften entail a long return horizonand a high risk profle. These deal characteristics create a number of challenges that M&A leaders must Conclusionmanage. The responsibility for addressing these challenges extends beyond the corporate development team, requiring continuing engagement by R&D, the product development team, the strategy function, and senior managementlong after the deal has closed. The M&A process need not end ina transaction to be successful. Its also valuable as a tool for gathering competitive and market intelligence that can be exploited strategically. Capturing and sharing the intelligence collected along the deal continuum can be of signifcant value to organizations seeking to innovate and grow, and represents an opportunity thatmany organizations have not yet explored in full.The ability toidentify and executedeals effciently and effectively is a critical competency well worth studying by executives in other industries that depend on innovationfor advantage.Copyright 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member rm, and may sometimes refer to the PwC network. Each member rm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PH-14-0080www.pwc.com/us/strategyTo have a deeper conversation about how this subjectmay affect your business,please contact:Roger Wery Principal, Strategy (415) 498 6401 roger.wery@us.pwc.comPatrick Gordon Principal, Strategy (646) 471 7978 patrick.g.gordon@us.pwc.comChris Lederer Principal, Deals Strategy (646) 471 9878 chris.lederer@us.pwc.comMartyn CurraghPartner, US Deals Leader(646) 471 2622martyn.curragh@us.pwc.com Rob FisherPartner, US Technology Industry& Silicon Valley Practice Leader, Deals(408) 817 4493rob.fsher@us.pwc.com