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The Dangerous Allure of Synergy, per Warren Buffett

“Assemblage of strengths is a huge asset,” Warren (his real name) said in a letter I received last week. He was describing his strategy to grow his business; given his success, I figured I better pay attention.

You see, Warren is that Warren, Warren Buffett, chairman of Berkshire Hathaway. His annual letter to company shareholders never fails to be a great read; no clichés, no lofty aspirational BS, but a deep dive into what’s going on in the company, and most important, why he and his partner Charlie Munger make the decisions they make. By the way, there’s a business idea out there for somebody to take his annual letters going back to 1965 and turn them into an entire MBA program. There’s more useful content in those letters than you’ll find in a library of business textbooks, but I digress.

What really struck me about Buffett’s commentary this year was his observation on Berkshire’s acquisition strategy. You see, what he didn’t say really jumped out at me. I guarantee if you ask 100 CEOs making an acquisition about the logic for their acquisition, the word “synergy” will be used in the first sentence. Synergy is an overused and frequently misunderstood concept, but the basic idea is one plus one equals more than two. In other words, when two companies come together, synergy says they are stronger together than individually.

Don’t get me wrong, I am a fan of synergy; I’ve seen it work. My former employer, The Walt Disney Company, buying Pixar in 2006 is a great example of synergy. Both companies were stronger after the acquisition than before. But here’s a dirty little secret about synergy: when used to justify an acquisition, the buyer will frequently (usually) overestimate the value that synergy brings and, hence, overpay for the acquisition.

Which brings me back to Warren Buffett’s recent shareholder letter wherein he said “assemblage of strengths is a huge asset.” This comment was in reference to the business model of Berkshire’s several insurance businesses. He never claimed his collection of insurance businesses had synergy that magically added value to the whole. Instead, he talked about how much he liked the business model of the insurance business, and that was his logic for making acquisitions in that industry. In my many years of M&A activity, I can count on one hand the number of times I’ve heard an acquirer justify an acquisition because they liked the business model of the company that was being acquired. A recent report from Bain & Company described private equity acquisitions: “they are willing to pay higher multiples for assets they view as strategic or that will lead to synergies and help fuel growth.” Simply said, the Goldman report acknowledged that some buyers are willing to overpay in hopes that an assumption of synergy becomes reality.

The way I see it, Warren Buffett might know a thing or two that corporate executives should remember: when making an acquisition, base your logic on the business model of the business you are looking to acquire, not what you think you can do with synergies in a combination of assets. If you follow Warren’s little secret, you’ll buy better businesses and likely not overpay.

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Tennessee Valley Group

Jim is an attorney (non-resident status with the Missouri Bar) and though he no longer practices law, he has read and negotiated enough legal documents to fill a cargo tanker. He has an MBA from Harvard Business School and knows how Wall Street and private equity operates. Jim is a Tennessee Supreme Court Rule 31 listed general civil mediator with tons of experience helping business owners (large and small) work through sensitive problems to achieve winning results. He is the author of "Home Run, A Pro's Guide to Selling Your Business, Seven Principles to Make Your Company Irresistible."