Every progressive company is interested in growth. The question of how to go about growth is different for each company depending on their strategy and resources. Some companies are positioned in their market so that they can grow internally and get a higher rate of return on that investment than they can by making acquisitions. Others see a better ROI by diversifying, adding another company's lines or markets, or by maximizing the efficiency of their organization through acquisitions.
Strategy is only one part of the puzzle, since acquisitions require significant financial resources. Regardless of whether the plan calls for using existing cash, borrowing or equity, growth through acquisitions requires that the impact on resources is concentrated at the time of the acquisition, rather than spread over several years of internal growth.
Most companies that are large enough to acquire others have already learned that even though it may appear expensive, it is usually easier to acquire than to develop internally. The decision to acquire begins with an analysis of your current IRR. This is the rate that you can earn by employing your capital internally with plant expansion, developing new markets or products, opening new branches, etc. If you find that you can earn 15% on monies invested internally, or you could acquire companies for an ROI of 20%, you should be in an acquisition mode.
If you find yourself in that mode, do you want to simply buy competitors and increase revenues, or are there synergistic products/services and markets that could maximize your current marketing operation? Consider whether you should be adding new geography or adding new lines in your current area. Develop a strategy before you start the process of looking for acquisitions. Because using internal personnel to do the searching and legwork is very expensive, we recommend using a merger and acquisition (M&A) expert to advise and guide you.
Buy Large or Buy Small?
With a goal in mind and a budget set for acquisitions, is it better to buy several smaller companies or find one large target and invest it all? Seasoned players can argue both sides, and there is not a clear-cut answer; you should be opportunistic. If you find one large target that is a great fit and a good financial investment, go for it. But do not overlook the fact that it is just as probable that you can find several smaller targets that may accomplish the goal. This strategy spreads your risk, but since small transactions are just as difficult and costly as large ones, there are disadvantages, as well. Another consideration is management resources. It is a fair generalization that smaller companies will require more of your current management's attention, since smaller companies tend to be thin on experienced management. The larger companies should have greater depth in this area, but always look below the surface. If your management resources are already stretched, the management of the target may be the most important element in a deal.
The following elements of an acquisition analysis are provided, assuming the reader is a strategic acquirer, not a financial buyer. The strategic buyer should be looking for synergies with his current operation and companies that take the company closer to stated strategic goals. The financial buyer looks at each deal as a stand-alone investment. The following are not presented in order of importance, as this will vary from one deal to another.
- Synergy: Does this company fit with your current operations? Will each company benefit from the operation of the other? Simply put, will the two earn more money together than they can apart?
- Management: Unless you plan to totally integrate the two and absorb the entire operation under your current staff, the management that comes with the acquisition is important. Be sure to look at this element from two perspectives. There may be management in the acquisition that can benefit your current operation.
- Products/services: Can the products/services be sold by the same marketing staff? Can the cost of manufacturing or servicing costs be lowered by combining the two? Are both products/services usually sold to the same companies and possibly the same person within those companies? Will the track record of one product/service boost the sale of the other? Does combining the two give you a new competitive advantage? Can you substantially reduce your marketing costs by this combination? Does the new product/service replace some of your products now facing obsolescence?
- Markets: Can this acquisition jump-start your entry into a desired market? Is the reverse true? Can your costs be reduced by selling both products/services in one or both markets? Does the new product/service allow you to diversify from a maturing market with limited growth?
- Savings: Savings usually result from overlapping operations, personnel or overhead. We see more acquisitions that offer increased profits through growth than through savings, but this is often a valid reason to buy a competitor or a company similar to yours that is in an adjoining market.
- Growth: Companies can grow by selling more products/services to existing customers, by getting a larger market share, by riding growth in the industry, or by selling new products to its current customers. Does this acquisition accomplish one or more of these?
- Capacity: Some acquisitions work if one company's assets are under-utilized and the other's are stretched to capacity.
- Price: Price cannot be discussed without discussing terms. Any price for any business is reasonable if the terms are right. Would you pay $10 million for a company earning $100,000 per year if you could pay just $10,000 per year for the business, with no interest or security? Unrealistic, yes; but it makes the point.
Companies that have decided that their growth strategy should include one or more acquisitions should not sit back and wait for opportunities to present themselves. There is little question that a company that presents itself for sale, either directly or through an intermediary, is a serious seller. But the downside is that if this is a good company and it is proactively marketed, you may well have to pay a premium to beat out the competition. Our experience tells us that for every one company that is "for sale" there are four that would like to sell, but will not seek out a buyer for fear of losing confidentiality or some perceived negotiating advantage.
Acquirers that search out those other four often make the best deals. They are able to negotiate without competition and may be the only buyer to ever see the opportunity. There is more work involved in a proactive search, but multi-million dollar transactions deserve the extra mile.
A professional intermediary may be a very good investment if you do not have staff that can be dedicated to the process of researching, approaching, qualifying and visiting prospective acquisitions. Your intermediary will also keep your intentions confidential, which we find is important to most companies in acquisition mode.
You should have enough confidence in your intermediary to let him or her assist in the negotiations and develop a rapport with the seller. This enables you to work through the difficult days of negotiations and avoid irrevocable personal conflict with the seller that may be your new employee. A qualified intermediary will save you a tremendous amount of legwork and travel gathering information and eliminating poor deals early on. He should be your eyes and ears as he interviews prospective sellers to determine motivation, expectations and chemistry. He or she should be in tune with your strategy and have a feel for what will work and what will not. He will not waste your or their time on poor deals since the deal must close for them to make a profit.
There is no set formula that can be reliably used to price acquisitions. Look back at your IRR and determine what you can pay for a given opportunity. That is your ceiling price, and anything under that is justifiable. You certainly do not want to pay more than you have to, even if the price fits under your ceiling. The buyer should focus on the past and projected income statements, not the balance sheet unless the seller plans to liquidate the company. There is no question that a strong balance sheet reduces the risk and makes the company easier to leverage, but it is the earnings that pays the debt and the ROI.
This is a complicated subject that warrants expert advice from your M&A advisor. Be aware that buyers can maximize the investment by working with sellers in creative ways to get the best outcome. No two deals look alike, so be prepared to negotiate terms that produce a win-win.
Although you should not expect the seller to carry a large amount of the selling price, it may be wise to have him carry a token amount so he has incentive to assist in the transition.
The decision to grow through a merger or acquisition is a big step that requires an experienced strategist. For assistance in any stage of your acquisition planning, contact us at 913-648-0185 or email us at email@example.com