‘In the land of the blind the man with one eye is king’
A client of mine recently asked me – “Doug what should I be looking out for as I enter these acquisition negotiations?”
As we are seeing a marked increase in M&A activity of late, attributable to a number of reasons but perhaps most specifically due to the fact that the Baby Boomer phenomenon, widely touted for a number of years, is in fact now reaching a crescendo, I thought I would share some thoughts on the subject.
As a starting point it is fundamentally important to acknowledge that most acquisitions don’t deliver on expectations and in most instances acquisitions fail to deliver an increase in shareholder (owner) value. One may go further to suggest that many acquisitions in fact result in considerable unanticipated disruption, a loss of business focus, cost and even loss of short and long-term value.
I guess one should therefore pause to ask the question – “If this is true why would this be the case and should I wish to conduct an acquisition how can I avoid this happening to me?”
My initial suggestion to you is remain totally objective and if you are not very experienced in this area get professional advice and support. Too often people get caught up in the emotion of the transaction, tending to lose sight of the reasons why they should want to do the transaction, or more importantly the reasons why they should not want to proceed with the transaction. Remember your guiding principle should be to increase shareholder value and to ensure that the combined entity post-transaction is stronger, more capable and of increased value. This is simply not possible if you pay too much for the acquisition to start with, which has been proven to very often be the case. So why do people pay too much and what typically goes wrong? My experience has been that:
To Start with they don’t have a clear strategy and have never carefully considered a growth-by-acquisition strategy and the implications thereof;
They get caught up in the emotion of the transaction, wanting to complete it at all cost;
They don’t perfectly understand what they are looking at and what they should be looking for;
They either don’t know at the outset, or lose sight of, the reasons why they should, or should not, conduct the acquisition;
They don’t know exactly how to value the target and what to look for in the valuation, most often not being rigorous enough in the valuation process;
- They overstate the anticipated synergistic, rationalisation and other benefits;
- They structure the transaction inappropriately;
- They don’t carefully and correctly consider the tax implications in the transaction;
- They lack post-transaction integration capability and strategic know-how;
- They underestimate the level of resources, time and commitment that will be required in successfully implementing the acquisition, and the distraction that this process may have on the current business and current and planned initiatives;
- They either don’t see or under-estimate the costs associated with bring the two entities together, which can often be quite considerable;
- They are poor negotiators, often paying away some of the identified value to be ‘potentially’ derived from synergistic and rationalisation benefits; and
- They don’t conduct a thorough due diligence or lack the knowledge and understanding of how to conduct the due diligence process.
Against this backdrop I provide my thoughts on what your approach to completing a successful acquisition should be.
- Be very clear in your strategy and the reasons why you want to conduct ‘the identified acquisition’ or why you may want to embark upon a strategy of growth-by-acquisition. This is a vast subject which includes endless very good reasons why you may want to conduct one or more acquisitions. The challenge is to know what they may be and more specifically which reasons apply to your situation and strategy. This process should include some thought about what competitive advantage may be gained in completing the target acquisition and potentially what may be lost should a competitor complete the acquisition, for example the acquisition of scare resources, valuable clients, intellectual property, important market share, etc;
- Commit adequate resources to the process and slow the process down. The use of time pressures and urgency is an old negotiating tactic, which could be used to pressure you into rushing through the acquisition and negotiation process resulting in sub-optimal care, thoroughness and due diligence. Make time your friend and be prepared to walk away;
- Gather as much information about the target as possible and ensure that the information you are provided is up-to-date and of high quality. This information should include audited financials if available, most recent management and tax reports, tax submissions, client details, material contracts and so much more. This information will be critical in your valuation and due diligence process and it is highly recommended that you seek professional advice and support in this area from your accountant or other advisor;
- Be rigorous in your approach to valuing the acquisition target, remembering four key things in particular:
- Ensure that the target acquisition will deliver a Return On Investment (ROI) above your cost of capital, and more specifically this should be a Cash Flow Return On Investment (CFROI);
- Identified ‘potential’ synergistic and rationalisation benefits are yours and not the vendors. Too often I see negotiations around the potential benefits that may be derived when trying to arrive at an agreed valuation of the acquisition target. Firstly, these benefits are not always easy to achieve or sometimes not achievable at all, they often come with a cost and almost always the acquirer has to make the effort in achieving them;
- Cross-check your valuation approach and methodology. Initially you should select the correct valuation approach. Typically this could include the DCF model or the Multiple approach, with most parties gravitating towards the EBIT Multiple approach largely because of its relative simplicity. It is important to remember that different valuation techniques take different factors into account and often yield different outcomes. It is therefore important to clearly identify what you should be taking into account given the information at your disposal and the nature of the business you are acquiruing, trying to select the most appropriate technique and then you should apply one or more other techniques to cross-check and test your outcomes; and
- Set very clear opening and walk-away price points which ensures that identified value is delivered to the acquiring entity and its shareholders;
- Now clearly identify the anticipated benefits of the acquisition, rationalisation and other, and factor these into your valuation process. At this point you should be carefully considering the post-acquisition integration process. It is important that you identify and dedicate resources to this process and that they are introduced into the process as early as possible as it will be their responsibility to deliver on the acquisition expectations. The post-acquisition integration team should compile a thorough integration plan, detailing the process to be followed post-acquisition, clearly identifying the targeted acquisition benefits and associated time-lines. Be very careful not to credit the transaction with false synergistic and rationalisation benefits. It is important at this point to also carefully consider and identify the associated costs of post-acquisition implementation and the derivation of the identified acquisition benefits. Identified rationalisation cost savings are often only achievable at a cost, for example it is extremely expensive to consolidate offices, factories and warehouses, IT systems integration is extremely disruptive and costly, people savings almost always come with significant redundancy costs, and the list is endless. The post-acquisition team or your advisors may want to simulate the post-acquisition integration process, producing a step-by-step implementation action plan which translates into post-acquisition pro-forma financial statements and forecasts which test the theory, based upon the probability and sensitivity of possible outcomes. If the implementation team are made accountable for their analysis and plan, this exercise will build realism into the valuation and implementation process;
- Carefully consider the tax implications of the proposed transaction and the preposed method of acquisition, i.e. do you purchase the entity or the entity’s assets. This decision has extremely far-reaching implications both in the short and long-term and it is highly recommended that you get quality tax advice well before you conclude your transaction;
- Carefully consider your negotiation strategy and tactics as so much is won or lost at this point. Often the mistake is made in believing that this is a simple process and that the discussions can be concluded over a quick cup of coffee – not true! This is a separate subject which I will return to in a later communication, suffice to say you would be well advised to take advice in this area;
- Carefully consider the structure of the transaction, paying particular attention to payment method and timing, transaction risks, what and who is required to make the transaction successful and so on. There are so many ways to successfully structure an acquisition, all of which may have differing and far-reaching implications. This is a complicated and often multi-faceted area which is best dealt with by an experienced professional;
- Enter a ‘non-binding’ Heads-Of-Agreement (HOA) which clearly sets out the most important points of agreement along with any important ‘non-boiler plate’ provisions and conditions;
- Get your lawyers to conclude the sale agreement, paying particular attention to special conditions and provisions, which may include valuation methodology and dependencies, undertakings given by the vendor, payment methodology and timing and so much more;
- Conduct a thorough due diligence process. This process is intended to confirm that what has been presented to you is in fact true, that there is not missing information, and that importantly there are no ‘skeletons in the closet’. This process is best conducted by your accountants or advisor;
- Embark upon your post-acquisition integration process with gusto and speed. Potential synergistic, rationalisation and other benefits must be realised as quickly as possible, preferably in the first 12 to 18 months after the transaction or the potential value enhancements may be lost. Furthermore, the longer senior management are preoccupied with the internal details of the integration, the more likely they are to lose focus on the business; and
- Finally, don’t declare victory too soon. Senior management often settles for sub-optimal decisions and outcomes. Often potential benefits that are identified are never completely captured because the organisation loses its concentration and as a result substantial value is left on the table.
We wish you well in you acquisition strategy and efforts, the time has never been better with the wave of Baby Boomers now seeking to exit their businesses over the next 10 years. We invite you to please call us should your require assistance.