Originally published in HLB's Insights.
Value creation in any business is rooted in growth. All other things being equal, higher-growth businesses enjoy greater transaction multiples (and, consequently, value) than do companies with lower growth rates. Growth in a business comes from five different sources:
- Expanding the product set offered
- Reaching more customers through existing channels
- Expanding sales and distribution channels
- Vertical or horizontal integration
- Creating new strategic business lines
All of these growth sources can be built internally or bought through acquisition.
To Buy or Build?
How do owners or managers decide to buy or build? Generally, teams make decisions based on the tradeoffs between the two, and strategic need will drive such decision making. The tradeoffs that enter into these decisions revolve around speed (a buy decision can execute faster than a build strategy), cost (generally higher and front-end loaded for an acquisition) and risk (a buy decision is usually “all or nothing” while a build decision provides an “out” if the strategy does not execute to satisfaction).
Due Diligence and Strategy for Buying
A growth strategy centered on making an acquisition (or series of acquisitions) should be designed as any other strategy. What is it that you are trying to acquire? The list of attractive attributes of acquisition candidates typically include:
- Speed of market entry
- Supply chain security
- Product lines
- Intellectual property
- Management talent
- Capacity absorption
- Operating synergies
Other considerations during an acquisition include:
- Affordability: The affordability of an acquisition and having financing sources available to close the deal must also be considered in developing a strategy. Commercial lenders remain inwardly focused on existing portfolios and customers’ credit quality and needs and may shy away from “story” deals that rely on pro forma synergies to work. That said, opportunities always exist, so take the time to develop these relationships.
- Culture: Keep cultural fit of a company firmly in mind when considering possible sellers.
Take the time up front to create granular criteria of strategic and cultural fit as well as the cost to acquire. Once this criteria is developed, assemble target lists of potential acquisitions on which to focus outreach efforts.
Not knowing the answers to the above questions creates the risk of wasting scarce resources (time, cost of analyzing opportunities, etc.). With a solid acquisition strategy and plan in place, companies will not be reviewing multiple opportunities with targets that do not fit their needs or be distracted from the day-to-day of running the business with sellers that will not fit.
Do Not Go it Alone
When prospective clients take the time to develop and plan an acquisition strategy, buy-side engagements are attractive and rewarding to advisors. An advisor will also assist a company with securing the capital required to close the deal and run a process to keep the company’s involvement to only that which is necessary, minimize valuation and maximize mission alignment between buyer and seller.
A significant challenge to succeeding with an acquisition strategy is the work involved in integrating operations after the transaction has closed. Even if an acquisition strategy is well designed and executed, not taking the time up front to consider how organizations will be merged can prove costly and time-consuming, and in extreme cases, acquisitions that do not have a properly planned integration fail. Start early and involve the entire management team, particularly finance and HR, once it becomes apparent that a prospective target is becoming a true opportunity. Assess which management team members from both companies will be retained and which will either be superfluous or the best of both organizations.
Involve the rest of the advisory team as an acquisition begins making progress. Both outside legal and accounting teams should be involved from the start. They can help work through term sheets, structures, documentation and how a financial statement combination will look post-deal, as well as tax implications. Experienced attorneys and accountants will provide independent guidance and advise when to put the brakes on before making costly mistakes. Consulting advice before you begin the process to establish acquisition criteria is an important service offering from GHJ. The firm also assists with building a holistic advisory team to ensure harmony on a company’s side throughout the process.
Looking to the Future
The COVID-19 pandemic has created unique opportunities for acquisition success. Competitors may be under financial stress and have need of a lifeline to survive. Strategic customers or suppliers may find themselves in similar straits and may be seeking a merger. In many industries, acquisition multiples have declined materially during the pandemic, presenting more attractive valuations for buyers and making financing potentially easier to obtain.