To acquire or not acquire, that is the question. Before you set your acquisition strategy, you need to explore the reasons and benefits.
Companies seek acquisitions for many reasons, some of the most common reasons for acquisition are:
- Geographic expansion in the same line of business
- Consolidation of competition in the industry
- Acquire R&D or other intellectual capital
- Streamline operating costs by plant, people, and/or technology consolidations
- Gain economies of scale in purchasing power, distribution channels, and/or market
- Improve competitive advantage against larger players
- Obtain a niche synergistic or complementary product
- Customer acquisition
For smaller companies, facing a decline in organic growth often opens the conversation of an acquisition. Even if an acquisition opportunity drops in your lap, setting a solid acquisition strategy is important. Start the process by exploring questions on the “why” and the “what” of the acquisition. Lastly, exploring the “how” the acquisition will result in a better outcome for your company and employees, no matter how good the acquisition deal looks on the surface.
Exploring the Why and What of Company Acquisitions
Acquisitions are costly and often fail to meet expectations. They aren’t always the best answer for the company, so it is a good idea to thoroughly explore any alternatives available before you take the plunge. Examine the driver behind your desire for the acquisition. Have you considered lower-risk, alternative paths to achieving your goal without acquiring a company?
Some reasons for acquiring a company and questions to explore before choosing acquisition:
- Slowing organic growth – Can you extend your own product line into new markets, new geography, or open to new customers? Can you buy a complimentary product line or open a new distribution channel? Can you cross-sell your other products in your existing markets?
- Industry consolidation is making competition more difficult – Can you acquire, or can your company be acquired at a favorable price? Can you narrow your niche? Could you amend your product to address an additional niche?
- Government regulations are creating higher cost burdens – Can compliance be outsourced to keep individual costs down?
Asking strategic questions will help you gain a new perspective. Analyzing why you want to acquire versus the alternatives will force a clearer picture of what you are really trying to accomplish. This exploration will help you to set parameters and define an ideal candidate for acquisition. This exercise will also help you avoid excess costs by eliminating those candidates that weren’t really a good fit to start.
In clarifying the “why” behind the acquisition, the definition of the “what” becomes clearer. The process of defining the “why” and “what” is often assisted by a business broker, lawyer, or other M&A professional. These professionals know the market, pricing, available deals, and businesses to approach and they can greatly assist in defining potential targets.
As you outline your acquisition strategy, it’s important to define what metrics will determine if the acquisition is a success. ROI is one measure, but not the only factor to examine. Consider other metrics that relate to the reason why. Did we succeed in accomplishing the why? Did it result in sales increases, overhead reduction, monetizing intellectual property, or was product line extension successful?
Setting Up Your Acquisition Strategy: Understanding the How of Acquisition
After hiring a team of advisors, including an experienced attorney and business broker or M&A Specialist (usually dependent on the size of the deal), the process of identifying candidates that fit your criteria begins. These may or may not be companies that are for sale. The formal search might include competitors, existing or potential partners, and those companies presented by brokers. The advisors help define candidates that meet your criteria and assist in pricing evaluation.
Letter of Intent (LOI)
After identifying a candidate and assessing their interest in a transaction, the LOI defines the basics of the transaction, stating the legal names of both parties and the intent or purpose of the transaction. It will include the stated intent (purchase the business), a purchase price, closing date, and specifics of price adjustments. It should also outline any special circumstances of the deal as negotiated. This is a legal document and should be drafted by an experienced transaction attorney.
Once the LOI is signed, both sides should be biased toward closing, not looking for ways out of the deal. There will be emotions and plenty of surprises during due diligence – not all of which should cause the buyer and/or the seller to walk. If you’re looking for the perfect deal, it doesn’t exist.
Due diligence is designed to verify the investment thesis for the acquisition and in so doing, to drive the integration checklist. Depending on the size of the deal, due diligence may be carried out by outside advisor’s team or by the internal team, if they are qualified.
Before starting the process, keep in mind that there are many concerns that may arise as your company prepares to make an acquisition. The negotiating process is the time to hash out these concerns. It’s important to keep in mind that negotiations are often broader than simply agreeing on the financial aspects of acquisition. Concerns that arise during the acquisition strategy and discussion may include:
- Due diligence – extent, timing, data room availability, and control. Access to customers and vendors, employee involvement needed.
- Personnel-related – position eliminations, benefits (insurance, PTO, sabbaticals, leaves of absence, etc.), golden parachutes, termination payouts, rewards for completing the transition.
- Physical-related – closing or consolidating locations, inventory changes (obsolete, excess).
- Assignments of contracts – leases, purchase orders, sales orders, software licenses.
- Timing and type of notifications – press releases and their approval, employee, customer, and vendor notices, cash commitments, and delivery.
As I often say, an acquisition isn’t a DIY project. Having professional support drafting letters of intent, arranging due diligence, and negotiating deal points will ease the initial burden of acquisition.
Good representation and advice in the negotiation is critical to your overall acquisition strategy. Your advisors bring experience to the table. They’ve seen many deals and thereby understand the parameters. They’ll use their experience to help prevent mistakes and improve your negotiating position. A well-negotiated deal and professionally drafted documents assure that both parties are on the same page and agree on the specifics of the acquisition.
In my personal experience, I worked on an acquisition with my boss, another owner, and their CFO in a small conference room. During the negotiations, the CFO and I both heard the same “yes” to a high-level point, but it was our responsibility to work with the lawyers to get the deal into the legal documents (as the bosses went to dinner). When we began to discuss the point, we realized we each heard a different “yes” based on the myriad of conversations with our respective bosses. In this case, “yes” didn’t mean the same thing, and we both had different interpretations of what each owner meant.
The lesson from this acquisition negotiation aided me greatly in future negotiations. It’s important to remember that agreements between the two parties need to be extremely clear. Outline the points, ask questions, reiterate for clarification. Do the detail work and get down to the nitty-gritty, rather than relying on generalizations. Extra diligence in the acquisition strategy and negotiation phase will help you avoid expensive renegotiation and redrafting down the road.
Your advisors will also have input on the types of clauses that are standard in acquisition and transactions. They will share where they saw pitfalls in the past, evaluation of pricing, as well as assistance in structuring debt and/or seller financing (if you don’t have as much cash sitting around as Apple). You just don’t know what you don’t know! Therefore, trusted advisors are vital to acquisition strategy.
In one of my acquisitions, the seller, a large local company, issued a press release stating we were closing the location. This statement was false, and I spent the first day post-acquisition on damage control. It is very important all key players are part of the acquisition strategy and negotiation. Again, your advisors offer transaction experience to avoid missing important transition items. Advisors will also typically suggest that you include a catchall clause in the contract to allow cleanup for insignificant items.
Building Trust and a Shared Vision
The details of the aforementioned acquisition strategy and negotiations will go much smoother if the seller and buyer can agree on a shared vision. The vision varies, whether it is a portfolio company, stand-alone add-on, or a fully integrated strategic combination. This sets the stage for a cooperative rather than adversarial relationship.
Combining two organizations is a complex process with many moving parts. In many ways, it’s not unlike a second marriage where the family grows well beyond the couple themselves (blood relatives, exes, steps, in-laws, etc.). If both parties focus on the success and benefit of the new organization, expected outcomes drive negotiations. Honesty and transparency lead to trust, which bodes well for the consummation of the deal.
Pitfalls to Avoid During Acquisition Strategy and Negotiations
There are many pitfalls, both legal and logistical, to avoid as you work through your acquisition strategy. Possibly the biggest pitfall isn’t due to a failure to plan out the moving pieces. One of the major stumbling blocks of an acquisition comes from a failure to consider the human and emotional side of the negotiation process.
People feel passionate about their livelihoods, especially when facing change. There’s often a great deal at stake for both parties. Beware of buyers and sellers falling into emotionally driven acquisition negotiations; these can happen in a few ways, but two of the most common are when:
- The buyer often “falls in love” with the acquisition, thereby creating many blind spots in the evaluation of the potential acquisition risks. In this case, it’s the advisors’ role to keep the desired outcomes as defined in the why and what in the forefront of the conversation. It’s your role as CEO to listen to your advisors.
- The seller, especially if an entrepreneur or founder, created the business from nothing, developed, and grew the business with years of blood, sweat, and tears. The sale of their business feels like they are selling a piece of themselves–their child. Deals fall apart if the seller did not thoroughly examine the “why” and “what” before they get to the negotiating table. Again, an advisor will help you navigate through these waters.
There are other pitfalls as well. Beware of poorly represented sellers who hire their “every day” advisors to work on a transaction that requires specific deal experience. Without knowing the standard and customary clauses and expectations, attorneys can derail a deal with unrealistic expectations. Even experienced attorneys can fall into the trap of forcing the abdication of a business deal point rather than protecting the point legally.
Beware of “fast-tracking.” If someone is in too much of hurry to close a deal, this should be a red flag. Consider a higher level of due diligence before the negotiations start. A party that is moving too slow is also a warning sign.
Setting up a strong acquisition strategy will lead to a successful deal for all parties. It’s important to the long-term health and well-being of your company that you maintain your reputation for fairness, honesty, and transparency throughout the acquisition.
Bring on trusted advisors to help steer you in the right direction with their insight and experience as you navigate the acquisition strategy and negotiation process. As a CEO, it’s your job to listen to your advisors and carry out a strong plan for the future of your business.