With the economy in a sustained recovery and lenders willing to help, many business owners are considering making an acquisition as a growth option.
Most accomplished acquirers will tell you they have learned more from their mistakes than they have from their successes. Current market conditions suggest it is a seller’s market with frothy multiples requiring an even more comprehensive assessment of the opportunity.
Here are ten things to avoid while evaluating an acquisition target based on the experience of those who have learned the hard way to do it right:
1. Poor operational due diligence
Although a checklist is necessary for effective due diligence, it is not independently sufficient. Buyers should discover everything they need to know about the business, market, operations, customers, pricing, management, etc. This requires a slightly unique process for each deal and each company.
To leave no stone unturned, tap the experience of your existing management team — but be aware that coordinating this effort can very daunting. Everyone is trying to run a business at the same time as doing a transaction. If needed, you can also get outside help for legal, financial, and operational diligence. Take the time needed to develop a good assessment plan and execute it with a realistic schedule. Shortcuts at this stage can be extremely expensive down the road.
2. Not doing a SWOT analysis and/or minimizing the risks
While there are many concerns when making an acquisition (i.e. management bench strength, operating tools, industry conditions, competitive barriers, organizational capacity, etc.) to consider during an acquisition, customer concentration is the biggest threat to success. Having a realistic assessment of company’s strengths, weaknesses, opportunities, and threats will help you match your own characteristics to what you are trying to acquire. Use your own team to develop this analysis after they have explored the operational due diligence checklist. You need a solid understanding of the strategic implications inherent in the acquisition
3. Not benchmarking the target acquisition against industry peer performance
There are numerous databases — like Sageworks, First Research and Business Valuation Resources (BVR) — are available to help you benchmark company performance. Use them to find out how well the business is being run. Comparing sales growth, profit margin and various components of the balance sheet can be extremely helpful to appreciate if the acquisition target is in the top or bottom 20% of its peer group, including both a size and industry filter.
4. Over-stating synergies
One of the most appealing part of an acquisition is the inorganic growth and synergies it can offer. But, be careful — cross selling is not a given. It takes time and is hard work to realize great synergies, even in the most obvious situations. Sales synergies are much more difficult to achieve than cost take-outs.
Careful consideration of headcount reduction is warranted to prevent people from being let go only to get hired back in a few months when its clear that an overly zealous manager acted too fast. There is usually some kind of investment for all cost savings. Know what the net contribution is; it might surprise you. There is a natural tendency to commit to too much up front, which can damage the enthusiasm of an organization during the proposed integration.
5. Poor interviewing of the top customers of the target company
Acquisitions become much less valuable if the target company loses its biggest customers during the transaction. To prevent this risk, you’ve got to ask the right questions and get an understanding of the top customers and their commitment to the new organization post-close.
Talking to the top ten accounts is not unreasonable. Getting their view of the target’s value proposition, quality and responsiveness and any recent issues, should provide a clear picture of the level of customer satisfaction and loyalty.
6. Not identifying cultural issues between the organizations
The “we don’t do it that way” attitude will kill the implementation of a good deal. Questions about culture can be asked during a separate interview with the target’s management team and then comparing answers. Asking about what makes the difference between a “good” and “bad” employee and what was done when either one was discovered will help understand how people are treated. At the end of the day, one culture should survive — pick one and develop a plan to transition the other one to it.
7. Proceeding without having the next steps lined up
According to Scott Whitaker of Global PMI Partners, who has extensive experience on integration of acquisitions, 70% of all strategic acquisitions fail due to poor implementation. Post-close communication to customers and employees, branding, and integration plans are critical. Without these, the investment is dangling in the wind and can easily get off on the wrong foot. A communication plan to the employees and customers at the time of close is imperative and will help explain why the merger is a positive strategy.
But, the drafting of the integration plan should begin once the due diligence is completed while the lawyers are negotiating language in the various closing documents. The plan should be ready to implement the day after close.
8. Not having all the key people tied down to an employment contract
There is always a hidden trap door for someone critical to the business — find it and nail it shut. It is critical for the seller to deliver the team and key people to the buyer upon closing, and that requires some careful evaluation of the employee contracts. If they are unwilling to sign a non-compete/non-solicit agreement, you may be headed for trouble down the road.
9. Paying too much
Offers need to be benchmarked against the market, risks quantified, and sensitivities analyzed. If the combined businesses — in the worst case scenario — doesn’t generate an ROI on the purchase price (without earn-outs) greater than the buyer’s cost of capital, the price is too high. If you can’t work it out with the seller, don’t walk away, run. Outside advisors skilled in this area can be very helpful in getting all parties to understand the issues and can enable a successful close or quantify the sensitivities of alternative outcomes.
10. Getting too emotional about the deal
Save the passion for the implementation in the days after close. Cool heads need to prevail between the LOI and close, demonstrating the ability to work out issues in a business like manner will get you through close or save you from a poor investment decision.
There they are, the top ten things to avoid when completing an acquisition. You may never see these on the Letterman Show, but each one can put you in a position where it will be hard to achieve your required return. Avoid these common mistakes when making an acquisition and you will be well on your way to a rewarding experience.
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