UK: Acquisitions – A Good Deal For Your Business?

Last Updated: 5 September 2011

Acquisitions, mergers and rollups are taking place at a record pace. These days, it seems, everybody wants to acquire another company. But just because acquisition deals seem to be going down on every corner does not mean that everyone should pursue an acquisition strategy.

Acquisitions carry a high degree of risk. When properly planned and implemented, an acquisition strategy can be a legitimate growth strategy for companies of all sizes. But when acquisitions fail, they generally fail big-time.

This article addresses nine crucial acquisition issues:

  1. Is an acquisition strategy right for you?
  2. What makes for a good acquisition?
  3. How to do successful acquisitions
  4. Finding the right acquisition candidate
  5. Due diligence: checking out the acquisition deal
  6. Determining the value of the acquisition target
  7. Negotiating the acquisition deal
  8. Managing transition: seeing the acquisition deal through
  9. Avoiding the deal-killers1.

1. Is an acquisition strategy right for you?

There are many legitimate reasons for acquiring another company. These include:

  • expanding your markets
  • acquiring people, systems or processes
  • acquiring new products, services or customers
  • achieving economies of scale
  • reducing expenses
  • creating opportunities for cross-selling
  • acquiring new distribution systems
  • eliminating competition.

Ultimately, however, all legitimate reasons for implementing an acquisition strategy fall under one all-encompassing umbrella: the desire or need for quick and substantial growth.

When you get down to it, the only real reason to acquire another company is to create significant growth. If you want to grow incrementally, don't bother planning an acquisition strategy.

To tell whether an acquisition strategy makes sense for your business, ask three simple questions:

  • What are the different ways I could grow my business?
  • Could an acquisition help me achieve that growth?
  • What larger strategic goals will that growth help me to accomplish?

2. What makes for a good acquisition?

To secure a worthwhile acquisition deal, you need to have:

  • a solid foundation in place, meaning that your people, systems and resources are sufficient to handle integrating an acquired company
  • a well-planned acquisition strategy
  • realistic acquisition plans in terms of expectations and time schedules
  • appropriate price and terms, with a "realistic" debt load
  • clear and well-executed people/transition plans
  • reasonable additional capital investment requirements
  • clarity around your personal and professional expectations for the deal.

Before making any M&A deals, ask yourself:

  • Will this acquisition increase our profits?
  • Will it improve the balance sheet?
  • Is the risk acceptable?

If you can't answer "yes" to each question, don't do the deal.

3. How to do successful acquisitions

To ensure a successful acquisition, get your acquisition strategy right first. Formulating an acquisition strategy requires four basic steps:

  1. Identify your goals.
  2. Consider other alternatives.
  3. Establish key parameters for the acquisition deal.
  4. Create a one-page acquisition criteria sheet.

Once you have completed these steps, you're ready to start looking for a company to acquire.

Before diving head-first into an acquisition, however, make sure you have the right foundation in place in your own business. This includes:

  • computer and information management systems
  • management teams
  • financial planning and reporting
  • human resources.

Strategic issues surrounding acquisitions

Potential buyers should answer four sets of strategic questions before making an acquisition:

  1. Does the company to be acquired clearly fit into my growth strategy? Will the acquisition increase my competitive position or my profits, either through growth in revenues, efficiency gains, breakthroughs in technology or some other quantifiable measure?
  2. Will the transition work smoothly? Will the existing business and the acquisition integrate well, physically and culturally?
  3. Am I acquiring the company at the right price? Do I have the right deal structure? Does the present value of the cash I expect to receive from the acquisition deal exceed what I will pay to acquire the company?
  4. What synergies – either in terms of revenue enhancements or cost reductions – do we intend to achieve via the acquisition? How and when will we achieve them?

Controlling the acquisition risks

One of the primary concerns in any acquisition is how to control the risks. The first step in this process involves developing a good acquisition strategy. Other risk management strategies crucial to any acquisition plan include:

  • conducting effective due diligence on the company you are acquiring
  • using the terms of the acquisition deal to get the seller to share in the risk
  • having a written transition plan
  • assembling an experienced acquisition team to consummate the acquisition deal.

If at any time during the acquisition deal the risk level exceeds the expected return, walk away.

4. Finding the right acquisition candidateTo guide your search for qualified acquisition candidates we recommend developing a one-page "acquisition criteria sheet" that outlines:

  • who you are, what you do and where you do it
  • your company's core competencies
  • how you are financed
  • what you're looking for in an acquisition, including:

- type of business

- size of business

- where the acquired company could or should be located

- whether you want to buy all or part of the business

  • whether you want to acquire people, places or things, or stand-alone business units
  • examples of what the acquisition deal could look like (if you have already done similar deals)
  • the contact person at your company.

Keep your acquisition criteria short and to the point. If you can't fit the information on one sheet of paper, you haven't defined your acquisition criteria clearly enough.

With acquisition criteria sheet in hand, you can now start looking for companies to acquire. Acquisition candidates can be found in many different places, including:

  • related companies
  • customers or distributors
  • vendors
  • trade shows and industry association groups
  • salespeople
  • the internet.

Once an acquisition candidate meets your initial deal criteria, the next step is to assess the potential synergies in the acquisition deal. Synergies come in two categories: performance breakthroughs and revenue enhancements. Without synergy in at least one of these areas, the acquisition deal will likely fall flat on its face.

In addition to assessing the potential synergy from an acquisition, ask the following questions:

  • Does the acquisition candidate clearly fit in with our growth strategy?
  • Will the acquired company integrate well (operationally) with our business?
  • Can the cultures of the existing business and the acquired company be integrated?
  • How will acquiring this company improve our competitive position?

Successful buyers share four essential traits: discipline, persistence, patience and timing. Work out what you want, stick with your acquisition criteria, take the time to initiate and develop relationships with potential acquisition candidates, and be ready to take advantage of acquisition opportunities when they arise.

5. Due diligence: checking out the acquisition deal

How do you know whether a potential acquisition deal will really work? Answer: do your homework.

Anyone acquiring another business should do in-depth due diligence in three critical areas:

  • marketing
  • financial
  • legal (which includes environmental concerns).

Marketing due diligence involves taking a hard look at your assumptions regarding the acquisition candidate's future revenue growth and profitability assumptions, as well as assessing the market's key leverage points and how those might be changing.

Financial and legal due diligence can be covered by examining the acquisition candidate in four key areas: assets, liabilities, cash flow and revenue, and growth rate.

There is also a fifth equally important area: 

  • cultural due diligence.

Carrying out cultural due diligence means researching how the acquisition target is run, how its management reviews, evaluates and rewards employees, and how its management sets performance expectations.

To conclude the due diligence process we recommend creating financial projections using different scenarios. To "pro forma" the deal:

  • List all your assumptions (in detail) regarding the acquisition deal.
  • Re-examine the potential synergies from the acquisition.
  • Do two to three-year cash flow pro formas.
  • Determine whether the projections indicate a workable acquisition deal.

To enhance your overall due diligence efforts:

  • Create a cross-functional due diligence team.
  • Have every member of your due diligence team ask people at all levels in the company to be acquired: What are the three biggest problems in this business? What are the three biggest opportunities in this business?
  • Avoid the two biggest due diligence mistakes: over-confidence in the acquisition target's future revenue growth and profitability, and misunderstanding the business you intend to acquire.
  • Keep your "bullshit" detector turned on high and avoid surprises.

6. Determining the value of the acquisition target

Before attempting to place a value on the company you want to acquire, it helps to understand three fundamental principles:

  1. The method used by a buyer to value a seller candidate is unique to acquisitions.
  2. Valuation is seller-candidate-specific.
  3. Price and value are not the same thing.

The value of a business is a reflection of four key elements: assets, technology, cash flow and synergy. Together, the first three represent the "stand-alone value" (SAV) of the business, which equals the value a professional valuator will place on the seller's business. Business valuators do not include synergy in their calculations of the seller's value; synergy can only be calculated by the buyer.

The "buyer's economic value" (BEV) establishes the maximum price you can pay and still have a successful acquisition deal. To determine BEV, subtract the pre-acquisition SAV value of your business from the value of the combined companies on a post-acquisition basis. Your BEV represents the high end of the price negotiating range.

The SAV of the seller candidate sets the minimum price the seller will ask (a rational seller will not sell his company below his SAV). The final price agreed to during negotiations will fall somewhere in between the SAV of the seller candidate and the BEV.

To avoid losing value in the acquisition deal, keep a close eye on the premium – the amount you pay above SAV. When calculating value keep the following in mind:

  • Synergy drives everything in an acquisition. Don't get involved in an acquisition deal that can't generate synergy.
  • Never try to force the numbers. If you have checked the numbers several times and the synergy isn't there, rethink your acquisition strategy.
  • Even if the numbers work, don't consider the synergy as a given. Creating the synergy is always harder than it looks on paper.
  • Recognise that price out the door does not represent the entire price. As the buyer, price equals the cash you pay for the business plus any debt you assume.

Successful acquisition deals involve finding the right seller at the right price with the right approach. If you do these three things right, you can do a lot of other things wrong and it won't matter that much. But if you do even one of these wrong – especially paying too high a price – you can do everything else right and still have a lousy acquisition deal.

7. Negotiating the acquisition deal

To get the best acquisition deal, let the seller set the price – as long as you get to set the terms. In many cases, creative use of terms will allow you to meet the seller's price without paying more than you want.

For example, suppose a business owner wants £2 million for his company but you value it at £1 million. If you structure the acquisition deal as £100,000 down, £400,000 in five one-year, no-interest notes, and £1.5 million as 5% of sales, the owner gets his asking price while you will pay only slightly more than £1 million (based on present net value of the five-year payments).

Equally important, you get the seller to share the risk. If the acquired company goes into the tank over the next five years, you only pay 5% of whatever the business ends up being worth.

When negotiating acquisition terms:

  • Pay as little cash as possible.
  • Use contingent payments that have a finite cut-off date.
  • Include any consulting agreements with the owner as part of the acquisition deal, not as an add-on.
  • Buy inventory on consignment, so that you pay for it as you use it over time.

When acquiring a business, it's always easier to reduce risk through creative terms than through lowering price. The more you can use terms to get the seller to share the future, the more you share the risk of the acquisition.

In terms of the overall acquisition negotiations, keep the following in mind:

  • You can't negotiate a good deal unless you're willing to walk away.
  • Probe on price but don't react to the answer.
  • Early in the relationship, look for ways to softly say "no".
  • Keep your ego in your pocket. Ego kills a lot of otherwise good acquisition deals.
  • Limit your lawyer's role to helping you document the acquisition deal and making sure all your decisions are properly and legally implemented.
  • Recruit a professional acquisition negotiator.
  • Go slow and build the relationship with the seller.
  • Avoid an auction situation.
  • Keep asking why the company is for sale until you feel comfortable with the answer.

In order to negotiate a good acquisition deal, be prepared to walk away at any time. Constantly ask yourself: "What will cause me to walk away from this acquisition deal, and am I there yet?" Knowing your walk-away points and sticking to them will save you a lot of grief in the long run.

8. Managing transition: seeing the acquisition deal through

Every acquisition has a "hard" and a "soft" side. The hard side of an acquisition represents the numbers – the cash flows, revenue streams, cost savings, valuation, price and terms. The soft side of an acquisition represents the people side of the equation. While most CEOs focus the majority of their time and attention on the numbers, the people issues often make or break an acquisition deal.

The CEO of the acquiring company needs to take a very active, hands-on role during the transition period. In particular, he or she must:

  • set crystal-clear performance expectations
  • communicate those expectations to all levels of both organisations
  • lay out what the transition will look like
  • address the WIIFM (what's in it for me?) factor.

Transition planning for acquisitions

Acquisition creates change, especially for people in the company being acquired. And as we all know, people tend to resist change. Unless you address their issues in a forthright manner, the transition effort can quickly grind to a halt.

A good transition plan addresses the following areas:

  • Who will do what, by when?
  • How will decisions be made?
  • What will the new reporting structure look like?
  • Do you intend to integrate the new people into your physical facility or keep them in theirs?
  • How will everything fit together?
  • Will the current systems support the planned changes? If not, what changes need to take place so that they can?

An acquisition transition plan needn't be overly complex or detail oriented. In fact, the shorter, simpler transition plans often work better – as long as they conceptually integrate all the key parts and players. To enhance your transition efforts:

  • Create the transition plan before you sign the acquisition deal.
  • Get involved and be visible.
  • Hit the ground running and make quick decisions.
  • Be honest.
  • Don't confuse cultural differences with political manoeuvring.
  • Avoid unplanned turnover.
  • Keep the best of the best.
  • Don't put new people in new jobs.

Above all, transition requires a team effort. To succeed, get the managers in both the original business and the acquired company working together early on and keep them involved throughout the transition.

9. Avoiding the deal-killers

It is a fact that only about one out every three acquisitions actually achieves its stated pre-merger goals. Some of the most common (and lethal) culprits are:

  • bad acquisition strategy
  • failure to properly analyse the acquisition deal synergies
  • bad chemistry and cultural conflicts
  • unrealistic expectations
  • failure to consider the potential impact of the acquisition on your core business
  • lack of – or poorly implemented – transition plan
  • sloppy due diligence/ignoring red flags
  • emotional buying
  • unrealistic debt load
  • failure to spend money on acquisition professionals.

Remember, this represents only a partial list of everything that can go wrong in an acquisition. No matter how you look at it, acquiring another company is a risky business. Go into it with your eyes open and know that a lot of things have to go right in order for your acquisition to succeed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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