M&A purchase transactions can be successful in any economic climate for a buyer with a clear investment thesis that systematically and strategically: (i) prepares early and plans well; (ii) selects acquisition targets wisely; and (ii) executes his or her planned acquisition process with discipline and competence.
In good economic times, credit is generally abundant, numerous acquisition targets are typically available for purchase, and upbeat attitudes in general help deals move forward. The opposite tends to be true during economic downturns, although, for the well-prepared buyer that is relatively strong strategically and financially, recessions provide rare opportunities to obtain bargains and fire-sale prices that can produce outsized returns.
Whether the economy is booming or slumping, a successful buyer is always focused on using an acquisition to strengthen his or her existing competitive position/foundation. Such focus requires having a clear investment thesis.
I. A “Clear Investment Thesis”.
Having a “clear investment thesis” means you clearly understand how a potential acquisition could strengthen your current competitive position/foundation, and how — assuming the acquisition is successfully completed — the acquisition would enable your business to do what it already does, only better.
Allowing your business to do what it already does, only better, raises the fundamental question of what your business does. The answer to this question will be largely based on how you view (or should view) your business, which is key and is not nearly as simple as it may initially seem.
To determine what your business is, so you can develop a clear investment thesis, you need to ask yourself questions such as: Why is my business making money? What is my competitive advantage? What are my current results, and what could make them stop? Who are my customers/clients? Are any changes in technology disrupting my competitive position/foundation, either today or potentially tomorrow? What trends are occurring in the marketplace that is affecting or could affect my customers (or my desired customers), even if only indirectly? How do I envision my business will (or should) look in 5 years? In 10 years? In 20 years?
Once you create a clear vision of what you want for your business in the future, you can work backward to organize your plans and strategies to build your optimal desired future.
II. Preparing Early and Planning Well, Selecting Your Acquisition Targets Wisely and Executing Your Planned Acquisition Process with Discipline and Competence.
a. Planning How Best to Succeed – Creating Your Acquisition Plan
Your acquisition planning begins with your selection of your acquisition management team (the “Team”). Team members should bring different skill sets to the acquisition effort, and Team responsibilities should be allocated among various Team members based upon their respective skill sets. You should chair the Team, and you may want to include your business mentor (if you have one) as part of your Team to assist you in organizing and coordinating its efforts.
Your Team should develop outcome-focused “acquisition target attributes” and “acquisition target quantitative metrics” based upon the acquisition outcome desired. These attributes and metrics should serve as key gating parameters that will define both your target selection as well as the success of your acquisition effort.
Broad and important questions that should be asked and answered include, without limitation:
- What are the success criteria for the acquisition effort?
- What business gap(s) or shortfall(s) is the acquisition attempting to address?
- What are the desired target attributes and desired target quantitative metrics, and are they consistent with the clear investment thesis?
- Should any qualitative metrics be considered, and if so what are they?
- How will target companies to buy be located and chosen?
- How much can we afford? What purchase price range in general is acceptable?
- What is the acquisition timetable?
Some of the target quantitative metrics should include desired minimum financial metrics, such as target balance sheet quantities and earnings. Some of the target attributes you may wish to consider include qualitative values such as if your target should have an “economic moat” around its business, whether your target should have a tight “cultural fit” with your company, and whether other “soft factors” such as entrepreneurship, integrity, and reputation are important value components in your acquisition selection.
b. Acquisition Financing: How Much of a Purchase Price You Are Prepared (and Able) to Pay, From Where Will the Payment Come, and What Type of Acquisition Financing Will Be Used
You need to decide in your Acquisition Plan how much of a purchase price your company is prepared (and able) to pay for your tentative acquisition.
This question is generally answered by the current financial condition of your company, how much third-party “acquisition financing” you can secure (assuming you do not intend to solely self-fund), and how much within those constraints you are prepared to spend.
Also, you need to think about and decide upon what type or types of acquisition financing you intend to offer your target, with the most common types being cash, stock, term loan, and SBA 7(A) loan. Please note that there is an entire “business funding solutions industry” that wants to help you (and themselves) with a myriad of financing solutions to assist you in financing your tentative acquisition.
Last, it can often be useful to include earn-out provisions and rollover provisions in your purchase bid to make a competitive offer that aligns the parties while protecting you from potentially overpaying.
III. Three (3) Best Practices of Successful Buyers.
During your overall acquisition process, three (3) best practices of successful buyers that you should always keep in mind are the following:
a. From Time to Time Update Your Target List for the Changing Environment of Today and the Direction of Tomorrow (Based Upon Your Clear Investment Thesis).
Be aware that once-successful business models may no longer work, or may be about to decline, fail, and be replaced. Target companies that were once market leaders may be headed for a major fall.
The key is for you to have a clear investment thesis that reflects both the new market reality of today and the direction of tomorrow. You should not attempt to use your acquisition deal to totally reshape your existing competitive position/foundation. You should use your acquisition deal instead to strengthen it and to do what you already do better. Remember: You should use every acquisition you make to give yourself a better competitive advantage against your rivals.
Accordingly, you need to evaluate each of your tentative acquisition targets and update your target list for the changing market environment of today, and for where you see your market headed tomorrow. You can emerge stronger from even a poor economic climate as long as your deal is based on a sound assessment of new market conditions as they affect your business.
b. Getting Your Real-World Target Valuation Correct (For You).
Based on your (i) financial due diligence review of your target, and (ii) general financial review of the current marketplace for similar targets (and recent sales of such targets), you should determine a valuation for each of your tentative targets and decide how much of a premium (based in part on its special strategic value to you), if any, you are potentially prepared to offer to acquire each of them. Also, you should decide in advance how much you are prepared to increase your offer if you find yourself in a competitive bidding war, so you do not become overly emotional and end up overpaying and later regretting it. Draw for yourself in advance a “line in the sand” and be disciplined. Remember: Having no deal is better than having a bad deal.
c. Being Patient, and Performing an Extremely Thorough Due Diligence Review of Your Target.
Your target will be in a rush and want you to conclude your due diligence review as quickly as possible. Regardless, as a buyer, you need to be patient and perform an extremely thorough due diligence review of your target. Never rush or scrimp in your financial or legal due diligence review of your target! You owe it to yourself to get the most accurate and detailed “snapshot” and understanding of the business of your target as is possible. If you eventually buy your target you will later need the information to operate your acquired target.
Performing an extremely thorough due diligence review of your target will pay you significant “dividends” later in the form of reducing your risk in:
(i) confirming your target is in financial and legal good order, and concomitant therewith;
(ii) uncovering problems that you can require your target to address now (i.e., before the acquisition signing and closing), at your target’s sole expense (and not yours); and/or you potentially getting (x) your target to agree to accept a reduction in your purchase price offer, and/or (y) more buyer-friendly transaction terms.
As a buyer you have much more power to correct problems of your target that you uncover before signing and closing the acquisition deal than you do after signing and closing the deal.
IV. Summary and Conclusion.
You can be successful in making an acquisition in any economic climate by preparing early and doing the following:
- Clearly understand what your business is.
- Develop a “clear investment thesis” that strengthens your current competitive position/foundation, that if achieved would allow you to do what you currently do, only better.
- Select your Team and create your acquisition plan (“Acquisition Plan”). Determine how much of an acquisition purchase price you are prepared (and able) to pay, from where the payment will come, and what type or types of acquisition financing you intend to offer your potential target.
- Locate and select prospective real-world targets that appear to be a strategic fit and conform to your Acquisition Plan, and be able to articulate for yourself and others the rationale of how an identified target opportunity will create additional value for your business (i.e., a variation of item 2 above).
- Perform a complete-and-thorough financial due diligence review of your real-world target, and a general financial review of similar targets, and determine your buyer-side valuation for your real-world tentative target, and also decide upon how much of a premium (based in part on its special strategic value to you), if any, you are prepared to offer.
- Determine approximately (i) how much third-party acquisition financing you expect to need for your offer, (ii) what type or types of acquisition financing (e.g., cash, stock, term loan, and/or SBA 7A loan) you intend to include in your offer, and (iii) whether you intend to propose an earn-out or rollover investment to make a more competitive offer.
- Perform a patient and extremely complete and thorough legal due diligence review of your target.
- Have the courage to “walk away” from a “bad deal” if the fit seems bad or you have identified significant problems with your real-world target that cannot be addressed to your satisfaction.
- Be disciplined, be patient, stick to your plans, and do not overpay. Your goal is to get your offer accepted by your target without overpaying.
In sum, if you can systematically and strategically prepare early and plan well, select acquisition targets wisely, and execute your planned acquisition process with discipline and competence, you will be far ahead of most other buyers, and more important you will be in an excellent position to be a successful M&A purchaser in any economic climate.
A longer version of this blog post can be found here.