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Business Acquisition
Tips
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A sound
acquisition strategy can help grow a business.
By William Poe
Despite the recent merger mania sweeping Fortune 500 companies,
a business doesn’t have to be one of the Big Boys to fuel growth
through acquisitions. Many small and medium-sized businesses, too,
can gain a competitive advantage by adopting an acquisition strategy.
“Continuous opportunity to gain advantage with the right merger
and acquisition activity is a fact of life in business today,” says
Deborah L. Douglas, Managing Director of St. Louis-based Douglas
Group, a private investment banking firm, which represents business
owners in the buying and selling of companies. “The pressure for
growth is here to stay.”
Unfortunately, Douglas says owners of small and medium-sized businesses
find growth through acquisition to be a daunting process.
“Many fail because they are not adept at finding the right target
and instead wander into an opportunistic buy that can be a long-term
disaster,” says Douglas, whose company typically represents companies
ranging in size from $10 million to $200 million in sales.
Buyers, experts say, must have a sound target strategy that begins
with the rationale for the acquisition.
“A good fit between a buyer and seller typically happens when they
are in the same industry or a parallel industry; they share customers
and the deal will bring additional market share,” says Pat Fister,
executive vice president Fister and Associates investment advisory
services.
“Most buyers are looking for growth,” adds Larry Weber, partner
in charge of mergers and acquisitions for Grace Advisors, Inc. “But
they may also be looking to add to their corporate capabilities
and products. Gaining access to new technology; increasing cash
flow; adding new customers that the other company might have; controlling
distribution or supply channels, and blocking out the competition
are all sound strategies.”
After you know why you want to buy, how do you go about it?
The first and most important step, Douglas and Weber agree, is to
develop a target strategy that outlines the profile of possible
targets. The profile may, for instance, stipulate manufacturing
companies of a particular Standard Industrial Classification (SIC)
code, employing a certain number of workers and generating a certain
sales volume. “The profile tells you what types of companies to
focus on and, just as importantly, what types of companies you are
going to ignore in your research,” says Weber whose practice serves
companies in the $1 million to $100 revenue range.
Only after the target profile has been developed does identification
of targets begin.
Douglas says that, although many in the acquisition hunt think they
know which company or companies they might want to buy, “some don’t
know the market as well as they think. Markets change, and new players
can emerge quickly.” It is not unusual, Douglas adds, for her firm
to invest 400 to 600 hours working to identify prime acquisition
candidates.
The search for takeover targets, Weber adds, can be extremely time
consuming. “It’s an inefficient marketplace. Not many advertise
the fact that they are for sale.”
Buyers typically rely on networks of associates to identify targets,
Weber says. “You must build relationships among professional advisors.
Attorneys, insurance agents and bankers are often among the first
to know that a company might be for sale, and they sometimes will
agree to make an informal introduction.”
Douglas talks about the need to “get creative.” She says you may
identify potential targets by “looking downstream at customers and
looking upstream at suppliers.” Other times, she begins with customers
and companies that serve those customers. Even trade journals and
trade associations can help buyers “get acquainted with what’s out
there,” Douglas says.
Weber calls the next step the “courtship phase” and says it is intended
to “turn suspects into prospects.” It’s the time when the buyer
first emerges from the shadows and makes his company known to the
potential seller or sellers.
Douglas, who calls buying a business a strange blend of art, science
and psychology, says she or her client usually makes the first approach
by telephone, although a letter of inquiry is not uncommon. “We
try to build the buyer’s reputation; show the seller why a sale
might make sense, and hopefully prompt the seller to give us his
view of his company and future. Sellers have different motivations.
Some want to sell and walk away; others want to keep their hand
in the business.”
At the time of initial contact, Douglas offers the seller a signed
non-disclosure agreement “to help with the conversation and convey
information about your buyer.” Weber says the non-disclosure agreement
offer is “ring one in what hopefully will become a series of tighter
and tighter circles” leading to an eventual purchase agreement.
Next, Douglas says, is the “getting to know you” stage when the
buyer begins to assemble information on the seller’s products and
services, customers, preliminary financial information, and other
areas “to help the buyer assess value. You want to get a sense of
the seller’s view of value early on. The more information you can
get from the seller about his concept of value the more effective
you can be in the negotiation phase. We want to know what he will
take and how little he will take,” Douglas adds.
The next step, Douglas says, for the smart buyer is “to try to tie
up the seller with a letter of intent to get a clear playing field
for yourself. And with that letter of intent offer comes the first
price offer,” Douglas says.
“The letter of intent stipulates price and principal terms,” Douglas
says. “Based on all of the information collected so far, you usually
make the lowest offer you think might be acceptable.”
For many sellers, getting top dollar for the business is not always
the seller’s chief concern, Weber contends. “There are usually non-price
considerations. The owner may want to know if his employees will
retain their jobs; if the business will be kept in town; and if
the local management team will remain in place. The seller has probably
spent the biggest part of his life growing the company so there
are considerations other than selling for the biggest dollar.”
The next step, Douglas says, is financial due diligence and “fleshing
out the rest of the terms of the agreement, including transition
details, non-compete agreements, representations and warranties
and ‘life after sale issues’ such as how operations will be integrated;
how relationships will be transferred; and how to inform employees
and customers. You can neglect some very important post-close matters
that can have a big impact on the likelihood of success for the
new entity,” Douglas says. “I will spend time with the buyer and
seller to advise them on what life after the sale is going to be
like.”
Finally, the parties draft definitive legal agreements, including
the final contract. Usually, there will be some modification to
the initial agreed-upon price, Weber says.
“The buyer may have seen a balance sheet and an income statement
before the first offer, but not other information,” Weber says.
“I’ve seen the price go up or down before the final contract is
signed.”
Both Douglas and Weber carefully advise clients in the area of price,
and Weber says industry-specific pricing formulas, such as multiples
of earnings, multiples of cash flow and EBIT (earnings before interest
and taxes) are generally no more than rough guidelines.
“Those formulas can tell the buyer whether he is in the right ballpark,”
Weber says, “but I prefer to focus on economic earnings, which involve
many other factors. We also have to project how long it will take
to recover the purchase price. If it takes five to seven years,
it’s probably not going to work.”
Purchases, Weber says, are nearly always financed with “a mixture
of instruments, probably four to six tools in 80 percent of acquisitions.”
The buyer usually has a portion of the purchase price as cash at
closing, but other considerations will often take the form of stock,
on-going consultation or employment contracts for the seller, non-compete
agreements, licensing and royalty agreements, and more. Most sellers,
he adds, finance part of the purchase. “There are a number of different
tools we can use.” From start to finish, a simple and straightforward
purchase may take only 90 days, Douglas and Weber agree. Most transactions,
though, take six to 12 months, Weber adds.
Of course, things can go bump most anywhere along the acquisition
road. Weber says many problems are centered “on an expectations
gap between the buyer and seller on overall price,” and he says
the seller often finds the “emotional price” of the sale just too
high. In other cases, he adds, the seller “has emotionally sold
the business” well before closing, and the company experiences a
downturn in performance that can threaten the sale.
Are there still buying opportunities in a time of slowing economic
activity?
“It’s a great time to get a bargain,” Douglas says. “There are a
lot of underperforming companies that have great potential for improvement.”
William V. Poe is principal of Poe Communications, a St. Louis
advertising and marketing communications firm. |
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