Making a strategic acquisition can mark a major milestone in a business’ development, and can be transformative for many, if not all, first time acquirers. Whether it represents a move into a new geography or new business line, or it simply brings together two businesses doing great things in the same area and creating economies of scale, there is a lot to be gained from growing through strategic acquisition.
Whilst they can take many forms, sizes, and structures, the significant benefits that the right acquisition can bring to a business are common across most transactions, and so are some of the familiar pitfalls that first time strategic acquirers could fall foul of.
Strategic planning
It’s true to say that there is no one-size-fits-all approach to acquisitions, but as is often the case, planning and preparation are incredibly important when it comes to being able to maximise the opportunity presented.
Before embarking on an acquisition search programme with our clients, one of the first questions that we pose is ‘what would an ideal acquisition target look like?’. The response to this single question captures a wealth of strategic thinking for our clients: where do they want their business to be in 5 years’ time? What do they see as their focus areas for strategic growth and why? Why is an acquisition the optimum answer, versus a do-it-yourself approach?
Being able to document this ‘checklist’ of key financial, operational and other features that an ideal acquisition target might have, and having another party (such as a trusted adviser) review and challenge that thinking to ensure it is robust, is an important first step when it comes to making a first (or indeed any) acquisition. Whilst any checklist like this may evolve over time, and it’s unlikely that a ‘perfect’ acquisition target would present itself, this planning will provide a simple and objective method of assessing opportunities consistently, as and when they arise.
Why make a strategic acquisition?
There are a multitude of reasons that a business may choose to grow inorganically, whether it is speed of growth that is sought after; an opportunity to reduce the level of competition by acquiring a close competitor; an ability to acquire intellectual property or ‘know-how’; or a combination of many factors.
Whatever the operational drivers might be, growth through acquisition may also enable the acquirer to benefit from an immediate and often significant uplift in their own valuation through what is called ‘valuation arbitrage’.
As those who value businesses regularly, we understand that those with greater scale, professionalisation of systems & processes and those with a fully invested leadership team often benefit from greater valuation multiples than smaller businesses that may not have some of these attributes.
If a larger business were to acquire a smaller one at a lower valuation multiple than its own, and assuming that the acquirer can successfully integrate the acquisition target into its own group, then the earnings that have been acquired at a lower multiple would likely then be ‘worth’ the higher multiple in line with the larger group. This arbitrage benefit can be very meaningful and significant for the value of the acquiring business, even before things like synergies and cross selling are considered.
Accessing benefits through integration
Often the largest blocker to being able to access the full benefit of an acquisition is the integration process and being able to achieve one cohesive group of companies both from an operational and from a people / ‘hearts and minds’ perspective.
Where acquisitions ultimately fail (i.e. they are not value creating), it is often the integration process has much to do with the outcome, leaving the acquirer without the synergies and opportunities that they were hoping for, and without being able to unlock valuation arbitrage.
Accepting all of that, integration certainly shouldn’t be seen as an impossible task, but it is one that should be considered and planned for carefully. In fact, we encourage our clients to consider the integration process even before an indicative offer is tabled and at each stage of the due diligence process, meaning that on completion a detailed plan is in place and all parties on the buy-side know what needs to happen, and when, in order to properly integrate the target business.
Cost vs benefit – protecting risk through deal structure
Certainly, making acquisitions carries significant risk and opportunity for acquirers. Deal structure is a useful way of managing this risk and importantly, ensuring the alignment of the various stakeholders to a deal.
To understand what the right structure looks like for a deal, we need to understand who the various stakeholders are, what are their goals from a transaction, and how can we align those goals through an appropriate deal structure, which may include contingent consideration, loan notes, management sweet equity etc?
Take contingent ‘earn out’ consideration for example, which is typically predicated on the acquisition target maintaining a certain level of financial performance post acquisition. Involving some sort of earn out consideration in a deal can reduce risk for the buyer if the business underperforms post completion (ensuring that they do not ‘overpay’), but it should also create some upside for the seller(s), if the business subsequently over performs, aligning the interests of both parties.
Equally, where a management team (non-shareholders) are part of a transaction, perhaps alongside Private Equity, it is important that they are incentivised properly within the deal structure, as they will be the individuals running the business once the existing shareholders step aside. In order to ensure that they are fully committed to the long term success of the business, sweet equity is often used to incentivise and align management’s interests to those of the incoming investor.
Closing thoughts
An acquisition is something that can be considered by any business with the financial scale and means to execute, but financial capability is only one element of ensuring that the acquisition is right for your business.
The most successful acquirers that we work with are often those with invested management teams, that have the ambition and capacity to plan fully for making an acquisition, and the ability to execute the integration plan confidently.
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