Choreographed effectively, a smart acquisition can move both the acquiring and the acquired company to the next level.
Running an effective and successful acquisition search is a major undertaking for any business. Acquisitions have always been a means to maximize shareholder value and create a sustainable competitive advantage for firms. However, acquisitions of any size require substantial financial returns to create shareholder value and to justify the significant investment of managerial time, effort and financial resources necessary to complete a transaction. It is important for any firm considering an acquisition search to be aware of the different processes, strategies and best practices.
The current climate is ripe for acquisitions as firms are ready to spend the cash that has accumulated on their balance sheets over the last three years. Buyers are looking to continue to grow, and sellers, shaking off the boom and crash of years past, are back to evaluating their personal situations rather than reacting to economic fear. Identifying strategically valuable candidates can be done with the knowledge of one’s objectives and recognizing the key assets being purchased. In service-based industries, like engineering and construction, the key assets in an acquisition include fragile intangibles like customer relationships, the leadership team, operational knowledge and company culture. A mishandled integration process can diminish or eliminate stockholder value and erode an organization’s culture and talent.
FORMULATING AN ACQUISITION STRATEGY
At the outset of an acquisition search, the first step is clearly to define a strategy and objectives for the search (see Exhibit 1). Failure to have an explicit strategy can cause the search to feel as if one were trying to take a drink of water from a fire hose. One may come upon so much information that none of it is of any value to the searching firm. Having specific objectives and desired target firm characteristics in mind will increase the probability of a successful search. Different search strategies that a firm may choose to employ include identified target acquisitions, geographic target searches or sector-specific searches.
While there is no magic formula for acquisition success, firms that make many acquisitions gain expertise simply by learning from past transactions. Some common themes emerge when examining multiple companies’ acquisition histories. When formulating an acquisition strategy, consider the following:
- What are the key strengths of the target company? What should you not change?
- What perceived synergies exist between the two companies? Where can you add value?
- What is important to the other company’s staff in terms of corporate policies, benefits and culture?
- Does the other company’s name hold greater sway in its local market?
- How will the ownership structure of the target company affect the integration process and subsequent organizational structure?
- What are the costs of this acquisition? If you are bringing on new capabilities, will you need expanded facilities and/or overhead to manage them?
- If you plan to integrate the target company fully from the outset, is the cultural match strong enough? Are the operating platforms for accounting, human resources, etc., compatible?
- How can you best use the management of the target company in a new capacity?
IDENTIFIED TARGET ACQUISITION
An identified target transaction involves an acquisition in which the buyer has already identified the target and possibly has already engaged in preliminary discussions. These transactions often occur after the acquirer has become attracted to multiple aspects of the target’s business, including brand name, customers, products and market territory.
Determining proper value, negotiating a purchase agreement and performing detailed due diligence are the three key process tasks in this scenario. Acquiring firms should have a clear idea of what they are purchasing, the fair market value of the assets and an understanding of the intangibles, including the management team, culture and brand name. Having this knowledge and key due diligence items enables acquiring firms to formulate the appropriate transaction value, structure and purchase agreement.
GEOGRAPHIC TARGET SEARCH
Geographic expansion can almost immediately result in a larger customer base and additional revenues. A geographic search could be an ancillary geography to grow a company’s existing customer base or service area, or an entirely separate geography where there is ample existing work or the expectation for future work.
For this chosen strategy, a firm would combine its knowledge of the players in a chosen geography with additional search methods to formulate a list of potential targets. Resources used to create the prospect list include research databases, trade association memberships and industry relationships.
A high-level, preliminary due diligence study is undertaken prior to contacting the potential targets. This serves to educate the buyer regarding the different firms on the list and the scope of services offered. The list then goes through a “scrubbing” process in which some firms are removed, additional firms are added, and others are marked to hold off on contacting.
The important first step of discussions is the initial contact with the potential target. It is beneficial to have an inside resource with a “foot in the door” at the target firm to increase the chance it would engage in discussions. Potential targets are often hesitant to enter discussions unless they have an existing relationship with the contact or are familiar with the inquiring party. If, after an initial telephone discussion, mutual interest remains, it is in the best interest of the acquiring firm to enter into a non-disclosure agreement to preserve confidentiality and schedule a meeting.
Having a meeting at the outset is important for service-oriented industries, such as the engineering and construction industry, as fit and culture are two of the most important aspects of an acquisition where human assets are key to a successful future. Determining whether a strong fit exists should be discerned right away so that poor candidate fits can be eliminated without wasted time, effort and resources. Acquiring firms can then proceed with management meetings, interviews, site visits and data requests to gather information for analysis on targets with a strong fit. Valuation and structure are both secondary in this process, as the intangibles, culture and fit determine the success of the acquisition and integration.
When you are looking into expanding into a new territory by way of an acquisition, understanding the current competitive dynamic is essential in formulating the appropriate target, valuation and integration strategy. Key characteristics of the competitive landscape include understanding market-share information, bidding dynamics, price leaders/laggards and growth prospects of firms and the market itself. To generate the necessary return from expanding into a new market, a firm should conduct an analysis on how much, if any, incremental overhead will be required to continue running the business. Given the specific sector and target, some firms may be able to eliminate some of the “back-office” fixed overhead expenditures. However, the acquiring firm must assess its own overhead infrastructure and determine if it has the ability and capacity to take on the additional work and eliminate certain costs. In other instances, an acquiring firm may require the full and complete overhead infrastructure of the target to make the acquisition successful.
SECTOR-SPECIFIC TARGET SEARCH
Acquisitions can be the quickest way for a firm to expand its service offerings. Motivations for expanding an existing line of services can include going where there is capital spending, seeking vertical integration or simply diversification. The search process is run in the same manner as that used in exploring new geographies. Target lists are compiled and preliminary due diligence is conducted using research, company websites and industry knowledge to learn about potential targets. Considerable benefit accrues from involving someone in this search with a comprehensive knowledge of the services that the acquiring firm seeks to add. Often, firms looking to diversify also must explore new geographies for an acquisition, adding an additional level of due diligence to analyze and understand the region.
Vertical integration is a primary driver for companies desiring to add a new level of services. Acquisitions afford a firm the ability to quickly add and incorporate a new service into its business without having to generate the growth organically. Once again, overhead costs can influence the success or failure of the acquisition. Questions needing answers include the need for additional infrastructure support, managerial capacity to handle new services and the strategic benefits to be gained. Successful vertically integrated businesses are desirable as they can achieve favorable valuations at the point where ownership is ready to sell.
Outside advisors with industry knowledge can bring significant value to a firm seeking to begin an acquisition search process. Timing is a vital issue in any successful acquisition as both buyer and seller must have proper motivation simultaneously. An industry-focused advisor brings specific knowledge and relationships that the firm can leverage to quickly identify strong potential target firms. Advisors often spend years cultivating relationships with buyers and sellers to be able to match them when the timing is right. Furthermore, a third party can act as a screen when contacting potential targets, preserving confidentiality and maximizing efficiency for acquiring firms.
Acquisition search strategies should be well developed at the beginning of the engagement to maximize the effectiveness and efficiency of the search. The search and subsequent acquisition process requires a substantial investment of a firm’s managerial time, persistence and financial resources. Buyers need to be serious when engaging a potential target as they are approaching sellers hoping for an exclusive deal. Additional industry best practices for handling acquisitions include:
- Evaluate multiple transaction structures, such as asset sale versus stock sale and potential for 338(h) (10) election.
- Ensure that there are clear gains on either side of the equation. Determine what the target company has to achieve by joining your firm.
- Get to know the people who comprise the target company. Ensure that there is a strong cultural fit prior to completing the acquisition.
- Incentivize key staff post-acquisition to ensure their commitment and loyalty to the new company structure.
The growth of global mega-firms during the past decade has skewed attention toward ever-larger acquisitions in foreign markets, but strong domestic firms have much to gain through acquisitions also. The game is always changing, and small or medium-sized firms can capitalize upon the existing market presence of an acquired firm to move into new markets or expand their service offerings. Firms that are not highly acquisitive, but have a solid rationale for a purchase, should take heed to lessons learned by others, invest in formulating the acquisition strategy, and go for it. There is great value in organic growth; however, certain situations are better-suited for acquisitive growth. Choreographed effectively, a smart acquisition can move both the acquiring and the acquired company to the next level.
Hunt Davis is a managing director with FMI Capital Advisors, Inc. You can reach him at 919.785.9212 or via email at firstname.lastname@example.org.