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Capital Ideas for Private Business

Pointers on Successful Acquisitions

Reducing Risk

By Doug Nix, Managing Director
Oakville, Ontario, Canada Office, Corporate Finance Associates

Deals Under $50 millionOver the past 3 years we have seen a marked change in the level of mid-market acquisition activity in North America. Looking backwards, the reasons are fairly obvious.

Starting in mid 2008 and carrying through 2009, as the US economy softened, most businesses started to see a significant and accelerating decline in customer volumes – from customers going bankrupt to reduced order sizes and reduced order frequency. Year over year, it was not uncommon to see revenue declines of 50% or more. During this time, uncertainty was running wild; most presidents we talked to had no idea whether their operations had bottomed out or if there was still more bad news coming.

With falling revenues came tighter credit and less cash availability. Amid this uncertainty, almost all management teams opted for prudence and conservatism. Survival of their business became the watchword in almost every discussion we had with business owners.

As it always happens, things change. In early 2010, the North American economy stabilized and a new “normal” business activity level emerged. For the companies that survived the fall out, sales inquiries have picked up and revenues have started to climb.

As we move into 2011, many companies are now refocusing efforts to both grow revenues and also utilize surplus capacity that was created as they streamlined operations. At the same time, financial institutions are demonstrating more of a willingness to provide predictable financing into most industries.

Our research predicts that there will be a strong rebound in merger and acquisition activities over the next 2 years. Growth oriented companies may want to take advantage of opportunities that often exist early in the cycle. With this as background, it might be helpful to talk about some of the important lessons we have learned about developing and executing a successful strategic acquisition plan.

1. Start your acquisition program with a hard look at your own business. Determine what your customers are asking for that you can’t deliver. Check out what your competitors are doing to set themselves apart from you. Ask yourself, what is required to take this company to the next level? Do you have significant capacity in certain operational areas? Do you have a core competency that can be leveraged? From this will emerge a picture of some of the key criteria of an ideal acquisition.

2. Keep in mind that just because a business is for sale doesn't mean you should buy it. The absolute bedrock question that you must ask is "why." We have found that if there is not a compelling answer to the question "Why are we doing this acquisition?" then you shouldn’t do it. If the benefits to your organization are not obvious, save your money and keep looking for something that really fits. Finding those ideal targets takes work and time. In those cases where completing a strategic acquisition is absolutely vital to a company, sophisticated strategic buyers will often hire an investment banker to find and contact acquisitions that fit the key criteria.

3. Just because something is a bargain, doesn’t make it a smart acquisition. The old adage that "quality is remembered long after the price is forgotten" rings especially true in corporate acquisitions. When you acquire a company you are making a long term investment, and price should never be the primary criteria to decide if an acquisition is sound.

4. The flip side of this is that paying a reasonable premium to acquire the perfect-fit operation is good business. When looking at the pricing of these rare opportunities remember the saying "extinct is forever." Once someone else buys that business, you can’t – it is now "extinct."

5. Develop in advance an assessment approach that reflects the fact that probably every target you look at will have had poor financial results during 2008 to 2010. Part of this assessment approach has to be a mind set that recognizes that the economy has gone through a major trauma and companies that have survived this acid test have demonstrated that their business model is robust and their customer base is real.

6. Learn to differentiate between price and structure. Price means what you will pay, structure means how you will pay it. Reasonable transaction structures can be used effectively to bridge valuation differences or deal with uncertain outcomes (e.g. new customers, outstanding bids, uncertain future earnings). When dealing with structure, complexity is not your friend – keep it simple and understandable.

7. Put a strong acquisition team in place before you start. Acquisitions are always time consuming and complicated. This team should include a senior member of your management team, a lawyer with extensive experience in acquisitions, your accountants and an investment banker. It might seem expensive, but in the end, it usually saves you time and money.

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