The most successful acquisitions are those that fit within a predetermined strategic plan but as the ideal targets are rarely immediately for sale, acquirers may have to react opportunistically when the right target companies become available. Well-run groups keep a watching brief on good acquisition candidates. Their homework allows them to react when a business becomes available. It also avoids the difficulty of having to convince a sceptical board of the logic of a previously unadvertised deal.
Figure 2.1 below shows that purely opportunistic acquisitions have the lowest success rate. Those acquisitions which were identified opportunistically, but which were part of a predetermined strategy and those acquisitions that resulted from a structured search were more successful.
Before setting its acquisition criteria and embarking on deals, the acquirer should already know why it is acquiring. This includes understanding what a particular acquisition will bring in terms of market access or core competences and how it will be run alongside existing businesses.
Buying a business simply because it is available is not a good idea. For example, Benson plc, a small British specialist engineering group, had been turned around and it successfully bolted on two small acquisitions to its core business. It then acquired another business in a non-core area, rubber mouldings. The logic for the acquisition was that the last time it acquired from this particular seller the deal turned out to be a bargain. This acquisition did not add value to the group, it became a major diversion when performance dipped further and it dragged the whole group into receivership.
Acquisition criteria are derived from the strategic reasons for acquisition. They need not be complicated, in fact the more precise they are the better. Think of it like buying a house. If you tell an estate agent you want to buy 15 Acacia Avenue he or she knows exactly what to do next. If you say you want a three-bedroom semi somewhere in the south east of England the agents will come back with such a long list of potential properties you will not know where to start. One acquisition search for facilities management companies yielded eight hundred names and got nowhere whereas an engineering company that worked out where it could add value to an acquisition specified a tight list of criteria which led to a short-list of three candidates and then to a deal.
Acquisition criteria comprise a mix of ‘hard’ and ‘soft’ issues. ‘Hard’ issues are quantifiable, such as revenues or employee numbers; ‘soft’ include skills or culture. It is often powerful to specifically exclude aspects of a target, or elements of its business model, which are unsuitable. For example, no unprofitable businesses, or no contract publishers, or no companies with more than 10 per cent sales to the automotive industry.
Table 2.1 sets out some example acquisition criteria, split between hard and soft issues.
Table 2.1. Example acquisition criteria
Acquisition criteria should relate to strategy; they should be simple and look further than financials | |
Example acquisition criteria | |
Hard/financial | Soft/operational |
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Published information | Unpublished information |
Having defined what it is looking for, an acquirer must now identify the right acquisition candidates. Large groups with a strong acquisition track record tend to attract opportunities, but even with this natural ‘deal flow’ they do not always identify or attract all of the opportunities that are relevant to them. Smaller businesses and those that are less visible as potential acquirers can find it even harder to attract opportunities, often not being offered the opportunity to bid for businesses which would make a good fit simply because they are ‘not on the radar’ as an acquirer.
Acquirers can attract or identify opportunities in a number of ways. These are:
Exploiting contacts and knowledge within the business
Communicating an acquisition profile to introducers
Building a database of targets through research
Advertising
Waiting to be approached by potential sellers
No single one of these methods is the best. They can all work, which is why successful acquirers use a combination of them.
Should the prospective acquirer’s strategy call for an acquisition of a close competitor, a supplier or even a customer, there will already be a great deal of knowledge to tap within the acquirer’s own business. Operational management are aware of the players within their sector and they may already know the management and some of the shareholders. They will also be very well placed to provide insights into their strengths, weaknesses and potential fit with the acquirer. All this makes it very straightforward for the acquirer’s operational managers to develop a profile of some prospective targets.
However, you should also remember that this resource has inbuilt bias. Line managers see the weaknesses in rivals and they can hold strong views born of the scars of battle. Their knowledge may also be out-of-date, particularly of more distant businesses which they come across rarely. Finally, their opinions will be more operational than strategic – there is nothing which excites a sales director more than buying out the competition.
Acquisitive groups are usually good at finding ways to meet the shareholders of businesses they are interested in. They are able to explore avenues of potential cooperation. A major benefit of using internal knowledge is that, where relationships exist at the right level, it may be relatively easy to find the environment in which to open discussions with the owners. The ideal is then to form a relationship with the business and its owners. This will be on both a business and a personal level. If the personal relationship works it is all the easier to sell the benefits of fit between the businesses. Of course, if the strategy is right and the target is right, both sides should see the benefits. Figure 2.2 below sets out the simple virtuous circle of the ‘sweetheart deal’. At the very least, an introductory meeting can be used to leave a marker, making it clear that you would be interested in a discussion should the shareholders decide to sell. Should the business be put up for sale, the shareholders will inform their corporate finance advisers of any such approaches and these will undoubtedly be followed up.
Acquirers who want to ensure that they see as many relevant deals as possible stay in touch with the ‘introducers’. These introducers range from investment banks through the large, medium and, sometimes, small accounting firms, with corporate finance activities to corporate finance boutiques to wealth managers and individual brokers or consultants. Introducers can either be generalists working on a wide range of deals, or sector specialists.
You need to keep in touch with the introducers in whom you have confidence. Keeping them up to date with your acquisition criteria keeps your name in front of them and helps you get onto their call lists when they are looking for buyers. Good intermediaries will be selective in who they invite to look at a business.
Staying in touch also has the advantage of sparking possible ideas for the acquisition of a business that is not officially for sale. For example when discussing an acquisition brief and the reasons for fit, an introducer may be able to make a suggestion based on his knowledge of the sector and of the intentions of the companies he or she deals with. Introducers can then start the process of brokering a deal, starting on a ‘no-names’ basis if need be.
Prospective acquirers should make sure they look like a good option when presenting themselves to introducers. Personal relationships can count for a lot but introducers will also be asking other questions. Most of them will work on a contingent basis (i.e. they only get paid when a deal completes) which means that their main concerns will revolve around your ability to complete a transaction. They will ask themselves questions such as:
Is it realistic about financing acquisitions?
Does this acquirer have a serious strategy?
Has it got board approval to acquire?
Has it got the procedures and resources to complete the transaction?
Will it be prepared to pay my introduction fee (should there be one)?
The downside of dealing with introducers is that you end up on the long list of companies which are invited into a controlled auction. In a seller’s market this means being given a glossy but rather vague information memorandum, which is often known as a ‘black book’ and being asked to name a price. Access to management, further information and the company’s facilities ranges from non-existent through stage-managed to reasonable.
These auctions are not for the faint-hearted. By definition the successful bidder will have overpaid. You should only enter an auction if you have the inside track and that means having done a lot of homework.
Serious acquirers build a database of targets as a part of their acquisition screening and monitoring process. This approach is particularly appropriate in fragmented markets or unknown territories, where the acquirer lacks the advantage of in-house contacts or a reputation as a serious acquirer amongst local introducers. It is also the only way of doing a sweetheart deal and thereby avoiding auctions. A systematic approach, designed to search out the most appropriate opportunities, can go a long way to preventing the disappointment of finding that a suitable acquisition was missed. This information can also form the start point for the evaluation process once negotiations start with a target.
Some acquirers even use their database as a negotiating tool, by leaving their target company’s owners in little doubt that the acquirer has a number of choices and is, therefore, unlikely to overpay. Exasperated by the antics of its US counterpart, one chairman of a UK plc thumped a thick acquisition search report on the table and shouted, ‘I have a lot more companies to go and negotiate with if we don’t get this deal sorted out soon’. The transaction completed a matter of days later.
The objectives of a systematic search are to find out:
What companies are in the market?
How close is their fit to the acquirer’s acquisition criteria?
Who owns them (independent shareholders, managers, parent companies)?
Whether they are available?
An advantage of a search is that it allows you to select acquisition targets based on their quality of fit, as opposed to availability. In other words it does not just consider the one or two companies put forward by introducers, but assesses the whole range of businesses with a good fit to the acquisition strategy and acquisition criteria. With a coherent basic knowledge of each target and its competitors, the prospective acquirer has at least the basis for making a decision, determining which ones to approach and possibly proceeding into initial discussions. Of course you will need a lot more detail on the target if you decide to go on and make an offer for the business.
The effort required to research a market for a list of acquisition candidates will depend greatly on the characteristics of the desired acquisition. For instance, if the search is limited to a narrow market or businesses with a large turnover in a single country then the numbers involved will be limited.
The researchers building the database can call on the plethora of available information sources. These include:
Financial and company databases
General trade directories (e.g. Kompass, Kelly’s etc)
Trade associations
Industry periodicals and directories (as listed in Benn’s Media Guide)
Trade show directories/catalogues
Buyer’s guides
Financial surveys (e.g. Jordan’s, Keynote etc)
Published market reports (e.g. Mintel, Euromonitor etc)
In-house knowledge
Suppliers and customers of the industry
If no acquisition results from a search it means that no appropriate company is available. The sector can then be monitored for developments and in the meantime resources can be more usefully directed elsewhere. For example, the European industrial ceramics business went through a period of consolidation in the 1980s and 1990s as many companies were acquired, leaving a handful of significant companies in independent ownership. Prospective acquirers, having established contact with each of the remaining companies could take no further action in the sector and had to concentrate development resources elsewhere.
Should an opportunity to acquire arise at a later stage within the screened sector the acquirer will have an understanding of all the potential targets and will be able rapidly to compare the available company with its competitors.
The acquirer’s staff may have sufficient resources, industry knowledge and contacts for this process to be conducted in-house. If this is not the case, it may make sense to use search consultants. Their role is discussed in more detail later in this chapter.
Apart from smaller deals in certain sectors, advertising is not a particularly effective way of finding opportunities. The exception is in those industries, such as retail and hotels, where businesses are regularly advertised for sale in the trade press. Acquirers can scour these advertisements and bid for those of interest. Outside the specific trade press in these industries, an acquirer will typically find searching advertisements a frustrating experience. They encounter the frustration that some of the sellers who advertise are not entirely serious about the sale of the business, or are not particularly well-organised. Businesses for sale that are not advised by a corporate finance house tend to be the least serious.
Only the most undiscerning and opportunistic acquirers should advertise for candidates to acquire. They will find that the enquiries they attract are not particularly serious or attractive.
Alternatively companies can wait to be approached by sellers. Whilst this may work reasonably well for well-known companies, even experienced acquirers do not rely entirely on opportunities coming to them. Less-well-known buyers will have to be very patient if all they do is sit and wait for the ideal opportunity to come along.
External organisations can play an important role as catalysts in the acquisition process. The role of intermediaries as mandated sellers of businesses and as brokers of ideas has been mentioned above. Acquirers can also retain external organisations to perform a structured search or help understand target companies. The occasions when this makes the most sense are when:
Targets are sought in a fragmented or opaque market
Targets are sought in unknown territories
The acquirer requires insight into a seemingly attractive target about which it has insufficient knowledge
The use of consultants requires a clear research brief, a statement of the work to be carried out by both sides and a specification of the outputs required. Otherwise, especially in fragmented or difficult sectors, you run the risk of results not coming up to expectations with at best the M&A equivalent of a list of three-bedroom houses in the south east of England. Consultants can be used for a single exercise, or they can be briefed to monitor a sector for the availability of companies through changing circumstances.
A single review of a sector for targets is best conducted when time is of the essence; a framework is required for comparing one or two targets which have already been identified, or to confirm that no unknown opportunities exist and therefore that resources are best redirected elsewhere. Table 2.2 below sets out the typical acquisition search process.
Table 2.2. Typical acquisition search process
Acquirer’s role | Searcher’s role | Result | No. of companies | |
|---|---|---|---|---|
Strategy | Develop and refine strategy | Understand acquirer’s strategy. Translate it into clear acquisitioncriteria | Well-defined acquisitioncriteria | Unknown |
Identify universe of acquisition candidates | Share in-house information including known candidates and sources. | Use the best information sources Identify all businesses meeting the criteria | Database of all possible candidates | 100–800 |
Screening | Provide feedback on progress | Investigate every company using phone research and desk research | Snapshot of each candidate containing key data relating to acquisition criteria | 80–200 |
Shortlist review | Review fit between candidates and acquisition strategy | Provide strategic insights and advice | Prioritised shortlist of top candidates | 3–30 |
Evaluation | Use industry knowledge to refine shortlist | Further desk research or meetings on no-names basis with key managers/shareholders | Clear view of which candidates should be approached and how | 3–12 |
Approach | Decide method of approach and key messages | Advice on approach methodology and assistance where required | Companies to negotiate with | 3–6 |
Negotiation | Embark on negotiations | Support based on knowledge | Heads of agreement | 1–3 |
Due diligence | Orchestration of process | Support based on knowledge | Successful acquisition | One at a time! |
A rolling approach to screening and monitoring a sector is best used in an industry with a large number of participants where a series of transactions is proposed.
Search consultants are often prepared to take a significant proportion of their fee on success, although they will invariably require a fixed fee element for their work. Those who accept the highest proportion of contingent fee will be more deal-driven and perhaps less discerning; those preferring to avoid highly contingent fees tend to be more strategic. The selection of consultants will revolve around trust and a view of their ability to perform. It is worth ensuring that they will use original industry research and that the project will not be entirely staffed by juniors.
The following case study sets out the example of an acquisition search conducted by a search consultancy on behalf of a group, which had taken the strategic decision to increase its share of the liquid waste business. Due to the impending consolidation of the UK industry time was of the essence and targets were sought in a highly fragmented market.
As in the case study, some acquirers choose to invite their consultants to go on and run the initial evaluation stage. The consultants have an advantage as they can seek and obtain information using professional interviewing skills from managers who might otherwise be reluctant to speak to an acquirer directly. The use of face-to-face interviews alongside telephone interviews and desk research gives the best available results. They can also approach shareholders so as to understand their intentions on a ‘no-names’ basis.
On other occasions acquirers ask market or strategic consultants to conduct a ‘pre-exclusivity’ due diligence study of a target. This is a very powerful tool, but can only be justified when the acquirer has good reason to believe that a transaction is possible.
In any event once an acquirer has a number of candidates in its sights it can monitor them, gathering information and insights from a range of sources and contracts. All this information helps to form a better view of the business and allows the acquirer to be better prepared should it have the opportunity to negotiate with any of the companies.
For many acquirers timing is as big a problem as finding the targets. Acquirers may have hired expensive strategy consultants to define their future direction and have a shortlist of businesses in their sights, but none is available. Indeed, if the shortlist comprises only one or two decent targets, the acquirer may have to worry about its overall acquisition and growth strategy.
When availability is difficult acquirers can increase their chances of success by attempting to form a relationship with the target companies. The objective is to be called first when the target does become available. If the two businesses have a strong and coherent fit the idea of working together can start to take shape. This approach is often difficult for competitors to put into practice, but it could be achieved, for example, through a joint venture to enter a new market or territory together. It could be a joint supply arrangement to obtain better rates from suppliers, or an industry benchmarking club. Obviously this route has significant advantages as the two businesses become natural partners, also the management teams get to know each other and it becomes clear how well they can work together. The evaluation will in fact have begun.
Experienced acquirers often comment that finding the company to acquire is the easy part of the exercise. The secret is to start with a well-worked-out business development strategy. This will help in drawing up a focused list of acquisition criteria which can be communicated to third parties and used to look for and screen potential targets.
Identifying targets is one thing, but there is no guarantee that they will be available. Monitoring targets for their availability should therefore be seen as a continuing activity as indeed should be the policy of keeping intermediaries warm.