There are pros and cons to be aware of if you are looking to merge with or acquire a company.
When it comes to a “bolt-on” scenario, the advantage is you already understand the business, so it can be easier for owners and lenders to get their heads around it.
The risk, however, could be that these companies are “usually run by two or three people that understand the risks and just a few major clients. Who’s to say that those clients and executives don’t go somewhere else? Ownership of the customer is a risk,” said Doug Davis, an independent director with Pro-Trans Ventures Inc.
Another risk involves proper value transfer, and knowing when to make a move.
“If you have a fairly aggressive, progressive management team, or if you want to take your organization to the next level, mergers and acquisitions is a key component of that. To start any proactive acquisitions work we start with helping clients figure out where they are trying to get to,” said Doug Nix, vice chairman of Corporate Finance Associates
“At the end of the day all businesses are the same: it’s either grow or die before overhead creep diminishes your returns,” added Davis.
But you should also look closely at your current business and your management team to figure out, if you were twice the size, would management’s skills sets still apply?
“You have to think about that in advance before you hit the road looking for acquisitions. The key thing is to understand the underlying business risks of acquisition, the underlying contracts, operations processes, and once you outline all the business risks you have to attach the right kind of folks,” he said.
Having a transaction lawyer, banker, and your operations people on the team at the outset is a good idea.
Keeping your core business running in the background is another factor to consider.
“Do you have the bandwidth to do the acquisition? If you don’t have the people you will have a difficult time later,” said Nix.
“Your extended team for the acquisition later becomes some of your middle management. Your existing business can end up being run sideways-it helps to give your management team heads up about the possible need for them to take on a little more (during the M & A process),” said Davis.
For asset-based operations 3.75 x EBITDA (earnings before interest, taxes, depreciation, interest and amortization), applied to normalized earnings, is a common valuation, he said.
But the market value of a business is ultimately what someone is willing to pay for it.
“You can use all kinds of multiples. But it’s based on what the market can pay,” said Davis.
If you are employing legacy staff post-acquisition, don’t assume that you can impose new conditions or less advantageous conditions on them.
“They are human beings and if they are good, they have options,” he said.
“If you use your same people principles you’re using to keep your key people, you’ll be just fine,” noted Davis.
Avoiding the critical mistakes
In the run up to an acquisition, Nix has observed that some buyers become so nervous, they try to build in a series of protections that no seller would ever accept.
“So they start stacking the cards against themselves right away. I don’t think you should ever bet the farm on an acquisition. Take it in reasonable sized chunks,” he said.
It’s also critical to apply a high level of planning around the execution at post-close.
“It’s about ensuring that you get the juice out of the deal that you expected. It’s a balance of interests between buyer and seller. Somewhere in between there will be an appropriate balance,” said Davis.