M&A Strategy
M&A Strategy
This is an introduction to M&A Strategy. Material includes a synopsis from multiple sources for easy reference for educational purposes.
Buy Side Process
M&A stands for Merger and Acquisition, and it broadly refers to a company buying or selling another company. M&A Buy Side Process typically involves ten steps, including Acquisition Strategy, Acquisition Criteria, Searching for Target, Early discussion, Valuation and Selection, Negotiation, Due Diligence, Purchase and Sales Contract, Financing and Integration.
This article focuses on M&A acquisition strategy, on why companies may want to do M&A. Companies may spend a lot of time defining and refining their acquisition strategy and criteria, then they use that to look for acquisition targets using public data from tools like Pitchbook, Capital IQ, Bloomberg, etc. They engage investment bankers and other professionals to help. They start early discussions with multiple prospects, then sign confidentiality agreements with some prospects to get a confidential information memorandum, which includes financial and operational data for the business. This can be used to build the financial model to value the company and evaluate the impact of the transaction. They may decide to negotiate and do due diligence with a specific company, and they move to execute legal contracts, close the deal, do financing, followed by integration.
Align with Growth Strategy
M&A Strategy is driven by the organization’s growth strategy. It’s about knowing what makes the business successful today, and what will add to it, and make it even better in the future. What’s the vision of where you want the business to go? How will the acquisition effect the growth story you want to tell? Is the inorganic value you are adding with the M&A something you definitely want to buy (versus build versus partner). When you source, evaluate, negotiate and integrate an add-on acquisition, every situation is unique, but the core challenges are the same. M&A can be a critical element of your growth plan, irrespective of industry, business model or scale.
Focus on Value Drivers
What’s the value creation thesis of your company? How does the target make you better? How do you make the target better? Knowing what strategic outcomes you ultimately want from engaging in M&A is key, and consider the value proposition for both the buyer and seller. Are you trying to enter a new market? Are you purchasing customers and contacts to geographically expand? Clearly define the value drivers that guide the acquisition decision, and have the leadership, investors and board clearly align on these fundamentals. When in doubt during the transaction, go back to the basic value drivers.
Stick to Core Values
Stick to your core values to stay in the market, and don’t take too many risks, or stray too far from your strengths. Consider the stress factors on your business to buy and integrate another company, while employees continue their primary jobs. Make sure there is available capacity to facilitate growth and a captive market for ancillary services. Is the downside risk significantly less than the realistic upside opportunity?
Get Organizational Buy-in
You need alignment on the overall strategy with the key stakeholders. Executive Management should define the strategy, but the impacted team leads should have inputs to gain their enthusiasm and engagement. Obtain early buy-in on macro points of your overall M&A strategy with a broad group including business development, operations, sales, R&D, financial, legal and your Board (individuals may be limited by discretion). Secure an early agreement on the deal structure from the outset that will help maximize value and avoid headaches later. Will integration require a fundamental change in either business? Are the sellers goals aligned with what you want to do? If after the evaluation, it’s not a good fit for your thesis and your long term vision, be prepared to let go of the pursuit, and walk away. If the timing is not right, you can come back to it later.
Sourcing Acquisition Targets
Use your acquisition strategy to find the right business to buy. Understand the value creation thesis of your business, and identify what can be added to help complete the long term growth story you want to tell. Then get your story out there to generate inbound leads. Establish a reputation for fairness, transparency, and do what you say. Network to build a healthy pipeline of acquisition targets by participating in industry groups and trade shows, and make time for those that approach you.
Leverage your customers, equity sponsor, and your most relevant employees. Sourcing acquisitions should be a team sport. Tell the organization where you want to take the business, and get their buy-in and suggestions for acquisitions. Reach out to people who interact with your customers and touch the product regularly. Satisfied customers are a valuable audience to leverage when sourcing acquisitions. Who do they use to complement your solution?
Approach potential seller as a would be partner. Be honest and fair, as well as persistent and holistic through the process. Give the seller a clear sense for your culture and approach to integration. Help them see the difference that investing in their business’ future can make. Try to deliver a clear and positive experience for the seller.
Creating Value through Acquisitions
Companies advance myriad strategies for creating value through acquisitions, but only some are likely to succeed. There is no magic formula to make an acquisition successful. Each deal must have it’s own strategic logic and specific well articulated value creation formula going in. If the strategic rationale is weak, the deal is likely to be less successful. Sometimes stated acquisition strategy may not even be real, as companies often talk up several strategic benefits. An acquisition’s strategic rationale should not be a vague concept, but be a specific articulation of one of these 6 primary or these 4 additional rationales to create value.
Strategic Drivers for Value Creation
Strategic drivers for value creation typically fall into one of the following:
Improve performance: Most common value creation strategy is to improve the performance of the target company by radically reducing costs and taking steps to increase revenue growth. This will improve operating profit margins and cash flow, and improve return on invested capital (ROIC).
Remove excess capacity: Value can be created by removing excess capacity from a mature industry. Consolidation removes excesses by shutting down the least productive assets across the larger combined entity, including shutting down plants, sales force, product portfolios and projects.
Expand market access: Value is created by expanding market access using larger sales force of the combined company. Working together, they can introduce the smaller company’s products into new markets, and accelerate revenue growth for the combined company.
Get skills at lower cost: Many technology companies may buy other companies that have technologies they need to enhance their own products. This is quicker and cheaper than developing it themselves, or paying royalty payments on patented technology, and keep it away from their competitors.
Economies of scale: When a large company buys a smaller company in a market with differentiated products and less buyers, they may get some economies of scale due to better bargaining power, lower cost of production and back office savings, leading to desired unit cost reduction. This may not be significant, and could be combined with other criteria.
Picking winners early: This involves making an acquisition early in the life cycle of a new industry or product line, and help them grow their business. This requires management to recognize these opportunities early before their competitors, and make multiple such bets, have the patience and skill to nurture the acquired business, and expect some to fail.
Additional Drivers for Value Creation
These are additional drivers for value creation:
Roll-up Strategy: This involves consolidating smaller competitors in fragmented markets into larger companies by coordinating activities to reduce costs and raise revenues. This works up to a certain size, as the costs eventually rise, making additional acquisitions uneconomic.
Consolidation: Consolidating to a very few players in a highly competitive industry will result in less focus on price competition, resulting in increasing profitability and ROIC. However, unless they can keep the new entrants out, pricing behavior does not change significantly, as smaller new entrants may offer lower prices to gain market share.
Transformational merger: Management team may decide to acquire a company to transform one or both companies. They use the merger as a catalyst for change, redefine the new company’s mission, strategy, portfolio, organization and key processes across all management and department layers, and shift to a performance based compensation system. This is rare, as the transaction timing and management execution has to be just right.
Buy cheap: Sometimes there may be a rare opportunity to buy a company below it’s intrinsic value as market may have fallen out of alignment for brief moments due to negative news. Acquirer pays shareholders a premium (generally 20%) over market value to gain control of the company. However, there is a risk of paying too much due to market over valuation (market bubble), multiple acquirers chasing the deal, or managements overstated ability to capture performance improvements (winners curse).
Due Diligence and Negotiations
Once you find a fit, due diligence and negotiation tactics will make or break the transaction, so manage carefully and strategically. Focus on the core principles and the big picture. Commit your energy to what matters the most to your business model, and don’t sweat the small stuff. Treat the seller with respect as a future partner who will get a fair deal.
Create one due diligence list and work off that to avoid unnecessary duplication, complication or miscommunication. Adapt your methods to get the answers you need without creating seller fatigue by accepting data in any format you get. Raise concerns as they come up, and don’t allow issues to fester through lawyers, document revisions, or emails. Make sure the seller’s financial information is complete and accurate. Make sure that the goals of the seller and the way they operate their business aligns with your own growth plans. Know the key processes and people that generate most of the returns for the acquired company and will have the biggest impact on the combined business. Don’t get wrapped up in the positives (expand services, integrate new clients, enter new markets), and consider the downside scenarios on what will happen if things go wrong. Look at the things outside your control, like market dynamics. How will sales opportunities change for the combined business in a downturn? What are the risks for technology disintermediation and product liability? Legal and Finance executives will drive deal due diligence, but this is a collaborative effort across the business (involves Finance, HR, IT, operations, sales, Integration).
You won’t create value if you overpay. Instead of asking what the seller wants, offer a realistic starting point that you can justify, and raise the bar from there. Explain what similar companies trade for, and how all the things you learned during due diligence fits into your valuation and strategy. Listen closely to the sellers perspective, so you can give the seller what they want, and get something in return, so both are happy. Do not negotiate in a piecemeal fashion; instead get all the important issues on the table at once, so that you can negotiate trade-offs. Look at the big picture, and defer answering requests till all key points are made, and then formulate a strategy on how to respond. Know when to walk away. Let things play out, and if now is not a good time, be prepared to walk away, and reconvene later. Minimize early involvement of ultimate decision maker.
Please contact us today!
Panvisage, Inc.
16192 Coastal Highway, Lewes, DE 19958
Contact Us
Ph: (312) 351-7900, sales@panvisage.com