Article : Acquisitions — Improving your chances of Success
An acquisition of another company can be very successful if the planning and execution are well thought out. A successful acquisition can among other things, allow a company to enter new markets more quickly or gain technology that it requires to grow. However, the results can be disastrous for both the acquirer and the acquired company if numerous issues are not handled appropriately. Based on the writer's experiences, the key issues to consider in order to ensure a successful acquisition process are:
Identifying the most appropriate acquisition candidate
In addition to the purely financial considerations, the following "soft" issues should be considered.
- Culture: Will the two companies and their employees mesh well? Do they have similar goals and ways of doing business? The only way to assess this is for both parties to spend some time together getting to know each other at various levels. If you can't get along on a personal level, then joining the businesses together could be a big mistake.
- Integrity: This may seem obvious, but you must be able to trust the sellers of the company. Post acquisition, these will often be people who will hold key positions in the acquired company. I'm not just talking about whether someone is a crook, but will they do what is in the interest of the business before and after the acquisition? Will they communicate openly with management? Are you hearing the whole story?
- Location: Is the acquired company near the "home office"? It is not essential that the companies be geographically close, but special challenges arise when there is a great geographic distance. This is especially true if the acquiring company is based in only one location and not accustomed to dealing with a subsidiary elsewhere. An "Us and Them" attitude can be exacerbated by the long distance communication.
- Management and Succession: How important are the current owners to the future of the business? Will current management stay after the acquisition? Do you want them to stay?
Structuring the Purchase Agreement
The terms of the agreement must allow both the seller and the buyer to achieve their goals. Obviously there are financial targets that must be met, but other goals that the buyer may have are:
- Gain expertise in the field that the seller is particularly strong in. If there are some employees that will be very important to the buyer, then employment contracts should be considered. If a key employee is also a seller, then the employment contract can be part of the purchase agreement. If a key employee is not a seller, the buyer should still consider providing an employment contract combined with a non-compete agreement.
- Entry into a new market that the seller is strong in. It is important to understand what the drivers are behind this market strength. Is it personal relationships? Legal barriers to entry? Unique technology? Each of the strengths that the seller has must be considered when the acquisition structure is formulated. The buyer must ensure that the seller's strengths are effectively transferred with the sale.
- What are the seller's goals? Beyond the money considerations, other issues to consider:
- Does the seller want to stay on in a significant management role, and for how long? Ideally, the goals of the seller and buyer on this issue are compatible, but if there is a divergence of goals, this will become clear as the sale terms are negotiated. Employment contract and non-compete agreement negotiations will flush-out these critical issues.
- Are there family members or other non-family employees that the seller has a strong allegiance to and wants to guarantee a place for them in the business after the sale? This can be handled with an employee contract, but the buyer should be wary of having their hands tied if the relevant employee is not important to the ongoing business.
- If the seller(s) are to be retained by the buyer in some form of management capacity, then there must be a continued incentive for the seller/managers to meet the buyer's goals. When the seller was an owner/manager of their company, they were presumably focused on maximizing long term profits. After the sale, this incentive to maximize long-term stockholder returns must be maintained, even when they are no longer an owner in the business. Earn-outs and bonuses can be very effective at ensuring that the seller/manager stays focused. The challenge is to set the targets appropriately. Are short-term profits the only measure of business success, or are there other metrics that are also important? Align the seller's post-acquisition incentives with the goals of the new owners. This is often the most difficult aspect of structuring the purchase.
There are usually a few stages to an effective due diligence process. Preliminary due diligence is done before an agreed-upon purchase structure is formulated. The primary steps are:
- Analysis of seller's financial statements. Three to five years of statements and current interim statements should be reviewed. Trends and potential red flags will be identified. Issues to be investigated further are identified.
- A rough pro-forma financial projection of the combined businesses should be prepared. How much will the businesses be consolidated, or will the acquired company remain operationally independent? Are there cost savings that will result? Will additional costs result from the acquisition? This possibility is too often ignored in the evaluation process. Be careful not to depend heavily on hoped for "synergies" when the companies are combined.
- The buyer will want to meet key employees if at all possible. The exact timing of this step depends on how confidential the seller wants to keep the sale discussions. This step may have to be delayed until a sale Term Sheet is developed, but in no case should a buyer neglect to evaluate key employees before a sale is closed.
After the buyer and seller agree on the purchase structure and a term sheet is executed, more extensive due diligence should be completed before the final closing of the transaction. At this stage of due diligence, all relevant people in the buyer's organization should become involved. Depending on the size of the purchasing company, this could include staff from such specialized areas as Accounting, Audit, IT, Marketing, Personnel, Plant Management, Engineering, or any others that could effectively evaluate an important aspect of the seller's business. It may also be appropriate to bring in outside professionals to evaluate certain aspects of the seller's business that are beyond the capacity of the buyer's staff. This could include outside attorneys, accountants, environmental consultants, etc. There are a number of goals for this more extensive due diligence process. First, the buyer needs to confirm that there are no problems that are serious enough to crater the deal, or require a renegotiation of the sale terms. Second, opportunities for improving the combined businesses should be identified. Third, post-acquisition business planning can begin so that once the transaction closes, the two businesses can move ahead as quickly as possible. Findings should be documented by the personnel involved so that an evaluation can be done by senior management. These reports will also be useful in the future integration of the two companies.
Closing the Transaction
Once both the buyer and the seller have decided to proceed with the purchase, the buyer's attorneys will drive the process. However, it is essential that some key business people on both sides of the transaction stay very close to the closing. Some issues that were identified in the due diligence process may be relevant to the final deal terms. Business people must also push the closing process along so that legal time and money is not spent unnecessarily. Do not underestimate the time commitment required on the part of the buyer and the seller to close an acquisition.
This is the stage when many acquisitions fail. Purchases that looked so good on paper may not succeed because of many factors. The factors that were considered to be strengths and weaknesses when the seller company was first identified must always be kept in mind post-acquisition. As an example, if the buyer company is a long distance away from the purchased company, then extra attention should be paid to ensuring that communication between the two companies is strong. Some time and money should be spent on travel to each location, in order to foster personal and professional relationships between the two organizations. An "Us and Them" attitude must be avoided at all costs.
Appointing an "advocate" for the purchased company, to work within the buyer company is a very effective way to ease many of the integration issues that can occur. This person's role is to be the point person for all integration issues both before and after the acquisition. The advocate must be able to represent the interests of the buying company, but must also be understanding of the seller company's employees and their points of view. This individual could be an existing employee at the buyer company. If however, specialized expertise is needed that is not available in-house, then a consultant can be very effective at filling this role. There are also situations where there may be adequate expertise within the organization, but there is no one who can commit the time necessary to this critical task. Do not underestimate the time up-front that needs to be devoted to this effort if it is to be done successfully. If it is done successfully, this point person will be able to back out of the relationship as the two companies are knit together.
There is always increased risk that employees at the purchased company will leave after the closing. The specific approach to this challenge will depend on the type of business and how important certain employees are to the success of the company. In some industries, the business can be devastated by the departure of a few critical employees. Hopefully, these key individuals were identified before the acquisition, and employment contracts or other appropriate measures were taken to ensure continuity. The buyer company should take extra care to ease the integration process for the seller company employees. It must be recognized by everyone involved that many things will change after the acquisition, but the buyer must be sensitive to imposing too much change too quickly. Changes should be implemented if they will really help the combined businesses, not just because "this is the way we do it so you have to conform to our process". Always remember that the company being bought had some level of success, and you don't want to jeopardize their strengths with a heavy handed integration process.
Succession planning will be critical to the long-term success of an acquisition. In spite of employment contracts, non-compete agreements and other measures to ensure management continuity, more often than not there is a departure of the former owner more quickly than had been planned for. It is often very difficult for an entrepreneur and former owner of a business to give up significant autonomy and control to the new owners. Open communication must be maintained so that the intentions of all parties are known and appropriate steps can be taken to pro-actively deal with such an event.
Acquisitions hold the opportunity to transform both the buying company and the selling company. Unfortunately, this transformation is not always a positive one. Never underestimate the magnitude of the effort and commitment to the process that must be made in order to create a winning acquisition. Careful planning and execution will dramatically increase your chances for success.
© Copyright David W. Kellogg 2005. All rights reserved.