How to Develop Effective Acquisition Criteria
As I mentioned in a previous article, the failure rate for M&A transactions ranges from 50 to 80 percent. However, you can greatly increase your chances for success by targeting your efforts. Before you begin negotiating for a potential acquisition, be sure to figure out what you want to buy and why you want to buy it.
Determining your acquisition criteria ahead of time will allow you to achieve the following outcomes:
- Reduce your risk of buying a company with poor strategic fit
- Proactively search for target companies instead of reacting to opportunities that arise
- Pre-align senior management or shareholders on potential acquisitions and investments
Given these advantages, what is the best way to establish appropriate acquisition criteria?
Your first step should be to develop a strategic plan that projects what your company will look like in three to five years. This is essentially a high-level plan setting out your desired revenues and profits, products sold, and sales territories. For example, your strategic plan might predict that your business will double in size over the next five years, and in order to do so you will need to add two new product lines and expand operations into three new markets.
Putting your plan together should help you distinguish between goals that can be achieved via organic growth and those that will require M&A activity. Some of your goals may be achievable either organically or through M&A, and in such cases you will need to compare the potential outcomes of both approaches. Generally M&A will bring faster results than organic growth, but it will also likely require a larger investment.
Once you have determined which of your goals will require M&A activity, your next step should be to make a list of the criteria you want to see in a target company. Obviously your list will be customized to reflect your strategic plan, but the following items should be considered.
Type of Transaction:
What type of transaction would you prefer? Broadly speaking, there are three types of acquisitions: (a) straightforward acquisition where you buy out a target company; (b) joint venture where you partner with an existing player; and (c) franchise where you seek existing companies that are eager to sell your product in their markets. Each model has distinct advantages and drawbacks, and you will need to spend some time deciding which model is right for you. Some companies such as FritoLay have a strong preference for outright acquisitions, whereas others such as Coke have a strong preference for the franchise model.
Another important decision involves the geographical areas or markets you want to pursue. If you are new to international expansion, you may feel you are open to any and all opportunities, but this would be casting your net a little too wide. It’s better to come up with a ranking of proposed countries/markets and concentrate on the most attractive ones initially. Another aspect to consider is whether you would prefer to do deals market by market or whether you would be open to a larger acquisition that might have a presence in multiple markets. Obviously the advantage of a larger deal is a more rapid expansion, but this could mean you end up with a presence in some markets that are not on the top of your list or have weaker share positions than you prefer. Other key questions to consider before pursuing a large acquisition are (a) whether you have the management team to handle it, and (b) how you will finance it.
Are you interested in acquiring a particular size of company? Many corporations set a minimum threshold in terms of revenues or market share because they realize that they are not adept at providing the nurturing environment that small organizations require to grow, so they need to find a larger business that they can simply fold into their existing organization. Additionally, the size of the target company is a key issue for many large corporations because today’s reporting and regulatory requirements often mean that a small acquisition is simply not viable.
Do you intend to acquire brands that complement your existing portfolio, or are you looking to acquire scale and re-brand the newly acquired brands under your name? Some companies are very comfortable acquiring scale businesses in a market and simply leaving the brands alone, whereas other insists on re-branding. This is an important aspect to consider upfront, because many familyowned businesses want to see their brand name survive any acquisition and it can become a major deal breaker if you are not in a position to guarantee this outcome. In addition, branding decisions can have a major impact on acquisition accounting, not to mention the potential risks associated with changing the name of a successful brand.
Are you prepared to take the risk of buying a struggling business with the goal of executing a turnaround? Although everyone would prefer to buy the current market leader with a great business model, such opportunities are rare and expensive. Often the only potential acquisition in one of your key markets will be a turnaround opportunity. If this is the case, do you have the necessary resources in terms of money and human resources to execute a turnaround? It may be that you already have scale in a particular market and an opportunity arises to buy out a weak competitor. This type of deal may be looked at as a “tuck-in” acquisition whereby the synergy savings resulting from folding the target company into your organization justifies the price and you have the added advantage of ensuring that a competitor can’t acquire it.
Do you want to add manufacturing capacity or gain access to a target company’s selling and distribution model? If your goal is to increase your manufacturing capacity, then the acquisition can be looked at essentially as an asset deal in which you are acquiring the physical assets of the target company as opposed to building the capacity internally. Or perhaps your goal is to acquire brands that you can manufacture using your existing facilities, as this provides opportunities for scale leverage. In the case of S&D it may be that your goal is to gain access to the target’s distribution model either because of its superior coverage or because it possesses characteristics that your company does not have, such as cold chain distribution that may be necessary to support the launch of a new line of products.
This consideration is closely tied to manufacturing and/or brands, as a transaction may be justified on the basis of acquiring the necessary skill set to enter an attractive category. Examples of this type of transaction include PepsiCo’s joint venture with Almarai that provided it with expertise in the dairy segment, or its acquisition of a small potato chip company to allow it to compete more effectively with Pringles in the fabricated potato chip segment. In cases where R&D capability is a key criterion for a potential acquisition, it’s imperative to ensure that the target company actually possesses the skill set you desire and that this expertise will not be lost as the result of key staff leaving the company post acquisition.
Management and Local Contacts:
This aspect may be of critical importance if you are entering an emerging market where you have no existing infrastructure to leverage. Although the need for a capable team who can run the existing business may be obvious, there are ancillary benefits that add even more value. For example, the target company may possess a deep understanding of the local consumer that may allow the parent company to design new products specifically for this market. Or by leveraging the contacts of the existing management team, you may be able to obtain the necessary approvals to launch some of your products in a heretofore restricted market.
This characteristic of a potential acquisition often is overlooked when people focus on revenue scale and market share. It’s important to realize that many successful companies in developing economies engage in business practices that are simply not acceptable to multinational corporations. Problematic areas may range from tax compliance to manufacturing processes and standards, and these practices are often deeply embedded in the culture of the target company. Converting such practices to Western standards will invariably be difficult and have a negative impact on operating performance. Indeed, many companies exclude from their acquisition lists companies that derive a high percentage of their sales from government contracts in developing markets, as the difficulty of achieving compliance with the Foreign Corrupt Practices Act makes this type of acquisition too onerous.
This is an area where it pays big dividends to be totally honest with yourself. Based on past experience and knowledge, you should be able to establish valuation ranges that you feel are appropriate for acquisitions. These can take the form of “Times Sales,” “Times EBITDA,” “Price– Earnings Ratio,” or some other standard that you feel is the most appropriate for your industry. Once you understand what your range is, then use this criterion as an effective filter on potential deals. Put simply, if your company typically pays between 8 and 10 times EBITDA for acquisitions, then there is little point in negotiating with a target company that is looking for a price that is 25 times EBITDA. Not only are you unlikely to be able to negotiate their price expectation down to your range, but you are also unlikely to obtain board approval for such a high multiple transaction. So do your homework and be aware that many companies put themselves on the market simply to find out what they are worth, even though they have no real intention of ever concluding a transaction. If someone comes along who is willing to pay a ridiculous price, they may sell. But if their asking price is unrealistic, you would simply be wasting your time and resources pursuing such a transaction.
If you would like more information on structuring successful joint ventures, please contact Donal by clicking here or call +662-6511-164