Top 7 Rookie Buyer Mistakes

Buyer Be Aware 

by Terry Stidham

1.    Not Doing the Math

Let’s say you’re Company A, and you have your eye on acquiring Company B. 

Ideally, 1 plus 1 will equal 3 or something greater.

Then why does it often turn out to be more like 1 plus 1 equals 1.5? 

You need to understand what the combined companies will look like. Start with an analysis of the strengths, weaknesses, opportunities and threats of your company and the same analysis of Company B and then do a combined analysis, the ‘layering effect.’ What are the savings? What are the cross selling opportunities? What the threats, like loss of customers or key employees? Are there any legacy issues that can present problems?

Of course it’s easier to the analysis on your own company (though I am surprised at how often companies don’t) than it is do to it on an acquisition targets, especially a privately held one, but you can still get information on your acquisition target. There are sources like Factiva, Capital IQ, D&B, Google and then there are the industry publications. 

Have your key management speak to other people in the industry to help size up your target. This can help you get a sense of what the two companies really look like together. You also have the right at some point in the process to look under the hood and inspect the books, speak to customers, vendors and key employees. I have developed an in-depth confidential questionnaire to uncover the good, bad and ugly.

2.    Letting Emotions Drive the Deal

As CEO, you are undoubtedly passionate about your business. That’s to be expected and applauded. Getting emotional about completing a deal is different. The tendency is to get excited about the possibilities of buying Company B, and before you know it your enthusiasm becomes infectious, to the point where your key management does not challenge you about downside risks of doing the deal. Getting emotional can keep you in a deal that shouldn't go forward.

3.    Lack of Perspective

Losing perspective is about getting lost in the process. If you've invested a lot of resources – time, talent, money – exploring the deal, it’s easy to think that you have to go forward with the acquisition irrespective of the price you pay. Ask yourself why you want to buy Company B. In your analysis, does it contribute to the top and bottom lines? Do you gain a new distribution channel? Does it eliminate a competitor? Make sure that it is a well-founded rationale and a sound business case that is 
moving you forward, and not the sheer force of momentum. 



4.    Ignoring the Red Flags

There can be hundreds of potential red flags.  Don’t ignore them. Don’t try to justify them away. Dig deeper, ask questions, and if you aren't satisfied with the answers or can’t find resolution, walk away. Red flags are signals to pause or even stop. Failing to do so is often a byproduct of getting caught up in the deal or losing perspective. Don’t close your eyes to the red flags. 

Did Company B have unusual charges or losses that aren't adequately explained?

Does the predictive index (assessment) on the CEO show instability?

Is there unusually high turnover on its management team?

Are there troubles fulfilling orders? If so, why?

Are there cultural gaps or differences in competency levels that will make it difficult to combine people and departments from both companies?

5.   Thinking Inside the Box

Let’s say you see some red flags, or deal just does not make sense. It’s time to review your other options. What if you only bought part of company B? Or maybe it would make sense to partner with another party to do the acquisition.  What about a joint venture? How about structuring the deal where instead of buying Company B for $30 million outright, you pay $20 million upfront and $15 million in potential earn-outs?

It is important to understand your alternatives. I recently had a client who wanted to purchase a company to expand his distribution and increase his overall sales. 

I performed as assessment of his company and the company they were interested in acquiring.  The analysis showed that the client really needed 20% of the target company. Why pay for 100% of a company if you only need 20%?  I recommended that my client partner with one of the other potential acquirers. The end result is that the client paid 10% of the total purchase price for the 20% of the company that he needed.

6.    Not Placing Yourself in the Seller’s Shoes

Your interest and Company B’s are not aligned. You want to pay the lowest price possible and possibly structure the deal with a future payout; they want to get the best price possible—now! Obviously under that scenario you both can’t get what you want and can often stall or kill the deal.

Put yourself in Company B’s shoes to understand why they are selling. Is the CEO looking to retire or play a transitional role? Is Company B being sold at the height of the market? Are there negative trends in the industry that are eluding you?

7.    Failing to Make the Case for the Deal

Try to prove your key points as to why you should acquire Company B.  

Can the two combined cultures really work together or are the management styles and daily ways of operating incompatible?

Can you gain incremental customers or will they leave to go to your competitors?  

Can you really achieve your cost synergies

How will your people and customers fare during the acquisition? 

Can you structure a deal so that you don’t overpay? 

You need to run worst-case, middle-of-the-road case, and best-case scenarios for the acquisition. 

Being aware of these mistakes should help you avoid them. Align yourself with seasoned advisors and remember your real work begins once you complete the acquisition.

Outlook for Mid-Market M&A

Location is to Real Estate as Timing is to Deal Making

by Terry Stidham

A unique set of factors has coalesced to form a “Perfect Storm” of M&A activity;

• A slow yet improving economy
• Historically low interest rates
• Supply and demand
• Strong appetite among many businesses for growth through acquisitions

Along with this heightened activity come opportunities and challenges;

• More competition for quality acquisitions
• The risk of cutting corners in due-diligence
• Real choices about whether to “buy it” or “build it”

RSB Citizens prepared an in-depth report on the current state of mid-market M&A activity based on a recent survey of more than 300 business owners and decision makers, supplemented by a series of in-depth interviews among U.S.-based mid-market ($5MM – <$2B in revenue) business executives that are open to or are currently engaged in some form of corporate development activity, including mergers and acquisitions and raising capital in the New England, Mid-West, and Mid-Atlantic regions.

KEY FINDINGS

OVERVIEW

The report points out that “In today’s slowly improving economy, many mid-market companies are finding it challenging to increase revenue through organic growth. As a result, acquisitions have become a common and sometimes essential strategy for increasing market share or improving distribution. Furthermore, for companies that decide to build it rather than buy it, their growth is being fueled through:

• Reinvestment
• Leveraging low interest rates
• Increasingly available sources of outside capital from private equity and commercial banks.

While it would appear that the present environment makes completing a transaction easier than ever, buyers are wary of inheriting unexpected liabilities in the process of making an acquisition, perhaps in their haste to “do a deal” or their inability to conduct sufficient due-diligence. Meanwhile, sellers struggle to fully understand their many options for achieving liquidity or fueling growth, including the possibility of selling only a portion of their business to remain in control or provide the opportunity for a “second bite.”

While not all buyers or sellers will rely on an external advisor for support meeting their M&A objectives, those that do will see a whole host of areas where their familiarity and knowledge of the process provides considerable value. While their number one concern is determining an appropriate valuation for their company, sellers (and buyers) also want:

• A better understanding of bidding strategies
• Support with due diligence
• Help to identify the widest possible set of potential target firms.

Whatever advisors, sources of capital, or course of action they elect to follow, buyers and sellers alike would be better served – especially as the expected pace of transactions accelerates – to carefully consider the increasing number of attractive options available to them in the age of transaction-driven growth.”

THE BUYER’S PERSPECTIVE

“It’s a buyer’s market!” – Or is it? Market conditions lead to opportunities for growth through acquisition, but competition is fierce and diligence is key.

• Buy, Buy, Buy! Interest in acquisitions is widespread. Nearly 80% of mid-market firms say they are currently engaged in or are open to making an acquisition. About one-quarter of these firms are currently in the process of making an acquisition, while an additional 14% are actively seeking purchase targets. The remaining four in ten firms are not actively looking to buy but would consider an acquisition if presented with the right opportunity. Regardless of their current status, all firms agree, the core objective of acquisitions is to drive revenue growth.
• Businesses have (or can readily acquire) the means to make deals happen. Mid-market firms making or looking to make an acquisition anticipate that the deals will be comprised of about equal portions
• Cash (35%)
• Debt (35%)
• Equity (30%)    Given that executives perceive debt as easy to obtain (and the cash and equity equations are largely within their control), funding deals will not hamper deal activity.
• Yet cash and enthusiasm are no substitutes for certainty or prudence. Despite their zeal for acquisitions, only three in ten mid-market firms actively seeking a deal feel highly confident they will actually complete an acquisition in the upcoming year. There are some factors that likely contribute to firms’ concerns about their ability to get the deal done, and those looking to extract commensurately greater value from their acquisitions should take heed:
• Don’t rush the deal, do your diligence. Chief among the concerns cited by all current or potential buyers is the prospect of inheriting liabilities and/or failing to conduct adequate due-diligence. Firms in a hurry to put cash to work may end up with a serious case of buyer’s remorse, or worse, buying a ticking time bomb.
• Remember, you’re not the only game in town. With more likely buyers than sellers in the mid-market, firms will need to look below the mid-market to make acquisitions where competition is high and inventory is limited. Meanwhile, the low cost of debt is giving target firms an attractive alternative to selling. Identifying the most appropriate targets, developing considered value propositions, and bidding strategically are key to success in this buyer’s market.
• Easy debt and market optimism may obscure the value of external support. Despite their trepidations, less than one in three mid-market firms intends to engage external advisors in their acquisition process. But of those bringing in an external partner, valuation is by far the top task where firms are looking for assistance.

THE SELLER’S PERSPECTIVE

“Valuation is king” — yet many sellers unknowingly hinder their ability to maximize their valuation by failing to approach the market from a position of strength.

• There’s a lot of talk about selling, but little action. Although current selling activity is low, interest is significant with one in three mid-market firms saying they are open to being fully or partially acquired by an outside investor. However, most firms open to a sale are not actively seeking a buyer, let alone entering into a full M&A process – running the risk that they will be undervalued or fail to find the best deal structure.
• Many sellers are unsure of their value, and what the market will bear. Being underpaid or undervalued is the top concern among current and potential sellers, especially among smaller firms with between $5MM and $25MM in annual revenue.
• Getting the most out of a sale means avoiding these undervaluation pitfalls:
• Misreading the market. Nearly three-quarters of mid-market executives view conditions today as a buyer’s market, and 55% believe that it will stay that way through 2013. In fact, the current market has led to a larger number – and wider array of – buyers, as well as an increasing number of appealing self-funding options.
• Misunderstanding the market. Most executives surveyed anticipate wanting or needing to sell off their entire firms. Yet, the majority of active deals in the mid-market are for a partial sale. Executives seeking a full sale oftentimes lack a full understanding of the various structures available to maintain a majority or partial ownership stake while also raising the funds they need or providing the liquidity they desire. In many cases, the parts may be worth more than the whole in terms of long-term opportunity and the ability to maintain control.
• Showing your hand. A desire for liquidity or fatigue continues to drive many to be interested in a full sale, leaving them vulnerable to taking less than they are worth, particularly if there is no formal process in place.
• Only a minority of sellers engage “the experts.” About four out of 10 sellers have or would consider having an external provider manage their selling process. Among the number of tasks these firms would engage a provider to handle, valuation is by far the most mentioned, though help with bidding strategies and due-diligence is also widely sought.

GENERAL MARKET OUTLOOK

Key indicators reveal that markets are ripe for transaction-driven growth.

Corporate development departments are firing on all cylinders. In a sluggish economy, mid-market executives clearly see corporate development as essential to driving growth. With the vast majority of mid-market firms currently engaged in or open to a minimum of three corporate development activities in 2013, all options are on the table when it comes to driving growth.

Acquisitions are clearly of greatest interest, with about eight in ten mid-market firms saying they are currently in the process of making an acquisition or are open to doing so within the next 12 months. In fact, mid-level managers say they are as likely to consider an acquisition as reinvesting earnings, further signaling that organic growth may be seen as less effective path to growth today than in previous cycles.

Buying is certainly more prevalent than selling in the mid-market, with less than one in ten reporting that they are currently the target of an acquisition. However, a sizeable proportion of the market (31%) is open to being acquired over the next 12 months.

Meanwhile, about two in ten are currently attempting to raise capital, with an additional 44% saying they are open to doing so in 2013. With current interest rates being at an all-time low, many firms see leveraging external cash as a more appealing option to diminishing their working capital.

Optimism about the future M&A market dynamics is high. More than half of respondents anticipate that the environment for raising capital and seeking outside investment will improve over the next twelve months.

Furthermore, deal volume is often driven by market participants’ view of future asset values. Over half of mid-market executives believe today’s prices will remain stable, and over a third believe they will increase.

The supply/demand equilibrium for M&A is likely to shift to support greater activity in 2013. On the supply side, demographic factors affecting private mid-market firms will emerge as a significant motivation for sales or equity offerings... Many aging baby boomers who have spent the past 20 years growing family businesses will look to monetize value for retirement. In addition, private equity firms that postponed selling portfolio companies in 2012 or took advantage of dividend recaps to return capital and buy time, will test the market for exits in 2013. On the demand side, larger companies will be under increasing pressure to show top and bottom line growth. Given current market conditions, organic growth will continue to face headwinds, resulting in further reliance on acquisitions to gain market share and/or expand operations.

What better way to grow?

Regardless of their current acquisition status, all firms agree that the core objective of acquisitions is to drive revenue growth (70%) (Figure 3). Secondary objectives, including expanding geographic reach (41%), improving operational efficiency (41%), adding adjacent products or services to core offerings (41%), and putting cash to work (40%) are viewed with about equal import. Across industries and firm sizes, increasing revenues is always the dominant motivator to acquire. Following revenue, however, firms in different verticals or with different revenue sizes tend to focus on different reasons to buy. Smaller firms with between $5MM and $25MM in revenue, as well as firms in technology or science industries, are more apt than others to view acquisitions as a means to expand their staff and purchase new talent. Meanwhile, mid-sized firms of the mid-market (annual revenues of $25MM to $100MM), and many manufacturing companies are more likely to look to acquisitions to improve their distribution capabilities.

Terry Stidham is the founder and principal of Target Search Group. He is a B2B Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment.  He has served as the head of entrepreneurial organizations as well as Fortune 500 companies.  He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions.  Mr. Stidham has been instrumental in aiding thousands of business owners prepare their businesses for eventual sale by teaching them how to maximize efficiencies in operations leading to significant increased cash flow.

Contact me today to discuss your exit or acquisition strategy.