“Growing Your Company With Acquisitions”

More than half of America’s fastest growing companies have expanded through acquisitions or are seriously planning a new business acquisition over the next three years, according to a recent Coopers & Lybrand "Trendsetter Barometer" survey of more than 400 growth company CEOs. If your company is considering an acquisition, important homework needs to be done well before due diligence is considered.

Acquiring another business could fulfill several of a company’s fundamental requirements, such as expanding its product lines or increasing its distribution channels," observes Don Bush, Entrepreneurial Advisory Services leader of Coopers & Lybrand’s Cincinnati and Dayton offices, "or, it could simply compound pre-existing management or operations problems. Many growing companies need to be encouraged to think through how a proposed acquisition could affect their current operations, and how it would fit into their long-term plans."

"Trendsetter" firms cited the two most important motivators of acquisitions as obtaining new markets or distribution channels (72 percent) or gaining complementary products to broaden or fill out a line (62 percent). Other reasons given were diversification, as a hedge against volatility; or a need for technology, management or facilities. Access to international markets was cited by 16 percent.

Glenn Timms, West Coast Mergers & Acquisitions practice leader with Coopers & Lybrand, suggests that acquisition-minded companies consider the following points:

• Look at the big picture.

  Understand the industry’s issues and the targeted company’s motives for selling. "Consider why so many companies are for sale today," says Timms. "For example, major automotive or other manufacturing OEMs (original equipment manufacturers) are seeking to consolidate their extensive supplier base to a smaller number of systems or subassembly suppliers. As a result of this trend, many long-standing suppliers with apparently strong customer relationships are in the process of being desourced.

• Recognize globalization requirements.

  Many major companies require that their suppliers serve their locations worldwide. Truly understanding the scope of a transaction means knowing if one large initial transaction must be followed by additional foreign investments. "Globalization requirements are changing people’s appetites for investment," says Timms. "A lot of privately held businesses are selling right now because they’re not willing or able to make the investment. Others are buying because they are willing to make the necessary investments."

• Stick to your knitting.

  Though the vast majority of acquisitions now are being done by companies in the same or a related industry, some do go outside of their field. These need to exercise caution. "Once a company goes into an area of business it doesn’t understand well, its risks go up exponentially," says Timms. "Perhaps the lowest risk is to expand a line of business regionally, then to expand its territory geographically could be a logical choice."

• Make value, and understand how much it’s worth.

  One plus one equals two, unless each are businesses whose combination creates additional value. Timms describes how understanding two key "valuation bookends" gives negotiators a reasonable price range to discuss. "On the low end, a buyer needs to know the value of the acquisition target as a stand alone entity," Timms explains. "And on the high end, the buyer needs to understand what additional value is created by combining buyer and seller — for example, cost savings from eliminating a sales force or head office and other revenue synergies. Price is negotiated between these two factors that we call ‘valuation bookends.’ Also, putting a cap on the purchase price before entering a negotiation can keep a buyer from overpaying in the heat of the moment."

• Watch out for key dependencies.

  Especially, watch for heavy reliance on specific employees or customers. A good acquisition target, particularly in a service-based business, can prove risky despite its excellent track record, if it depends on people who could walk away from the business. Companies must carefully think through mechanisms for protecting their interests. In California, for example, it is difficult to get noncompete agreements.

  "I’ve been working with a client seeking to acquire a company which is doing over 60 percent of its business with one major customer," says Timms. "The acquisition candidate looks good now, but when we spoke with its big customer as part of our due diligence, we found out that the customer was consolidating its supplier base. In three year’s time, the target company would no longer be a supplier to them."

• Understand the true cost of finance.

  There are two reasons to understand the cost of money: first, to recognize that debt is more efficient for financing an acquisition than cash or shareholder equity because it is tax deductible; and second, to measure the company’s return on investment.

  "Make sure your company determines how it is going to measure whether an acquisition was successful or not," says Timms. "Then see that the company goes back and does so. This can also offer insight into improving the acquisition process for the next time."

• Have a plan to integrate the business.

  Before getting swept up in a negotiation and making a deal, the buyer must have a plan for how to integrate the new entity into day-to-day operations. "Particularly if a company is buying a spin-off of a larger company," Timms notes, "it should not expect the accounting, computing, payroll and other systems to come with the business."

• Look for alternatives.

  Companies looking for creative ways to reduce costs and risk and add intellectual capital to take their business beyond its existing level should consider tapping another company’s resources in a strategic alliance.

  "A new wrinkle that I see," observes Bush, "is companies becoming more creative in their growth strategies by going beyond the straight acquisition and looking for joint ventures to gain additional capabilities. One client, who has a line of premium food products, is looking to expand into the mail order business," he explains. "The client had an acquisition target with a pre-existing mail order business, but lacked a management team with the experience to grow the business to the next level. As an alternative, the client has identified a strategic partner with a national mail order business in place who is willing to outsource its backroom operations to our client in exchange for an equity interest in it."

Overall, as "Trendsetter" growth firms have increasingly answered the traditional "make-or-buy" question with a well-researched acquisition, they have prospered. Growth firms that have acquired other businesses tend to be significantly larger today (54 percent higher revenues than average), and have grown much faster over the past five years (49 percent greater growth rate.) CEOs of acquired firms attribute over one-fourth (27 percent) of current corporate revenues to their business acquisitions, and expect this impact to grow to 30 percent over the next year.

"The time to understand the impact that an acquisition is going to have on an existing business," counsels Bush, "is before beginning an acquisition program. During a formal pre-acquisition review, the company’s manager — or another professional — should evaluate the company’s strengths and weaknesses in each of the operating processes necessary to market and deliver a product to a customer. This important first step can make the ultimate difference between a successful or an unsuccessful merger or acquisition."

About the Writer: One of the world’s leading professional firms, Coopers & Lybrand L.L.P. [now PricewaterhouseCoopers] provides services for enterprises in a wide range of industries. The firm offers its clients the expertise of more than 16,000 professionals and staff in offices located in 100 U.S. cities and, through the member firms of Coopers & Lybrand International, more than 66,000 people in 125 countries worldwide.

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