Acquisitions 101 – What to Look for When Acquiring

Posted on: August 12th, 2019

Acquisitions 101

Whether a large or middle market size companies, there are cardinal rules of what to look for in an acquisition. Some are easy to analyze, while others are more subjective and subtle. The questions to be answered is how to know a business is worth being acquired. There are three groups of businesses – undifferentiated businesses, differentiated companies and institutions. Undifferentiated businesses earn industry level returns, and have little specialization. Differentiated companies are specialized in one or more areas, and earn above average industry returns. Institutions are specialized across all dimensions of their business model and have strong, moat-like positions in their industries.

So, the question is – which category does the company you are considering for an acquisition belong. Is it an institution, or an undifferentiated business? There in lies the rub.

First step is to analyze the financial statements. Through due diligence you should evaluate their financial performance, cash flow, and balance sheet health. Moreover, you can look at their product and customer profitability metrics and sustainability of revenue. Institutions have monthly financial and management reporting dashboards enabling them to have their finger on the pulse of the business. Undifferentiated businesses tend to only have financial reporting and lack an ability to evaluate real time trends in the business.

Second step is to diligence their products and customers from a market perspective.Differentiated companies have strong customer and supplier relationships and are seen as go -to resources by their customers. Institutions are seen as high value-added partners by customers. Evidence of product innovation and customer acquisition is essential to be defined as a differentiated company or institution.

Third step is analyze the quality and depth of the management team. Is the team cohesive, do they communicate frequently, do they have defined spheres of responsibilities? Are the senior leaders experienced, well-seasoned and good team players. Strong companies have deep benches of high quality people, who are good at developing junior talent and getting people to follow them.

This due diligence should also expand into the legal realm. While you might be able to catch some of this in their financials, you should also conduct extensive background checks into the company and its senior management. This should be done on the front end to ensure there are no big legal uncertainties.

It is also important that the acquirer and potential acquisition have similar brand values and operating philosophies. While no two companies are the same, you should have every confidence that the two companies can blend efficiently, and bring greater value to the market post-closing.

Company culture, too, is a big piece of the puzzle. If the existing culture is not healthy, this could be a major hurdle. Differentiated companies and institutions have identifiable, employee & customer centric, positive cultures that make everyone feel they are part of something special.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.