Finding ROI: The Right Acquisition Approach
With a basic Google search, it would not be hard to learn about acquisitions that have failed to generate the return on investment (ROI) that was expected post-acquisition. Buyers cite many reasons for the lack of ROI, such as lower than expected financial performance, integration challenges, material unanticipated post-acquisition costs, etc. Many CEOs have lost their jobs because they had "a pet project" or chased a deal that made strategic sense. Getting the right deal is difficult.
I have also observed that select serial acquirers tend to generate repeatable and consistent ROI from their acquisitions. How do they do it? Do they do something different that most others do not?
In the world of investment advice and financial planning, clients are always told to "invest for the long term" and "not try and beat the market". In addition, clients are often advised to apply a disciplined approach to investing, ensuring that their risk profile matches their investment strategy.
These recommendations also hold true for M&A. Serial acquirers tend to have a well-thought-out, disciplined, and consistent acquisition approach. They do not "chase winners" or try to "buy at the bottom". Their approach determines appealing targets and prices them fairly. They are rigid in the design of their approach, yet opportunistic as well. They are patient but can move quickly when there is a deal to be had. They ensure they have the capital available, and they do not overpay.
Establishing a "hurdle rate" is key.
Successful acquirers spend considerable time determining the intrinsic value of a target, setting a "hurdle rate" within their acquisition approach. A hurdle rate is a threshold ROI (or rate of return) that must be achieved to proceed with the deal. For example, if your hurdle rate is 20%, you will not proceed with the acquisition unless the price paid allows you to achieve a minimum of 20% from the future after-tax cash flows of the target. And this does not change from deal to deal.
The level of hurdle rate can vary depending on your industry, the nature of the assets you are buying, or your cost of capital. However, determining the right hurdle rate is critical for a successful acquisition strategy and approach.
Ensure acquisition discipline throughout your organization.
Successful acquirers are transparent with their acquisition approach to targets, employees, referral partners, and other stakeholders. They clearly communicate that their approach is rigid, but if the right opportunity presents itself, they can move quickly.
Acquisition discipline does not relate solely to financial characteristics; it also relates to what target company characteristics are important to the buyer (e.g., sector focus, management team credentials, market position, customer relationships, etc.).
There also needs to be a separation between members of the acquisition team and members of the sales or operations team. Sales team members (including a sales-focused CEO) often see the bright side of every deal, its strategic importance, or its upside. In addition, these individuals tend to downplay the negative or inconvenient aspects of the deal. Acquisition team members need to be able to "call the bluff" and be realistic with the opportunities that are presented (but they can also be too pessimistic). Having both sets of team members can also be helpful and allow for a balanced view of the target opportunity.
Do not rush the financial and valuation analyses.
Successful acquirers spend considerable time asking questions of the target management team and require transparency around the target’s financial results. Often, these acquirers will back away quickly if targets are too protective of their information. There are always nuances with respect to financial and other disclosures; however, targets must be willing to share information that is sufficient for an offer to be made.
Once key financial information is provided, successful acquirers spend considerable time evaluating the financials and attempting to understand what their post-acquisition performance will be. Acquirers care about historical performance, but more as a measure of the risk of what the target can achieve after they are purchased. Valuation is also determined based on future after-tax cash flows, not past cash flows.
Remain steadfast in your offer pricing.
Although you may not win every deal, your targets will appreciate your consistency and transparency on pricing. Many deals that "fall through" have experienced a fluctuating offer pricing environment throughout the deal process as acquirers played games with the pricing and valuation of the target company. Some acquirers feel that they can overprice an offer but reduce the price during due diligence. This type of pricing approach should be avoided.
In some cases, targets may not appreciate your pricing but realize that if they made some operational changes over a couple of years, they could get the valuation they are looking for. Acquirers should be transparent with these observations to potentially allow for a deal to happen later.
Secure your capital up front.
Successful acquirers have capital available prior to negotiating a deal with a target. This could be the acquirer's own cash or financing available to them. This becomes a strategic advantage if you are competing for a target. Being able to waive financing conditions can potentially allow you to secure the deal, even if your pricing or other terms aren’t as favourable as competing bids.
Be okay to walk away.
Not all deals will be good for you. It's okay to walk away. Walking away from a bad deal gives you the opportunity to find a better deal.
We can help.
Welch Capital Partners staff have worked with many acquirers in the purchase of other companies, raising capital to fund acquisitions, performing due diligence, and/or helping craft acquisition strategies and processes. If you are considering an acquisition program for your company, please contact Adam Nihmey at firstname.lastname@example.org.