The process of acquiring a business requires a significant commitment of time, energy, money and ultimately a willingness to take on risk, but the right acquisition can transform and enhance your business significantly. A structured acquisition process can help overcome the challenges and pitfalls typically encountered along this journey, writes John Fogarty, Managing Director of AIB Corporate Finance.
The following overview provides a high level insight into the approach which can be adopted in exploring a potential acquisition where no formal sales process exists i.e. where the target company has not been put “up for sale” but is the subject of an unsolicited approach. The steps involved in a formal sales process are broadly similar, with the principle differences being the early availability of comprehensive financial information, defined timelines and the presence of competitive bidders for the asset.
It is important to define the approach you plan to adopt in executing the transaction. The streams below warrant consideration, though the final approach will need to be tailored to the complexity of the business to be acquired.
Key Work Streams Involved When Acquiring a Business
Selecting the most appropriate target can be time consuming; when faced with multiple potential options, it is important to be clear in defining the strategic motivation in pursuing an acquisition. Examples include:
- A search for revenue and cost synergies
- Ambition to scale-up
- Margin enhancement
- Geographic expansion
- Growth in the customer base and sales channels
- Removal of a competitor
- Technical abilities / asset base / brand opportunities
The spectrum of targets may be large so, to facilitate an efficient search process, it is important to screen and shortlist potential targets against a set of pre-defined metrics. Commercial and financial considerations will comprise the core of these; one of the most important things to address at the outset is the achievable “bite size” in terms of how much you can afford to spend on the acquisitions as this will guide the size of targets to evaluate.
Additional key considerations to include in the screening and shortlisting process are:
- Financial performance and balance sheet strength
- Core products and their relative contribution
- Customer base and concentration
- Cost saving and potential synergies
- Manufacturing facilities and estimated capex required for the future
- The business’s reputation among customers and competitors
- Strength of management and any key staff risks
- Pension liabilities
- Other potential undisclosed liabilities, such as tax, legal, and environmental.
This is not an exhaustive list as the criteria employed must be tailored to specifics of the business and the sector in which it operates.
Valuing a business is the next stage of preparation. This process can be subjective, though a number of established approaches can be applied. Commonly used methodologies include:
Each methodology requires a detailed analysis of the companies under consideration in arriving at an indicative valuation. The various approaches can also be using in combination as a means of cross checking.
Prior to making any approach with an Indicative Offer, consideration needs to be given to how the purchase will be financed. The size of the acquisition and nature of its business will influence the range of financing available. Typical sources include:
- Senior debt
- Mezzanine debt
- Private equity
- Invoice discounting
There are merits associated with each of these sources of funding and it is important for companies to understand the typical conditions and requirements of each of these options to assess the impact on its existing business and future plans.
While unsolicited approaches are not uncommon, if not carefully orchestrated, the dialogue may not gain traction if the approach arouses suspicions as to the motivations of the purchaser. It is critical therefore that the manner in which the Indicative Offer is documented and communicated to the target demonstrates that the purchaser has serious intent and is not a competitor “kicking the tires”.
Due Diligence & Final Offer
A Confidentiality Agreement (CA) will be signed between the parties if discussions proceed beyond the Indicative Offer stage. Once the CA is signed, Due Diligence can commence; this is critical prior to making a Final Offer as it comprises a detailed examination of the target across all aspects of the business. It is important to prepare a list of all documents and information the purchaser requires from the target to undertake their due diligence. The objective of this phase in the transaction process is to ensure the purchaser is aware of all material information on the target prior to revising and finalising their valuation of the business.
At the end of Due Diligence, a Final Offer Letter is submitted. This will include the price the purchaser is offering for the business and how they propose to structure the payment. This may be a 100% “up-front payment” or as a partial payment e.g. where 60% is paid initially, with the balance subject to an “earn-out” payment over a specified number of years. This will have a series of financial milestones, which must be achieved by the target so as to trigger the payment of the earn-out component.
Negotiations & Closing
After a Final Offer is submitted, the closing of the transaction remains subject to final negotiations based on conditions outlined in the Final Offer Letter. A number of these will relate to the confirmatory due diligence, which must be completed prior to closing. However, a key point of discussion will be focusing on the Working Capital requirement of the business.
Working capital can be a point of contention with the potential seller as they will wish to minimise the amount that remains in the business. Assuming agreement is reached and a Final Price agreed, the legal documents are signed and the process of payment of the proceeds and transfer of ownership of the business commences. Depending on the nature of the acquisition, Competition Authority approval may be required and this may delay the actual transfer of funds/ownership between buyer and seller.
Find out more from https://business.aib.ie/blog/2016/09/key-steps-for-buying-a-business