Pursuing acquisitions to fuel growth is an attractive way to grow a company. But business acquisitions can appear risky, especially if you have never completed one before. Acquisitions often require a business owner to take on substantial debt. An acquisition-based business strategy also requires a higher level of financial discipline. For unaccustomed businesses this can appear very risky. Be sure to avoid these four common business acquisition mistakes.
(Are you attending SEMA this year? As a subscriber I would like to meet you. These are casual meetings for us to get to know each other. I am nearly booked but do have some availability Monday afternoon or Wednesday morning. Visit my SEMA meeting request page to get on my calendar.)
Over-Optimistic Growth Scenarios
Overoptimistic growth scenarios can torpedo an acquisition’s likelihood of success. The reality is that both a buyer and a seller want to get a deal done. Sometimes in the zeal to get a deal done good numbers are created to fit a poor acquisition. Overoptimistic projections, or “hockey stick” growth scenarios, often results in buyers overpaying for deals. To avoid overoptimistic growth projections it is important to consider the following:
Worst Case Scenario. Look at multiple scenarios to ensure that you are analyzing both the good and the bad of an acquisition. Be sure to specifically develop a worst case scenario as well as other scenarios. Then develop a financial and operational strategy to mitigate that risk.
Cash Flow vs Profit. Understand how cash and profit flow through your financials. Remember that the cash required to get the deal done is separate from the cash required to operate the business post transaction. Even very profitable deals can be a drain on your cash post close, so prepare accordingly.
Working Capital Needs: Working capital is a significant driver of cash flow. So it is important understand your cash conversion cycle, or how many days the existing business will have to finance the day to day expenses of the new business. Well thought out projections will help you to be proactive in determining your total capital needs and ensure that you are not underfunded post close.
Lack of Focus
Lack of focus often manifests itself in two key areas: Strategic drift and due diligence.
Strategic Drift. Previously we discussed the importance of developing a proactive acquisition strategy. Strategic drift comes from not having a strategy, or moving away from your established acquisition strategy. Pursuing sub-optimal acquisitions becomes a significant drain on the business, financially and operationally. Lack of acquisition focus consumes time, management focus and capital.
Due Diligence. Want to know a dirty secret about due diligence? No one likes doing it. Not the buyer. Not the seller. Due diligence often means calling the baby ugly. Due diligence is often tedious and frustrating for all parties. For a buyer, an unfocused due diligence process can result in significant expense, lost opportunities and a reputation as a business to avoid when considering a sale. Lengthy, drawn out and generally unstructured due diligence can kill deals. Due diligence ought to be at minimum an efficient risk mitigation strategy and at best a value enhancing strategy. Effective buyers have disciplined due diligence processes that are efficient and thorough, but not unnecessarily burdensome on the seller.
Cultural Fit
Poor cultural fit is a major reason transactions fail to live up to expectations. But culture often gets overlooked in an acquisition process. It is understandable, culture is hard to quantify. In acquisitions there is a lot of focus on hard numbers, financials, strategic fit, etc. It is easy to neglect the role of culture in the overall transaction.
For example, a buyer changing employee or technician pay plans immediately after an acquisition may be making what appears to be a sound financial decision. However, if the transition is handled in a way that is incompatible with the culture of the newly acquired business the buyer may find a shop full of cars with no one to work on them.
The thing about culture is that it does not magically change overnight because there is a new owner. Culture takes years to build, and it also takes years to change. Smart buyers critically asses culture and build that into deal evaluations.
Post Deal Integration Plan
Often, acquisition mistakes are not in target selection, identification, strategic fit or valuation, but rather in post-deal integration. In a consolidating industry, developing economies of scale and leveraging cost synergies is a major reason for an acquisition-based growth strategy. But economies of scale and cost synergies do not magically appear. People have to go out and get them. The best acquisitions have a detailed post-deal integration plan in effect, to quickly leverage available cost synergies and build economies of scale.
A post deal integration plan includes both an operating plan as well as a financial plan. Successful acquirers continually analyze the effectiveness of their acquisition strategy by using metrics such as return on invested capital (ROIC). Sophisticated acquirers measure the internal rate of return (IRR) which annualizes return measurements rather than looking at the return across an entire time horizon (subscribers: feel free to email me discuss the nuances of an annualized vs a general return metric).
To avoid these four common business acquisition mistakes having a team experienced in business combinations is important. There are numerous professionals that have significant deal experience that can help guide you through the process. Some advisors bring industry specific knowledge that is indispensable in creating effective deal flow while others like bankers, CPAs, and attorneys are more generalist in nature. A common mistake, especially for companies relatively inexperienced in acquisitions, is to attempt to manage the entire transaction in house. I remember a conversation I had a while back where a business owner proudly told me he personally spent nine months on due diligence in a recent transaction. While this business owner may have saved on advisory expenses, I was astounded by the lost opportunity cost, both for the owners’ existing business as well as the newly acquired business. Frankly I was shocked he was able to keep a seller engaged for that amount of time.
I do have a few openings for new “buy-side” clients, or clients looking to build and execute an inorganic growth strategy. If you think an acquisition strategy is right for you I want to help. Let me know if you are interested and we can set up a time to talk more about it. And if an inorganic growth strategy is not for you that is OK. I still like to hear from you! I enjoy talking with others in an industry I am passionate about. Either way, you can get a hold of me via my contact page. Subscribers you can email me directly.
Until next week!
Great article, well balanced from all perspectives. After selling two businesses over last 20 years, I would put “Cultural Fit” as the first filter and weight it at 50% of the decision. Of course this will reduce M&A opportunities, so maybe a growing company should balance two strategies simultaneously, one for culture – intellectual assets and one for zip codes.
As a “seller” who genuinely wants to continue contributing and profiting from the industry, “Cultural Fit” should be bumped up to 90%+ of the decision process. These are new rules I just created for myself through trial and error!
Thanks for the compliment Jeff. Good insight as well. Whether you are pursing growth or evaluating a potential sale, the role of culture in driving business value can’t be understated!