Mergers & Acquisitions: Special Report: Tips for the New Acquirer

The signs of recovery are there: factories humming, stocks rising and a third straight quarter of expanding GDP. After a year of near record lows in M&A activity, conditions are ripe for attracting strategic buyers. Those buyers have likely been sitting on cash, and sellers are extremely motivated so many deals are closing quickly. And with a backlog of transactions, M&A activity is picking up dramatically. In fact, Robert W. Baird & Co., reported an impressive 93% increase in U.S. middle market M&A transactions in March – the largest monthly deal count since June of 2000.

Clearly, it is a buyer’s market. Although opportunities are ripe and liquidity is loosening, it’s important not to rush into a merger or acquisition, particularly for first time acquirers. There are a variety of risks and rewards associated with this type of growth, and a successful transaction requires a solid understanding of each.

"An analysis run of 24,000 acquisitions from 1996 to 2006 found the deals done during or just after a recession returned three times the return of those done at other points in the economic cycle." - “Winning in Turbulence,” Darrell Rigby

HOW HUNGRY ARE YOU?
One of the first steps is evaluating both your appetite and your readiness for growth. Before entering any transaction, you must determine if you have the financial wherewithal by performing a thorough financial health check. Since the recession, most organizations have shifted their focus away from profit and loss statements and towards liquidity. Do you have enough liquidity to carry off a transaction successfully?

Once you determine if you have the liquidity to make and sustain an investment, then ask if your capital structure can bear the added strain. If not, assess a range of debt and equity capital funding strategies that will give you the balance sheet you need to be successful in the M&A game. Also ensure you have a team in place with the experience to assess a transaction, complete an investment, forecast its performance and tolerate sensitivities around the results.

Absolutely key is the ability to envision and solve the challenges (financial and organizational) you will face in integrating the transaction and creating a smoothly functioning new company. If not, consider bringing in flexible executive leadership to help you through. In all, you must be dead-sure that the projected benefits, synergies and savings from the transaction can be realized in fact.

BASICS
The way you structure the deal ultimately has a great influence on your ability to control and maintain risk, which is why integration planning should be part of the due diligence phase. During the deal stage it is imperative you verify how you will recognize the strategic value post-purchase. For starters, understand the business you are buying.

Don’t let wild-eyed projections drive your synergies. Review the acquiree’s strategy and operations to validate assumptions. Meticulously plan for how you would integrate operations. Which IT applications would you keep? How will you merge the two companies’ information? Test assumptions about how the combined business will operate, along with its projected sales, cash flows and margins.

Ultimately, strategy drives due diligence and integration. The planning for due diligence and integration need to be an integral part of developing the strategy, and the highest value elements of due diligence are those that test the key drivers of the strategy. For example, if you’re buying technology and don’t care too much about existing costs or infrastructure, the strategy dictates that you spend more time testing the technology and less time on the other items.

As you structure the deal, avoid scenarios that allow value to leak from your transaction. For example, leaks can occur when it takes too long to define your strategy, and you miss an opportunity; or when integration becomes drawn out or doesn’t achieve your objectives. Your value will also fall short if you fail to operationalize intended benefits, as when organizations continue operating separately or when morale drops or confusion arises about roles and productivity.

Also plan generously for transition and closing costs – making sure the deal is financially viable pre-purchase. As a rule of thumb: integration will cost at least 10% of the acquisition price. If you cannot absorb a wide swath of sensitivities around forecasted performance – if it all must go right from day one - it won’t succeed. Pre-close planning should include performance tracking measures that post-close will help you monitor the transaction’s success.

AN ACQUISITION PRIMER
After verifying your readiness for an acquisition, there are key steps to follow to realize value and mitigate risks.

DEFINE YOUR GOALS & SUCCESS FACTORS
The basis of your M&A strategy should stem from an analysis of your current competitive position and your future objectives. That means understanding what you’re doing with your business, where you want to go and what you value most. Make sure you understand what it is you are trying to gain through this transaction. Is your goal to increase market share? Do you want to enter markets contiguous to the ones you already play in? To acquire new products, processes and intellectual capital? To increase your economies of scale so that you can be the low cost company in your market? Perhaps you are trying to eliminate a competitor, expand a product line or achieve a vertical integration.

Regardless of your goals, focus on them relentlessly throughout the process and align your decisions with them. The acquisition should be a way to bridge the gap between your company’s current state and the future state you desire for it. These factors become the items to test for in screening prospective targets and then performing due diligence.

There are a number of important factors to consider as you screen targets for acquisition. One is integration feasibility. What are the organizational and operational challenges of integrating them? For example, which of the key people would you want to keep and would they stay? Another integral step in evaluating targets is developing revenue and cost models for the combined organization. Define key success factors to realize value along with “threshold” assumptions and a business forecast to understand what you must achieve for the acquisition to be successful.

As you search for acquisition candidates, avoid becoming too fixed on a particular one – search for alternatives and understand the pros and cons of each. Though a target may seem to be a perfect fit with just the right management and expertise, there may well be drawbacks. For example, it may require that you seek additional capital, either through debt or equity. Its financial statements may be “dressed up” or it may be overly reliant on a few key people. Hidden issues like a culture clash can also sink any transaction.

PLAN AND EXECUTE DUE DILIGENCE
Due diligence is more than just “audit lite” or an exercise of checking arithmetic. When done properly, due diligence should test the strategic fit of the acquisition.

Start by considering your goals for this acquisition and the drivers of the valuation. Knowing what you need to preserve will dictate what you need to test for in due diligence. Your overriding goal is to verify that the value you expect is actually there. It encompasses financial, operational, legal, technology and people due diligence. There is also customer due diligence – understanding what cements those relationships and how to sustain them.

INTEGRATION
Remember – value is not made when you sign the deal; it is made during integration. More deals fail due to poor integration than any other factor, so begin planning as soon as the target is identified. Develop your plans according to function and accountability and concentrate on those issues raised during due diligence that threaten your ability to realize value.

THE FOUR Cs:
• Compensate – If you want existing management to stay, make their targets achievable and compensate appropriately.
• Communicate – People on both sides of the transaction should be completely aware of what’s going on to help quell rumors and paranoia. People will respond to uncertainty by assuming the worst.
• Care – How you react to challenges can make all of the difference. Even small inconveniences can generate ill feelings. Respond quickly and completely.
• Cull – If you must say goodbye to any members of management, make your decisions quickly, but carefully.

Major transitions require strong leadership; it sets the tone for savings and efficiencies. That is why it is critical to create a transition steering committee and a functional team. These groups should engage leaders from both sides – those with a stake in the acquisition. Members of the integration team should understand their role in realizing value assumptions. They should set their expectations high and work from a well-defined work plan, revisiting it as conditions on the ground change. The integration team must include line managers who are close to the action and can see problems brewing.

PERFORM THE INTEGRATION
Now is the time to merge operations, processes and cultures to realize your objectives. As you integrate, focus on re-validating all of the plans you have developed since the deal was first considered. Remember, this is an iterative process – evaluate what drives value, what is working and what is not. And throughout, remember speed is critical at this stage – delay drives failure and may cost you key people. This is the time to sweat the small stuff, like being sure that acquired employees know how to enter expense reports and check their benefits.

Document, document, document – tracking performance at every stage. Before the deal ever closes, determine key metrics and develop a reporting process around them. First, thoroughly document your expectations, potential savings, and your plan. If you neglect this step, your savings are likely to slip away. Report early and often - when public companies merge, Wall Street analysts closely track their success in achieving the savings they claimed for the deal. Private companies should do no less.

Establish integration milestones that are on equal footing with performance milestones. They should also measure and drive value creation. If you expect revenue growth in the first year, you must expect to hit each integration milestone. Tie incentive plans and earn outs to the completion of milestones. Also execute essential day one activities: control, communications and governance. Drive the integration deep into the organization, holding managers responsible for successful execution of each. Throughout, focus on the future – not how things “used to be done.”

THE TIME TO GROW... IS NOW
Growth during - or in advance of - a recovery can be extremely successful. But transacting in this economy is unlike any time in history – the rules have changed. In order to succeed, know your organization well: your identity, your resources and your goals. Plan carefully and thoroughly, and before you take action, evaluate every alternative. Be aggressive in pursuing and negotiating but conservative in forecasting and integrating. Once you understand that every transaction impacts the economic recovery in a positive way, you can overcome the risks and reap the rewards.

Remember: many mergers don’t succeed. But successful companies have often executed many mergers successfully. In today’s “buyer’s market” undertaking an acquisition with the right combination of strategy, planning and sheer determination can help you accelerate your company’s growth trajectory and achieve your strategic vision.