M&A: Key considerations in the target

Your own company seems like a strange place to start talking about in an article titled, “Key considerations in the target.” However, defining your company’s own corporate strategy is actually the first step to take when looking at target companies: a successful acquisition isn’t just a financial transaction; it’s a strategic fit with your own company.

Its incredible how many companies out there are looking to acquire companies, without ever defining what their corporate strategy is. This means really getting to the core of what your company’s goals are – in specific rather than general terms. Once the strategy has been defined, key considerations that any potential target should have, become a lot clearer.

Broadly speaking, there are five motivations for acquisitions: financial, improving cost structure, protect, expand or change the company’s market position, changing the industry and disrupting the industry (see chart below. Source: CFA). It’s not that an acquisition is going to fit into one of the boxes – there will be overlap between the categories. But it’s useful consider which boxes your target fits into.

Be aware when looking at potential acquisitions that certain acquisition strategies in the chart are nearly always difficult to execute. Too often, managers fall into the “buy something cheap” column, which means they’re looking for a deal regardless of whether or not it’s a good fit for their company: not unlike the man who walks out of a suit store after buying a suit six sizes too large but which he’s happy with because it was cheap.

Any target that falls inside the first four columns in the chart is going to extend your business. The fifth column, “disrupt the industry” is for those targets that are going to shift the paradigm for your business. This is typically found where an industrial firm takes on a millennium generation firm which is heavy on technology – Imagine if Indigo Books back in 2000 had taken over Amazon instead of Chapters Books, for example.

The case of Amazon.com is the textbook example of a disruptor arriving on the scene and not being given due attention, but there are similar examples of it happening in just about every industry. The lesson for managers is this: don’t ignore the new companies which arrive offering lower costs or newer business model. These companies are looking to eat your lunch so they’ve got to be on your acquisition radar.

These businesses are the ones that transform your business – the ones that are going to shift your business model. However, if you want to extend your business without changing your business model, focus on the resource part of the target. This distinction is crucial when looking at potential acquisitions.

When you get to this stage, there are some questions we tell clients they have to ask themselves:

1. Is the proposed acquisition strategically logical?
2. Are we acquiring to extend or transform? … this will change how you view the acquisition. And is the combined company capable of what we think it’s going to do?
3. Will it build management or other capabilities?
4. Is the combined company capable of delivering the results?

These questions can bring a lot of clarity to why you’re considering purchasing a firm and whether it’s an acquisition that you should be considering at all. If, in answering them, you’re coming up with some compelling answers, the target may be a good choice. If not – it’s back to the drawing board to consider other options.

M&A: Finding Good Acquisition Targets

The acquisition process is nothing without good targets. These targets generally don’t just appear on the horizon - Management has to be proactive in searching them out and creating a long list or database. The companies in this database can come from tip-offs from people you know, small companies you heard about or just old fashioned research. But as is often the case, a pro-active approach here is far more effective than a passive one: the best acquisition opportunities often aren’t immediately obvious. And managers of potential acquisitions won’t come knocking on your door asking you to buy their company.

Some of the companies we’re in touch with keep an active database of over fifty companies that might become acquisitions at some stage. Fifty companies isn’t even that excessive a number. Keeping a list of this size is good practice for any management looking to partake in M&A: The best acquisitions are often opportunistic. But opportunistic shouldn’t be confused with catch as catch can: Preparing a long list of potential targets allows firms to be opportunistic – to be ready for good acquisitions as opportunities present themselves.

What I mean by that is that there’s no wrong time to make an acquisition. If a target firm provides a compelling answer to why the company would want to acquire it, any time there’s an opportunity to buy that target, the company should be doing everything in its power to acquire it. There just isn’t a bad time to acquire a firm which is a good strategic fit. Body Shop, a cosmetics retailer coined a phrase, “extinct is forever” and the same could be said for missing out on a target which is a good strategic fit. Once the opportunity to purchase that company has passed, the chances are, it’s not going to arise again.

“Why?”

Why is the over-riding question here. If management can’t answer this question when looking at targets, the likelihood is that it’s not a good target for the company. At some point during the search for companies or even during the negotiation process, the CEO is going to ask “why are we doing this?” In the most simplistic terms, management will know they’ve found a good company when the answer to this question is compelling – essentially, an acquisition that meets the strategic objectives of the acquiring business. The companies in your database should answer the question why for you as soon as you see their name on that list.

Once your database has reached a good size, you’ll begin to apply filters – it’s highly unlikely you’ll approach every one of those firms. These filters should be driven by an M&A framework, which I plan to discuss in a later article. The framework is driven by your firm’s strategy and how the target you’re looking at fits in with that strategy. There are broad ‘dos’ and ‘don’ts’ here, such as not betting your firm on any acquisition and avoiding acquisitions which have the potential to detrimentally affect the reputation value of your company. But the framework I will discuss addresses these issues.

Finally, I’m often approached about the statistic which says that around 70% of acquisitions fail. This is based on academic studies which have been carried out to look at the share price of acquiring firms in the days after an M&A deal has been completed. If the stock prices of the acquiring firm goes up, the deal ‘created value;’ if not, ‘value was destroyed.’ Is this really how we should be assessing the value of M&A? Of course not – it misses so much of the value which is inherent in the deal and the strategy behind it. By identifying a target that’s a good strategic fit for your firm, there’s no reason the acquisition cannot be a long-term success.