One of the things we are most frequently asked for as Corporate Finance Advisers, is to support clients and private equity firms in the execution of a buy and build strategy. The logic for acquisition is clear; inorganic growth delivers scale, fills capability gaps and offers the opportunity for “multiple arbitrage” – ie to acquire at a lower multiple than you hope to ultimately sell for.
That is the theory. In practice, it can be incredibly challenging to implement such a strategy for the following key reasons:
Finding transactable targets is a bit like looking for a handsome prince in a pond full of frogs. Would-be acquirers often have a list of criteria, which include; geography, size, capabilities and price. With information in the public domain unlikely to be sufficient to test against those criteria, it is necessary to try and dig into what a business does and how much it is likely to be worth without committing oneself to being interested and without offending any potential acquisition target. Inevitably only a handful of those businesses, originally identified as of potential interest, will turn-out to have prince-like qualities.
The Clarity/Realism paradox
In trying to identify potential acquisition targets, it is obviously helpful if a client knows what they are looking for and why. By the same token, a set of criteria that is too narrow will almost certainly result in failure and frustration. To find transactable targets, an acquirer will need to set criteria which are broad enough to capture a meaningful number of businesses – but still meet their strategic objectives. In considering potential targets they will need to be pragmatic, and avoid persuading themselves that a frog is a prince.
Vendors and the “unsolicited approach” mindset
There is a definite tendency for vendors to believe that an unsolicited approach from an interested party means that the potential acquirer is prepared to pay a premium for their business. There is no logic for this belief, but it can create a disconnect in discussions and undermine trust between the parties.
This exists on both sides of the table. A potential acquirer is looking for their thesis about the potential charms of a target to be disproved. While flirting wildly with their targets, they are checking them out for flaws and weaknesses (customer concentration, over-reliance on shareholder management, unsustainable margins etc). At the same time the potential vendor is neurotically concerned about disclosing commercially sensitive information, looking too enthusiastic and ensuring the potential acquirer can afford them. Several rounds of dancing around handbags whilst edging towards sensible questions, and realistic answers, is likely to be required, before anyone can determine whether there is a match. This is particularly true in cases where you are going to need to raise external finance to fund the acquisition. The ”prove you can afford us” chicken and the “if you give me enough information to go to my bank/private equity investor I will” egg, represent a common quandary.
If the business which is approached takes advice, they are likely to be advised to go to a wider pool of potential purchasers – before accepting any offer you might make in any case. This has the advantage of setting a market price, but loses you all the benefit of approaching cold in the first place and can be extremely frustrating. You might refuse to participate in an auction process but that arguably just serves to demonstrate to the vendor that you were never that serious anyway! You might hope that your potential target doesn’t take advice, but you probably do want them to have some support due to point 6 below…
When acting for a potential acquirer in a search situation, our clients are usually financially sophisticated and have an existing clear view on market valuation parameters, the information they need to come to a view on price and standard sector KPIs. By the same token, when approaching potential acquisition targets off market we often find that the businesses we approach don’t have the financial analysis necessary for us or our clients to form a quick view of valuation. There are two challenges here. The first is simply the time it can take to get the financial information we need and the second is the risk that even once it has been provided, it is not presented in a way that would allow us to get to the “right” valuation. For example, based on realistic outturn figures and with appropriate addbacks and adjustments to optimise the profit. For this reason, we would always prefer targets to be advised rather than unadvised, so that someone working with the target understands the nature of, and reasons for, specific information requests and will minimise the risk of a canyon-like gap between buyer and seller views of value.
So, you can see how the apparent charms of a long list of businesses – selected via keywords analysis, market knowledge, Companies House and websites – can quickly evaporate into only a handful of those targets who are of serious interest and are prepared to engage in a blind date. In practice the process of moving from a completely cold approach to a meaningful engagement is a highly iterative one. It requires empathy, skilled questioning, pragmatism, patience, and a recognition that you are not going to get all the information you really need before you sign heads of terms.
But despite all these challenges, finding and acquiring the right business can be a real accelerant of strategy and once an acquirer is known to be credible within their sector, other opportunities will open up much more quickly. Indeed vendors will start to find you themselves. As advisers our hearts might sink a little when the words “acquisition search” are uttered, but when an acquisition completes the sense of achievement at bringing two compatible strangers to the altar, is immense.
If you are looking to acquire a business, we would be delighted to assist you through the process. Contact our team on 01491 579740.