Mergers and Acquisitions For Dummies (15 page)

In addition to owner expenses, you may have other add backs to account for, including one-time expenses such as severance, a lawsuit settlement, or a once-in-a-lifetime capital investment (for example, buying equipment with an extremely long useful life). The proverbial “acts of God” also fall into this category.

The rule of thumb when analyzing whether an expense is one time is simple: What are the odds of this expense happening again? The higher the odds, the less the ability you'll be able to claim it as one time. If the so-called one-time expense happens year after year, it's not a one-time expense, and you'll have a difficult time arguing for that add back.

Owner, make thyself expendable

Companies with the greatest value to Buyers are those companies where ownership is completely, totally, and utterly replaceable. Not surprisingly, that's a spiky pill for many owners to swallow. Heck, the thought of being utterly replaceable is spiky for almost anybody! But ego aside, think of the issue this way: How can you expect to get top dollar for selling your company if the company can't operate without you?

Here are a couple ways you can make yourself replaceable as an owner:

Train other managers to run the company without you.
Empower them to make decisions, and trust them to work independently and make their own decisions.

Design and implement systems that remove any ad hoc decision- making systems.
You're not trying to cripple the decision-making of others; instead, you're providing a framework for employees to make decisions so that they can do so without constantly running to you.

Exploring Typical Reasons to Acquire

Since time immemorial, mankind has grown through acquisitions. Granted, those early acquisitions were really conquests, but in recent years, empire-building has focused on acquiring companies.

As I note in Chapter 1, an acquisition allows a company to skip the growth stage and buy existing sales and profits. For this reason and those in the following sections, a company may choose to buy other companies instead of relying on organic growth.

Make more money

Make no mistake: The pursuit of money is a main reason for making acquisitions. Although it may be the most base and crass of reasons, it's an extremely valid one. Making more money is a noble pursuit. Profits make shareholders happy and therefore keep the vultures from descending upon high-flying executives' careers.

Gain access to new products and new markets

Acquiring a company with a similar product allows the acquirer to increase its share of the market. Being a larger player in an industry can have benefits, such as the ability to negotiate better prices or terms from suppliers and vendors, increase awareness to customers (larger companies typically are better known than small companies), and raise prices.

Buying a company may also allow the acquirer to introduce its products into new markets, as well as introduce the acquired company's products into Buyer's markets.

Implement vertical integration

Vertical integration
means buying a supplier or an end user of your product. An ice cream manufacturer that buys a dairy farm is vertically integrated. The benefits may include better pricing (the ice cream manufacturer doesn't have to pay the dairy farm's markup) and control of raw materials.

The downside is that the acquired company may service other competitors. If that dairy farm also supplies other ice cream manufacturers, those competitors may balk at buying from their rival. This situation is a
channel conflict.
(And you thought that was when you and your spouse argue over what program to watch!)

Take advantage of economies of scale

You're likely to hear this term countless times.
Economies of scale
simply means that as a company grows larger, the fixed expenses stay the same (or increase far more slowly than the top line revenue). Therefore, the larger the company becomes, the more profitable it becomes.

Buy out a competitor

If you can't beat 'em, buy 'em! If Company A is killing a Company B in the marketplace, Company B may determine simply buying Company A is the best way to make the competition go away.

Prepping before an Acquisition

A company thinking about making acquisitions just doesn't wake up one day and close a deal. Successfully acquiring other companies takes some planning and preparation; I cover the vital considerations in this section.

Determine the appropriate type of acquisition

How much revenue does the target need to have? Does the target need to have a minimum profitability level, and if so, what is it? Are you willing to consider acquiring a money-losing operation? Should the acquired company be a product extension or a new product? Should the acquisition allow you to vertically integrate? (See “Gain access to new products and new markets” and “Implement vertical integration” sections earlier in the chapter for more on these topics.) These are only a few of the possible questions to consider when choosing a potential acquisition.

Unless you have a clear idea of what you want to buy, you probably won't successfully close a deal. Many strategic and financial Buyers often take a “show me everything” approach when looking for acquisitions. The odds of finding the right fit are exceedingly low when you haven't defined the parameters of a right fit.

Get your company's balance sheet in order

How's your balance sheet? No, really, be honest. How is it? If your balance sheet is a mess, your company isn't ready to do deals. Companies able to successfully do deals have strong cash positions and little or no debt. Working capital should be positive, and the current ration should be at or above the industry norm. (The “Clean up the balance sheet” section earlier in the chapter gives you some balance sheet basics.)

Have the money lined up

Have your sources of cash ready to go before you begin the acquisition process. Sure, a strong balance sheet with lots of cash is very helpful, but an acquirer doesn't necessarily have to use its own money to fund 100 percent of a deal. Depending on the acquirer's situation, a line of credit from a bank, a
mezzanine fund
(a lender subordinate to the bank loan), and/or a private equity fund may be able to help with the financing.

Although you don't have to have a private equity fund or mezzanine fund as a financial partner to make an acquisition, failure to line up your sources of financing ahead of time may mean you're unable to close a deal, resulting in wasted time for both you and Seller. Also, reputations travel because people talk. A Buyer unable to close a deal because of a lack of forethought sullies its reputation.

Set up an acquisition chain of command

In order to successfully complete acquisitions, you need to determine who's taking what role. If you're handling the acquisition internally, give team members specific jobs: compiling the target list, making the calls, negotiating and structuring the deals, and so on. If you're bringing in an outside firm to perform some or all of these tasks, appoint an internal person to be the main interface with the intermediary. Following this chain of command at all times helps the acquisition process go smoothly and efficiently by eliminating poor communication and duplicate steps.

Designate a specific individual as the deal point-person to have all of the interaction with Seller or Seller's representative. All requests and questions go through this one person to prevent poor communication, duplicated steps, and a frustrated Seller.

Buying a Company from a PE Firm

In some situations, you may consider acquiring a company from a
private equity
(PE)
firm,
a pool of money that buys companies with the intention of reselling them later for a sizable profit. PE firms can be very motivated Sellers. But be warned: They're also extremely crafty deal-makers. After all, buying and selling companies is their industry. They're experts. (Head to Chapter 4 for the lowdown on PE firms.) The following sections offer some considerations to keep in mind as you look at dealing with a PE firm.