According to PricewaterhouseCoopers’ 10th Annual Global CEO Survey, more than 70 percent of CEOs expect to acquire all or part of another company in the United States within the next 2 years. So, why are so many companies buying other companies? And should you be one of them?
Barriers To Organic Growth
In many cases, acquisitions are a way to overcome barriers to organic growth, or growth from your existing assets. In other words, if your existing business isn’t growing, buying another business is a common strategy to grow and benefit through increased cash flow, higher business value, greater ability to attract capital and talented management, and business sustainability.
The following barriers can keep a company from growing:
- Changes in knowledge, belief and behavior that affect purchasing decisions
- Changes in interest rates, inflation and unemployment that affect economic growth
- Technological changes that make your machinery and equipment less competitive or obsolete
- New products or services that make yours less competitive or obsolete
- Low barriers to market entry that make it easier for new competitors at home and abroad to take away your market share
- Many small companies selling to a few large companies, putting the bargaining power in the hands of the buyers.
- Many small companies buying from a few suppliers, giving the supplier more leverage
- Slow industry growth and overcapacity shrinking the pie and increasing rivalry among competing firms.
Strength From Within
If you find yourself faced with these barriers, an acquisition is one alternative that may help you overcome them. In addition to addressing these external forces, acquisitions enable your company to bolster its competitive advantage by acquiring resources like strong management or skilled labor, complementary or proprietary products or services, and production capacity or new technology to meet demand.
In other cases, acquisition can be a way to expand your company geographically or manage your business risk through market or customer diversification. These are ways to avoid relying on one large customer or a single market for the majority of your sales. If you lose that customer, or the economy in your region slows down, having exposure to other markets and customer diversification can help you buffer the blow while you work to replace lost business.
Companies Searching For Acquisitions
Here are a few examples of why companies pursue acquisitions.
Earnings and sales growth. A large precision machined products manufacturer decided to boost its organic growth with acquisitions. In addition, the management team wanted to fill existing capacity, acquire new products in new markets and establish operations in new locations close to certain customers. The company is owned by two private equity groups and, therefore, has the experience and capital to purchase businesses. However, it doesn’t have the human resources to manage the entire process. As a result, they outsourced part of the process and engaged a financial advisor to identify, contact and negotiate with acquisition targets.
Business model change. Another company interested in making acquisitions wanted to transform its business. The company’s management team acquired a troubled company in an out-of-favor industry a few years ago and completed a dramatic turnaround. In the meantime, the company grew quickly and accumulated significant cash on its balance sheet. Through its strategic planning process, the company decided to change its business model and enter a related industry with better long-term prospects. To do so, they engaged a firm to advise them through the entire acquisition process—from strategy development to closing transactions.
Vertical integration. Another reason for acquisition is to become more vertically integrated. What is the benefit? In this case, the management and the board of directors of this consumer health care products manufacturer decided that vertical integration would help them gain more control over the supply of certain raw materials. They considered building these capabilities themselves. However, they concluded it would be faster and more cost effective to acquire these capabilities instead and worked with a firm to identify, contact and negotiate with acquisition targets.
How To Get Started
You might have decided to explore an acquisition and know some likely targets, which is a good start.
What’s next? You can begin contact on your own, or if you don’t have this type of business experience, you can engage the services of an investment-banking firm. The biggest benefit to outside help is that you can tap into their expertise in making acquisitions while you focus on your expertise: running your business. The right advisor will help in other ways as well:
- Creating or refining your acquisition strategy and criteria
- Determining whether or not you have the capital, human and other resources to make an acquisition
- Providing advice on current market valuations and valuation methods
- Identifying and weeding out acquisition targets
- Analyzing and valuing interested targets
- Developing transaction structure alternatives, draft term sheets or letters of intent, and presenting them to interested targets
- Arranging the financing to complete transactions
- Helping you and your legal advisor and CPA conduct due diligence and close transactions.
Many of the variables that affect the way deals are priced and structured are currently favorable to buyers. Interest rates are likely to remain steady or go down, and commercial bankers are aggressively pursuing good business deals. After increasing for several years, purchase price multiples decreased at the end of 2007, suggesting that multiples may have stabilized or may continue to decrease. In the meantime, debt to EBITDA multiples have remained steady.
What does that mean to you? It’s a good time to buy if your cash position is strong and your strategic plan calls for customer or market diversification, or you want to eliminate your competitors by buying them out. Talk to your investment banking firm to see what your options are and the most appropriate way to begin the process.