Acquisitions. You hear the word often these days. Acquisitions are driving industry consolidation in many business sectors. Acquisitions are being used to accelerate the growth of companies and to provide sustainable competitive positioning. In fact, companies are often forced into considering growth by acquisition because of what their competitors are doing.

 Does acquiring a company make strategic sense for your business? The media shine their spotlight on the advantages of this current merger and acquisition frenzy. However, many more acquisitions fail than succeed each year, or at the very least reduce shareholder value in the acquiring company. Companies overpay, improperly finance or don't properly gauge the managerial or human resource capabilities of the target company. Not much is mentioned about these risks. They are considerable and potentially fatal to any business whose owners underestimate them.

Successful acquisitions require expert know-how to originate and evaluate, and to complete business and financial due diligence. Acquisitions often demand expert guidance with regard to valuation, financial structuring and tax planning. Most importantly, since the culture within companies, even those in the same industry, is rarely the same, acquisitions require thoughtfully developed and carefully implemented post-acquisition integration plans.
 
WHY BUSINESSES NEED ACQUISITION HELP:

Based upon Source's many years of practice experience, we find that most companies need acquisition assistance for one of four reasons:
 
1. They learn that the owners of a competitor, with whom they've maintained some industry relations over the years, are thinking about selling because of health problems or for retirement purposes, or because there are no family members who wish to operate the business in the future. Because of their business relationship, the competitor contacts them before retaining a broker, however they are not experienced with acquisitors.
 
2. Their internal revenue growth is not enabling them to accomplish their strategic goals quickly enough to keep up with competitor activity or customer expectations. They must accelerate their growth to remain competitive, diversify, increase capacity or for any one of a number of other reasons. They decide that external growth needs to be included in their strategic plans. They have generally a limited universe of prospective companies to approach, and do not have the managerial depth or experience to develop and implement an acquisition program.
 
3. As part of their strategy reassessment, and without being pressured by actions of competitors, they conclude that an acquisition can enable them to lead industry change, or otherwise better competitively position their company in the future. They have relatively few targets in mind, limited acquisition experience and will probably need to refinance in order to free up capital for buying other companies.
 
4. They are rapidly consolidating within an industry. They are an experienced management group with plenty of acquisition experience. But they need help with some specific aspect of their acquisition program, or they have too rapidly acquired a series of companies and their post-acquisition integration results are not producing the gains anticipated.

Source Companies, LLC has nearly twenty-five years of experience in assisting clients with acquiring companies. The capabilities of our senior staff and affiliates enable us to assist with any aspect of acquisition evaluation, finance, negotiation, closing or post-acquisition integration as well as to perform effectively from start to finish. Whatever your needs dictate.
 
BUYOUT MULTIPLES & BUYOUT FINANCE
 
As has occurred during past economic cycles, since 2004 business acquisition multiples have increased as the economy has improved, buyout fundraising has skyrocketed, credit markets have been wide open, and competition for acquisitions has increased. The current market conditions are motivating sellers and capital support is available at favorable terms to buyers.

By way of background, as illustrated in the table above, during the 1997-98 period, multiples had reached a level comparable to the late 1920’s. Also, during that period, as depicted in the chart below, low equity and high debt levels (supported by junk bonds) facilitated a run-up in buyout multiples.
 
 
 
 
 
 
 
 
 
 
 
 
 


 

In the 1997-98 period, although lenders required more equity in buyout transactions than in the late 80’s, with more debt available for buyouts and a flood of low-cost equity, buyout multiples were driven to their highest point of the Twentieth Century. Between 2000 and 2003, the economy slowed, loan defaults increased and credit was tightened. With less debt available for buyouts, multiples receded.
 
The current M&A market can best be described as highly competitive. Both strategic and financial buyers are flush with cash coming out of the slowdown in 2003, the result of which has been increased purchase multiples. As these multiples have increased, lenders have demanded higher equity contribution rates, which has been easily accepted by the buyout funds riding two consecutive years of record breaking fundraising efforts, although lenders have also demonstrated a willingness to increase their own exposure levels from 2.5-to-3.5x EBITDA in 2001 to 3.5-to-4.0x+ EBITDA early in 2006. The banks willingness to increase leverage results from loan default rates being at their lowest level in a decade, as well as increased competition primarily from the entrance of hedge funds into the senior debt markets. What defines the current M&A market from previous periods of robust M&A activity is the dispersion of activity across a wide number of industries as well as the increased number of capital structure alternatives available including the acceptance of second lien debt financing.
 

If external growth is part of your strategy, purchase multiples are attractive to sellers and increased competition in the capital markets can provide financial solutions on very favorable terms.
 
If you are planning to pursue an acquisition in the current environment:
 
1.  In addition to buyout capital, consider asking the seller to provide some level of seller finance. This can enable you to pay the seller a bit more, which might sway the transaction in your favor.
 
2.  In a market where the seller is “getting more,” be prepared to suggest an “earn-out” formula. If the business performs well, it will not hurt to pay a bit more based upon the future performance.

Thoroughly evaluate the company before you buy it to determine whether you can improve its operational and financial performance.

However, given the lofty expectations of sellers and the competitive buying frenzy at the moment, many business owners are seeking strategic alternatives. Three general areas of focus are:
 
a.  performance enhancement of current operations
 
b.  seeking “know-how” and development support from Fortune 500 companies under licensing agreements or joint ventures, and
 
c.  targeting non-core and underperforming subsidiaries or divisions of larger companies, which have recently been acquired or owned by buyout funds that are liquidating within a few years.
 
For more information on such alternative strategies, please contact Source Companies, LLC.
 
PRE-ACQUISITION IDEAS

In most cases, clients use our target company evaluation tools. These include our Value Growth Contribution (VGC)™ financial analysis which measures management’s effectiveness to create shareholder value in the target company. Our Value Driver Analysis (VDA)™ is a non-financial measurement which quickly helps to gauge a target company's competitiveness relative to industry best practices in the four critical value driver areas of marketing, people, process and information. Both of these assessments provide our clients with a comprehensive understanding of a target company’s performance strengths and developmental needs.

Our proprietary Design Measurement software enables modeling of organizational changes to isolate those which will create a more valuable company post-acquisition, and our Insight tools can be used to precisely measure the effectiveness of a target company's people, individually or in teams. Such capabilities provide competitive advantage when analyzing and negotiating acquisitions.
 
In other cases, our core strength in finance is needed most. Client companies, which have not traditionally had aggressive external growth strategies, typically have restrictions under their bank loan agreements that preclude the use of their bank credit facilities to fund acquisitions. Our expert guidance can aid in negotiations with existing lenders or, when necessary, quickly enable you to replace your lender or to arrange specific acquisition financing.
 
Our experience in dealing with closely-held and family businesses also enables us to provide acquisition search, evaluation and negotiation services to help bring about successful outcomes. We have represented hundreds of companies over the years, know many others and maintain one of the most extensive private company databases in North America. Typically, we can help broaden a company’s acquisition perspective or enable them to reach targets that would otherwise be unavailable.
 
Because of the inherent risks of any acquisition, some combination of our acquisition and operational effectiveness services is often the most effective approach to facilitate success. Companies benefit from our operational effectiveness services by gaining the tools and systems needed to improve business performance. Hard work alone is not enough to ensure success in integrating acquired companies into your business. Desired operating results can only be achieved through a focused effort by the entire company and the one being acquired. Such an effort requires effective communications, appropriate and continuous training and development, and resource rationalization.
 
The key to operational success is to get all employees to know and embrace your growth strategy and to understand how it relates to their departments and their jobs. Source can provide your management team with the tools necessary to maximize their effectiveness in this regard, enhance organization performance, increase cash flow, and achieve strategic goals and objectives. All of which results in a more competitive company, a more productive work force, increased customer satisfaction, and increased revenue and profitability—the very reasons you want to acquire another company in the first place.

We offer a no-cost, no-obligation preliminary meeting and assessment which can help us determine, and you to evaluate, whether our acquisition and organizational effectiveness services can assist you in developing and implementing an acquisition program, or in getting the best return from a company you intend to or have already acquired.
 
As always, we are here to help. Whatever your requirements. "We'll get you there."

Confidential - ©2006 Source Companies, LLC as an unpublished work. All rights reserved. This work is the proprietary and confidential information of Source Companies, LLC. It is intended for the recipient only and may not be copied or reproduced except as authorized in writing by Source Companies, LLC.