The Cardinal Rules of Buy-Side M&A
Evaluating opportunities and cautions for acquirers
Most of my activity as an investment banker was on the sell side, but as an operator, I have many battle scars as well. During one rigorous stretch, I acquired 13 companies in 36 months — an experience that provided me with hands-on knowledge of what works and what doesn’t. In this post, I thought it would be interesting to explore some of the opportunities and cautionary thoughts that exist for companies looking to acquire to expand their market position. This overview provides a framework — my cardinal rules — for preparing for, evaluating and optimizing an acquisition. At a top level:
- Get Your House in Order
- Target Location
- Culture
- Technology Fit
- Internal and External Due Diligence
- Post-Close Integration Plan
- A Bad Deal is Worse than No Deal
- Implications of a Banker on the Other Side
- Structure
- Financing
Get Your House in Order
Before considering any acquisition, it is essential that your company has a foundation in place to make the strategy successful. This involves four major elements:
- IT Infrastructure: Do you already have a fully comprehensive IT infrastructure in place that can be used to assimilate another organization? My preferred strategy is to put the acquired company on my operating environment as soon as possible. This creates control and communication benefits as well as possible cost synergies. If you are considering geographically diverse transactions, your system must be able to support multi-currency and multi-tax. These are some of my top thoughts, but a rigorous technical analysis is in order.
- Operational Excellence: Are policies, procedures, and processes well documented for all aspects of the organization?
- Management Depth: Is your management team mature enough and deep enough? To be successful, you need to have bench strength — I found that if you could ‘sacrifice’ one of your current executives to live and work with the acquired company post-acquisition, the chances of a successful integration went up exponentially.
- Strong Internal Communication: Deep communication and transparency are the last ingredients for success. You need to build a bridge with the target post-acquisition to ensure that the combined teams are working harmoniously and that the newly acquired entity feels part of the organization.
Target Location
Over the years, I have developed one major rule for myself as it pertains to potential acquisitions. “Never buy a company in a location that you don’t want to visit often.” The senior management team will need to work very hard to ensure optimal integration and often this is translated into deep visibility and support for the new team. Great communication obviously helps this, but the real leverage is in developing deep face-to-face relationships with the employee base and executive team.
Anecdotally, I once walked away from a transaction in a city that it was impossible to get to on a direct flight. I realized that any member of my team would consider it to be a lost day in each direction just getting there and back to the Corporate office. It turned out that this city also had challenging weather — exasperating air travel to and from their corporate location.
Culture
It’s important to consider the implications of cultural fit with each potential target. I have found that post-integration success depends heavily on this characteristic. I have seen significant cultural differences exist within the US and Canada, and even more so as you expand the geographic focus. From employee benefits to working hours and everything in between — culture matters when bringing two houses together under one organizational brand.
To explore the question of fit, I always make sure to have many social functions around the due diligence process as possible — to get a clear understanding of what makes the executive team tick.
One great leading question is to discuss branding post-closing. In my experience, it’s been valuable to continue with the acquired company’s own branding for a limited time (as an example, “Chance Corp., a subsidiary of Acquire Co.”) before moving exclusively to your own brand. I remember vividly talking to a potential target in Europe who had the strangest corporate name, and he insisted we adopt his name. I realized very quickly that this deal had a lot of challenges, and that working with this individual would add significant overhead to the relationship.
Technology Fit
It goes without saying that acquiring companies with similar technology framework is extremely important. Without this type of consistency, it is virtually impossible to get maximum synergy from the engineering team as well as the technology. Your engineering team needs to part of the early stage due diligence to ensure that integration can be seamless and cost-effective.
Internal and External Due Diligence
My strong recommendation for any meaningful transaction is to have your own team do phase one of the due diligence effort leading up to the non-binding LOI — but to hire expert assistance for the confirmatory process. Firms like Duff & Phelps and the top accounting firms have strong Quality of Earnings / Due Diligence teams that — while not inexpensive, will provide you the necessary comfort to ensure the accounting systems and accounting controls are in proper order. These types of engagements typically cost between $100K and $150K but are well worth it. You are generally not equipped internally to do this type of detailed review unless you have a larger internal corporate development team and it also eliminates your team from being the “bad guy” in the confirmatory due diligence phase.
Post-Close Integration Plan
In my opinion, the old adage of “Failing to Plan is Planning to Fail” resonates in a buy-side acquisition. The Post Integration Plan Document normally starts off as a strategic rationale document for the Board and a modeling exercise to help frame valuation.
As the likelihood of moving forward increases, the best companies begin developing a very detailed integration plan. In my time as an M&A banker, I saw no one better than IBM. Obviously, they had the resources to complete this effort but every deal requires this level of process development.
At a minimum it needs to include the following:
- Announcement Dynamics
Press Release
Buyer Execs at Target Company
Handouts for New Employees
Health Plans
Key Customer Contact - 90 Day Operating Plan
Key Objectives
Reporting Structure
Titles
Employment Agreements
Product Roll Out - Internal Integration Committee
Made up of both companies
Weekly integration calls
A Bad Deal is Worse than No Deal
This is a simple rule that you must keep repeating to yourself. As the transaction size gets larger the potential downside risk of a bad deal increases. Do not fall in love with a transaction. You need to have the maturity to walk away if the diligence feedback is negative. A bad transaction can do irreparable harm to your company and it is not a risk worth taking.
Implications of a Banker on the Other Side
Some people believe that having an M&A banker represent the target is not a good thing. I will admit that if the banker does a good job, there is a good chance the price of the transaction could go up and the terms may be harder to negotiate in your favor. However, for me this was a real indicator that the target wanted to sell, so my strong view was that the positives outweighed the negatives provided my team took a professional approach to valuation.
Structure
As you can imagine, the optimal buy side structures form the buyer’s perspective are completely opposite of what we would want as sellers. As a buyer, we want to ensure ongoing engagement, commitment, and common objectives. We want to retain the key employees for an extended time- period and want to ensure there are no hidden liabilities in the company.
In the perfect world, I would like to buy assets rather than shares as the tax implications are generally improved and the diligence effort reduced.
I want strong retention plans for key employees and normally a delay through an earn-out or other mechanisms on when management receives their purchase price consideration.
I want to negotiate strong non-competes and non-solicits for every employee receiving purchase price consideration.
Working with a strong M&A lawyer will greatly assist your team and Board.
Financing
I have purposely left the most important area to the last. There is a lot of money available today both in debt and equity to help fund strategic acquisitions. In many cases, your existing shareholders may want to participate or help lead the round.
No seller will take you seriously if you are trying to purchase a company and you have a “Financing Contingency”, so some amount of effort needs to be completed in advance — deciding the optimal partner for financing your transaction.
My experience is that the alternatives depend on the size of the acquisition as well as whether it is a one-off deal or part of a longer term multiple acquisition strategy. One-off transactions tend to be optimized using debt, equity or a combination of the two. Larger transactions or serial transactions generally require the support of a more committed partnership. My experience says that for these types of opportunities, Private Equity or Growth Equity tends to provide the capabilities and capital access to significantly accelerate the process as well as provide the existing shareholders with secondary options. The best firms also allow management and the existing shareholders to roll into the same strip of equity that they will own.
We are fortunate at Inovia Capital to have LPs that are amongst some of the largest in the world. This provides strategic leverage for our portfolio companies that are contemplating the acquisition path. Inovia Capital has also added bench strength in HR, Corporate Development and Sales to further support our portfolio partners.
Scott Munro is an experienced operator, a Venture Partner at Inovia Capital, and co-founder of Pagemill Partners. He works with Inovia Capital on the acceleration team, helping companies understand and prep for M&A activities. He shares his time between Quebec Canada and Carmel, California.
