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Drivers that Make or Destroy Value in Deals
The purchase or sale of a business can be the biggest financial transaction of an owner’s life, with plenty of items to consider along the way. From our experience of valuing thousands of companies and working on deals in a wide range of size and industry, we have prepared a list of pivotal items to consider that can make or break acquisition deals.
1. Purchase Price and Value:
Price is what you pay and value is what you get. This may seem obvious, but overpayment may be the easiest way to destroy value. Paying a fair price for a business will provide a margin of safety for an acquirer, but paying a high price means the business is priced for perfection and if it underperforms, the value paid is quickly eroded.
For sellers, it can increase the purchase price if you are able to improve the company’s revenue mix by increasing revenue from more products / services. This may include upselling, cross selling, adding new geographies or market segments, boosting sales and marketing initiatives or even new product innovation. Improving profitability through cost saving initiatives can also help drive a higher sale price, but be sure not to cut to the bone right before a transaction as a buyer will likely see this for what it is. Buyers pay for future performance, not the past. If the glory days are behind your company, they will be skeptical and pick up on that and discount pricing accordingly.
Performance improvements can also be implemented by an acquirer to increase top line growth and profitability. If the acquired company can be successful in implementing performance improvement initiatives, it can be a significant source of value creation after the deal closes.
2. Due Diligence:
Due diligence is critical to either confirming the deal pricing, walking away or negotiating adjustments to the pricing for items found in due diligence. Focusing on riskier areas, this should involve an integrated team covering areas such as operations, finance, legal, risk management, taxation and human resources – seek qualified advisors for gaps in expertise. If well done, due diligence can ensure a buyer is paying a fair value and potentially identify opportunities to create value post-close. If poorly executed, skeletons in the closet will rear their heads post-closing and value is eroded. Potential liabilities such as a litigation claim, or a significant tax exposure can turn an otherwise good transaction into a bad deal if there are inadequate seller indemnities available.
Sellers will want to lower risk ahead of an acquisition to get ahead of any potential issues that may come up down the road. To the extent possible, diversify your supplier and customer base so that your company is not exposed to concentration risk. Perform due diligence on yourself as the seller to dig up any risks you may have missed, including getting CPA prepared financials and a quality of earnings (Q of E) report. Try to eliminate or fully disclose any liabilities that your company is dealing with that may not be resolved before a sale occurs. Transparency and credibility are important during the due diligence process as issues don’t kill deals as much as not disclosing them to a potential buyer.
3. Alignment:
Since the success or failure of many acquisitions depends on alignment of policies and procedures, an alignment of human resources (HR) and culture is critical. HR should be part of the overall due diligence and integration process to preserve value and should not be managed in isolation. It is also more critical in professional services businesses like consulting that rely on retaining talented staff and personal customer relationships than in capital intensive businesses. Also cross border issues should be carefully reviewed since foreign labor regulations and cultures can create additional issues, but possibly also opportunities.
The alignment of management teams is also crucial to the post-acquisition success or failure. Notwithstanding that the buyer and the seller may have compatible cultures, if the corresponding management teams aren’t on the same page it can destroy value. Also if retaining key owner managers and ensuring they do not compete post-closing is critical to a successful ownership transition, the buyer should ensure the management is contractually bound to remain, and not compete, with the selling business for a reasonable period of time after the closing of the sale.
4. Macro Trends:
Acquisitions do not happen in a vacuum. Understanding where a business is in the business or economic cycles can impact the price paid and reduce overpayments at the height of a cycle or missing opportunities near the bottom of the cycle. A buyer should understand trends in their target’s industry, for example is the target in a mature industry facing threats and possibly declining, or a newer industry with disruptive qualities and significant growth potential? The U.S. is currently in one of the longest economic expansions on record, but if the economy contracts deal volume, and prices, may dive.
Of course, not every acquisition will be considered a success. Some will inevitably underperform while others will overperform. Even if the acquirer does everything right from pricing and due diligence to integration, it still may not meet expectations, leaving work to do. It is management’s ability to recognize issues as they happen and adjust and adapt to mitigate them which may even lead to a potential divestiture down the road to preserve value for shareholders.
These are just a few of the items to be mindful of when buying or selling a business. One thing not on this list is the element of time. While buyers may not need to hire ahead of the process, it may take years to properly set up a business for a successful exit. So if you are looking to sell your business down the road, engage a team of qualified professionals and get started!
To learn more about value drivers, please contact Michael Frost.
Moore Stephens North America is comprised of 43 member firms that provide key services across a wide variety of industries and niches. This article is a collaboration between Michael Frost with Mowbrey Gil and Matt Rampe with Beene Garter.
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