Ten Questions to Ask Before Pursuing
an Acquisition
Corporate acquirers can
benefit from asking the same questions private equity firms ask themselves
before pursuing acquisitions.
Most mergers
unfortunately fail. Looking at Quaker’s purchase of Snapple or the merger of
AOL and Time Warner, mergers regularly expose executives to insurmountable
culture clashes, integration challenges, or even biases that make them fall in
love with a deal and drastically overpay. As my colleague Jay Kim shows
in his research, desperation can
also make executives throw the kitchen sink at a deal, with dire consequences
for the long-term plans of the business.
Corporate acquirers
pursue acquisitions for many reasons from gaining access to complementary
resources and capabilities to increasing their size and economies of scale; the
hunt for synergies is the key term. Private equity funds on the other hand have
a different mandate when it comes to acquisitions or investments. They have a
clear end goal in mind: improve or transform the portfolio company and sell or
exit the investment. The ability to exit is vital in Private Equity (PE) and
the implied measure of success, makes for an interesting study for the benefit
of all acquirers.
In the Private Equity
elective, part of the INSEAD EMBA programme, we give the students detailed
documentation of various acquisition opportunities and ask them to prepare a
pitch for the investment committee of a mid-market buyout fund. When vigorous
debate inevitably gets underway, we always find one key question bubbling to
the surface: What’s different about the way PE players approach a deal to the
way corporate acquirers do; what can we learn from their ability to capitalize
on the opportunities? As Graham Oldroyd, former Partner at Bridgepoint, and I
argue in the class, PE players ask themselves ten questions in regard to every
proposed acquisition. Corporate acquirers can benefit by asking themselves the
same questions too. In the main, each will have similar desired
answers. There are, however, some subtle but important differences. Many
acquisitions are contested, and corporate acquirers may frequently find themselves
competing against PE bidders. It is then helpful for corporate acquirers not
only to ask the same questions but also to understand where there may be
different considerations being applied by PE.
1. Why invest in this
company?
PE buyer
considerations: Can this be positioned as a compelling opportunity to
investment committee colleagues and to investors in the PE fund?
Corporate acquirer
considerations: Will this be compelling when described to the holding
company board, key shareholders and other stakeholders?
2. Is this in line
with the investment strategy?
PE buyer
considerations: Does the investment fit the fund mandate? Is it in the right
geographic region? Does the transaction fall within prescribed enterprise value
and equity investment size limits? Is it in a target sector? Is it at the
correct growth stage (start-up vs. early stage vs. growth or established
business)? Is it a ‘good to great’ or ‘turn-around’ investment? Is there
development potential and market opportunity? Is the management of the right quality?
Having bought and developed the target company, will there be a ready exit
through IPO or sale?
Corporate acquirer
considerations: Does the acquisition fit or conflict with the acquirer’s published
acquisition strategy and/or previous statements by the Group Chairman or CEO to
investors? If the acquisition takes the acquirer group in a new direction, can
this be readily explained and justified?
3. Are reputational
issues addressed?
PE buyer
considerations: Are there reputational, ethical, environmental or other issues
affecting the investment, and, if so, have they been priced in, and are they
being fully, responsibly and satisfactorily addressed? Does the target
carry out activities excluded by certain PE fund investors (e.g. armaments,
tobacco, etc.)? Will the acquisition require Competition Authority or
other regulatory or government approvals?
Corporate acquirer
considerations: Are there reputational issues affecting the investment, and, if
so, have they been priced in, and are they being fully, responsibly and
satisfactorily addressed? Will this be seen to be the case by
stakeholders? Are any risks so large that, however well managed, if things
still go wrong they could potentially threaten the whole Acquirer Group?
Will the acquisition require Competition Authority or other regulatory or
government approvals?
4. What is the
quality of the earnings?
PE buyer
considerations: Is the current and projected future profitability on which the
investment case is based sustainable? What is the extent of cyclical exposure?
Does the target have earnings resilience, pricing power, sustainable
competitive advantage?
Corporate acquirer
considerations: As for PE, and: What synergy benefits exist and how certain are
they?
5. Is there an
opportunity for good returns?
PE buyer
considerations: Is the expected purchase price reasonable and within relevant
benchmarks? Is an appropriate level of debt funding available? Do projected
potential equity returns meet PE fund requirements? Is the investment
characterised by unlimited, strong potential upsides through multiple possible
routes, and limited or moderated downside, or the reverse?
Corporate acquirer
considerations: Is the expected purchase price reasonable and within relevant
benchmarks? Will it be earnings dilutive or accretive? Is finance
available internally or at a reasonable cost as new funding? Do returns
depend on synergies? If so, how certain are they and how is the projected
value shared between Acquirer and Seller? Will the acquisition block
other expansion options?
6. Realism of plans
and projections?
PE buyer
considerations: Has the target company demonstrated past forecasting/budgeting
accuracy; solidity of assumptions; contracted future earnings; cyclical
exposure; quality of management, etc.? What is within the target
company’s control, and what is outside? Are there any key dependencies
(e.g. suppliers, customers, third parties)?
Corporate acquirer
considerations: As for PE.
7. Management?
PE buyer
considerations: What is the existing management team’s track record? Is the team
capable of delivering the projected turn-around/revenue and profit growth, and
running a larger, expanded business? Are there any existing gaps or team
members leaving post-acquisition? Can these gaps be filled? Do key
customer, supplier or other relationships depend on individual management team
members? Is management ready to invest personally in the acquired
company? Were any key functions fulfilled by the Seller, and, if so, how
will these be handled once ownership changes?
Corporate acquirer
considerations: What is the existing management team’s track record? Do they share
the same culture as the Acquirer? Is the team capable of delivering the
projected revenue and profit growth, synergies, and running a larger, expanded
business? Are there any existing gaps or team members leaving post-acquisition?
Can the Acquirer cover this? Do key customer, supplier or other
relationships depend on individual management team members? Were any key functions
fulfilled by the Seller, and, if so, how will these be handled once ownership
changes? Will management be happy with incentives in the Acquirer Group?
8. Exit opportunity,
ease and timing?
PE buyer
considerations: Having bought the company, how easily will the PE Fund be able to
sell it at the end of the investment period? If so, when and how – IPO, trade
sale, timing, etc.? Are there obvious future owners?
Corporate acquirer
considerations: Is the aim to merge the acquisition with other Acquirer Group
companies or run it as a free-standing entity? In either case, if the
acquired business at some point in the future becomes non-core, can it readily
be resold? Would such a sale expect to attract a premium or discount to
the acquisition pricing?
9. Matters requiring
further due diligence investigation?
PE buyer
considerations: Do we know the company, the sector and the management? Have we
taken references? What are the key assumptions underpinning the
investment case? How can these be tested? Have potentially disruptive new
technologies, market or regulatory changes been assessed? Are there any
key customer, supplier or other dependencies? What are the potential
‘left-field’ risks? In addition to ‘standard’ due diligence (accounting,
tax, pensions, commercial, legal, environmental) what specific further issues
need investigation? Any potential issues under UK Bribery Act 2010 and US
Foreign Corrupt Practices Act 1977?
Corporate acquirer
considerations: As for PE.
10. Competition to
buy the business?
PE buyer
considerations: Do we know competing bidders? Can we expect to win, and will
the Seller sell at the purchase price assumed?
Corporate acquirer
considerations: As for PE
So what can corporate
acquirers learn from the way PE firms execute acquisitions? In summary, given
that PE firms are directly measured by and succeed or fail based on their
investment performance, they are more selective about the acquisitions they
make and more financially disciplined post-acquisition. They’re also more open
to the type of acquisition as long as there is clear potential for the target,
whether in growth, turnaround or development potential. Given the importance of
making an exit, PE firms are focused on immediate improvements and are willing
to invest in making such improvements; culture is less important as long as the
management shows potential.
Claudia
Zeisberger is a Senior Affiliate
Professor of Decision Sciences and Entrepreneurship and Family Enterprise at
INSEAD and the Academic Director of the school’s Global Private Equity Initiative.
Read more at http://knowledge.insead.edu/blog/insead-blog/ten-questions-to-ask-before-pursuing-an-acquisition-4753?utm_source=INSEAD+Knowledge&utm_campaign=ea2019b44d-23_June_mailer6_23_2016&utm_medium=email&utm_term=0_e079141ebb-ea2019b44d-249840429#dED6m4zbo6uJ08A1.99
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