| The M&A process
has changed. Today, buyers and sellers are more cautious than
ever before. Pre-LOI due diligence is lasting much longer
prior to firm deal terms being agreed upon. There is much
more focus on forecasted revenues and stable and growing customer
bases. Integration planning on paper is taking longer prior
to the execution of a Letter of Intent. Finally, management
teams, while extremely important in all M&A activity,
are becoming much more central to success in today’s
M&A transactions.
For buyers and sellers alike, the key to achieving
successful M&A transactions, with the assistance of intermediaries,
is to identify the value components or "value drivers"
of the transaction and then to make certain a plan is in place
to integrate these components at the least cost. At FOCUS
Enterprises, we assist our clients in carefully evaluating
twelve specific Value Drivers when considering a buy-side
transaction.
Value
Driver #1: The Customer Base
The customer base of the company being acquired is extraordinarily
important. What is the buying trend from these customers over
the past five years? What is the extent of customer churn?
How many new customers have been acquired annually over the
past few years? What is forecasted revenue from these customers
over a specific forecast period? How stable is the customer
base? What is the profile of the customer base? Are the customers
large, medium or small? How vulnerable are these customers
to economic fluctuations? What is the revenue distribution
of these customers over the entire revenue base of the company
to be acquired?
Value
Driver #2: Recurring Revenue
One of the top value drivers to consider is the recurring
revenue coming from the customer base of the company to be
acquired. Of total revenue, what percentage is recurring?
This portion of total revenue is valued more highly than so-called
"one-time revenue." Will the combination of revenues
from the acquiring company and the acquired company create
an opportunity for a higher recurring revenue percentage of
the total when the deal is completed? Finally, is there an
opportunity to change the business model of the acquired company
to result in stronger recurring revenue?
Value
Driver #3: Product Integration
A major reason for making an acquisition is to acquire a new
and complementary product line(s) so that the acquiring company
can leverage its current distribution system and therefore
increase gross margins. Great attention must be paid to technical
platforms of different products. Even more attention and analysis
needs to be completed on whether products are complementary
or competitive. Product/market segment research often must
be completed before a product integration advantage can be
substantiated.
Value
Driver #4: Gross Margin
At Focus Enterprises, we believe this is most important line
item on the P&L. In-depth analysis on paper needs to be
completed to determine whether acquiring the target company
will ultimately improve or degrade gross margins. Manufacturing
processes need to be analyzed to accommodate more--and presumably
complementary--product sets as well as items such as customer
installation/training and service/warranty commitments.
Value
Driver #5: Intellectual Property
"Intellectual property" is a catchall term meaning
one thing to one person and something entirely different to
another. Generally, at Focus Enterprises, we use the term
in its broadest sense when assisting a client with a transaction.
Intellectual property certainly means trademarks, patents
and copyrights but it also can mean a "developed process"
such as a unique way to generate sales leads and then close
sales using only the Internet. Accordingly, proprietary processes
should be closely examined when evaluating a company for acquisition.
Value
Driver #6: Human Capital
Today, this area is being looked at and evaluated to a much
greater extent than ever before. During the late 1990s, a
common approach was to acquire a company, assume that management
and other key employees would stay for a while and then, the
acquiring company would expect to augment or replace management
as employment agreements expired. Today, buyers look for situations
where management wants to stay for the long term. Post-sale
integration failures of the past are largely the result of
management departing after the deal is closed.
Value
Driver #7: Management Experience and Expertise
This Value Driver is closely aligned with Value Driver #6:
Human Capital, with the following differences: Does the management
team of a company being acquired have substantial knowledge
of a specific product, process or market segment that is a
necessary requirement of the acquiring company? Can the managers
of the company to be acquired add value to the current management
team? Will this new management team give the organization
the capacity to grow to the next level?
Value
Driver #8: General and Administrative Leverage
Almost as important as the Gross Margin Value Driver is the
general and administrative leverage when combining the acquiring
company and the company to be acquired. Once again, careful
planning is necessary in this area prior to the LOI stage.
Buyers tend to overestimate the cost savings of combining
companies at the G&A line. Also, transition costs are
often underestimated, if not overlooked altogether.
Value
Driver #9: Distribution Leverage
Potential buyers frequently say, "I want to buy a company
where I can drive the products from the acquired company through
my existing distribution system." While this concept
is sound, there are pitfalls. Buyers need to be sure that
end user customer requirements are complementary to this strategic
approach.
Demand should be measured through effective
market research. Sales and dealer training costs need to be
taken into account, and customer service expense of the new
products needs to be analyzed. These are just a few of the
items about this Value Driver that need to be studied. Distribution
leverage is an exciting concept and a top Value Driver, but
a hard look at implementation details is critical.
Value
Driver #10: History/Reputation and Operating Tenure
In the heat of an M&A transaction, this Value Driver is
often overlooked. It has to do with the stability and constancy
of the business being acquired. The fact that the company
to be acquired has been in business for some time does matter
and does have value.
The fact that customers have been with this
company for some period of time does matter and the fact that
the company is operating with the same management team in
place is a positive factor. While there are other factors
with this Value Driver, company history, reputation and continuing
operations are very important to the contemplated transaction.
Value
Driver #11: Sales and Marketing Effectiveness
This Value Driver is right at the top of our list when we
are advising clients. All too often buyers concentrate on
exotic product sets, exciting technology (that someday could
be turned into a product) or new markets and customer sets.
One key and very important element of a successful buy-side
transaction is to determine whether the company to be acquired
has developed an effective and "least cost" sales
and marketing model.
When was the model developed? How long has the
model been in place? What are the statistical results of the
sales and marketing model over time? Is the model scaleable
through the forecasted period? If the answers to these and
additional questions are positive, chances are you are on
the right acquisition path.
Value
Driver #12: Barriers to Competitive Entry/Competitive Differentiation
Barriers to competition are becoming more difficult to identify
as time goes on, as many companies are reluctant to file for
patents even if a technology or a process is evaluated to
be "protectable." Buyers must look for effective
barriers to competition when evaluating a potential acquisition
through competitive differentiation.
Examples are: Does the company have a "first
mover" advantage in a particular market or market segment?
Does the company to be acquired have significant product features
that would provide a real product advantage when compared
to competition? Does the company to be acquired have a significant
technological edge that affords a 12 to 18 month product roadmap
advantage? These are but a few of the questions that should
be asked and then thoroughly and objectively answered when
looking for a competitive advantage Value Driver.
Conclusion
In today's tough merger and acquisition environment, it is
more important than ever to concentrate on these twelve solid
Value Drivers when advising clients on the transaction process.
The late 1990s called for buying a company and then making
it work. Today's environment dictates careful study and analysis
of all of the potential Value Drivers prior to establishing
value, setting a purchase price and executing a Letter of
Intent to acquire.
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