Targeting potential acquisitions

Too often the discussion in the M&A area is about getting bigger through mergers rather than getting bigger through acquiring stand-alone entities. The advantage of the latter is that they are much easier to evaluate, certainly easier to transition to new ownership and don’t have the problems of culture clashes which mergers seem to throw up.

In targeting potential acquisitions, companies too often overlook acquiring businesses that can be left to operate substantially on their own. Too much attention is given over to overlapping activities, merging operations and cost savings. Take time out to look at which business could be acquired and contribute to overall profitability but be left under local management. One of the advantages of such an acquisition is that the evaluation is limited to what the acquired business can do in its own right without having to work out what combined operations will deliver.

I have always thought of a stand-alone acquisition as a financial deal rather than a strategic one. While I am sure there are sometimes elements of threat mitigation, a stand-alone business basically generates future profits without the complication of trying to assess synergies. Thus the evaluation is often much simpler and probably less influenced by non-objective or emotional or personal agendas.

Start with the existing operation. Instead of focusing the evaluation on what has been achieved in the past, concentrate on what can be achieved in the future. The value of the investment is entirely in what it can produce as net earnings in the future not what the current management has achieved in the past. After adjusting for the probable loss of the business founder and some senior executives, you need to work out what you would need to do to put the business on an effective and efficient basis.

The next phase of the evaluation is to factor in what you can do to the business to make it more profitable, more resilient and more growth oriented. This is where your own capabilities need to be tapped. What do you have in the way of spare resources, processes, intellectual property or business acumen which can be inserted into the new acquisition? What effect will this intervention have on the overall growth rate and future profitability of the business?

When you have competed this analysis, after accounting for the costs of the intervention activities, you will be able to value the business using a net present value calculation applying your hurdle risk rate. This is the maximum value of the business at the time of acquisition. If you are able to acquire the business for anything less then this value, you are likely to achieve a rate of return above your investment hurdle.

The key to a successful financial acquisition is to evaluate what you will do to the business after you take control of it. If you don’t have the capacity or capability to undertake the evaluation, negotiation and subsequent intervention, then perhaps you should walk away from this type of acquisition. However, if you can see your way to a clearly defined strategy of business improvement post-acquisition where you have the available resources and knowledge to undertake the task, then this type of acquisition can be much less problematic and much more reliable in terms of subsequent returns than the oft sought merger.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.