Process
Step 6: Select Search Criteria and Find Target Companies
Following the decision to pursue mergers or acquisitions, set the cri- teria for the target of your hunt. In other words, select the search criteria.
The following are the primary criteria that should be on any criterial list:
• Industry.Generally this is the same industry or a similar industry to that in which the acquirer is currently active. A relevant question is whether only vertical acquisitions are of interest or if horizontal prospects are also to be considered.
• Products or services.Often acquirers desire products or services that have a significant presence in the market.
Thus, they seek to acquire a target that has a better brand name or an expanded line of products or services,
particularly higher value components or lines.
• Revenues.Revenues are usually evaluated based on size, and usually the target will be smaller than the acquirer.
• Earnings.Acquirers should decide if they require a desired minimum amount of earnings, or whether losses (see turnaround criteria) are also acceptable, if correctable. A target with losses will likely be dilutive to the acquirer’s
earnings in the short run; however, this is often less significant than indicated by the M&A market’s fixation on whether earnings are immediately dilutive. Negative earnings can be corrected if they are a result of weak management or an inability to fund growth or to modernize plant. Often a target with correctable losses can be acquired at an attractive price.
• Whether turnarounds are considered.Turnaround situations can include anything from a target that has recently experienced losses to one in bankruptcy. Some acquirers are willing to look at turnarounds while others rule them out by policy. In a seller’s market, when there are many buyers looking at every attractive company available to be acquired, the willingness to consider turnarounds can assist the acquirer.
Usually there are fewer possible buyers for turnarounds, and the sellers tend to be more realistic about price. The more conservative prices paid for turnarounds also may provide the acquirer more time to achieve synergies.
• Geographic area.Most buyers want to acquire targets in a given geographic area. With the globalization of markets and the continuing reduction in trade barriers, acquirers are increasingly interested in targets throughout the world.
The decision on where expansion should next take place should be based on the acquirer’s overall strategic plan.
• Whether target’s management should be retained.Most often this choice is influenced by the acquirer’s depth of competent management. When a company has excess management worthy of a promotion, it may seek to acquire a region or product line for them. Growth strategies, however, should always be tied to value creation.
When the M&A market is hot, the price required to ac- quire a successful company is higher. Often these higher prices can be justified only through an earnout used to bridge the higher price the seller feels is appropriate based on the future outlook versus the lower price the buyer feels is appropriate based on the target’s current status and performance. Earnouts are discussed further in Chapter 14.
• Private companies or public companies.Generally, this choice is most dependent on whether the acquisition is consistent with the acquirer’s strategic plan.
• Ideal fit.A target is usually an ideal fit when its product or service naturally fits the acquirer’s marketing, sales, and distribution system and its geographic requirement. Such a fit allows fast and efficient integration. Buyers must be cautioned, however, that even the best fit remains a poor investment if the price paid is too high compared to the risk-adjusted returns.
Having selected the criteria to judge targets, the next step is to find prospective targets. The more common ways to locate tar- gets include:
• Industry contacts.While hit and miss, targets sometimes are found through personal relationships within the desired industry. This process works better when the desired targets are in the same industry as the acquirer because this
increases the number of companies and trade associations with which the acquirer has contacts.
• Business intermediaries.Business broker and investment banking firms represent companies available for acquisition as well as acquirers. Providing such firms with the acquirer’s criteria informs them that the acquirer is looking and provides guidance as to what is desired. The acquirer should recognize that the use of intermediaries may
generate many inappropriate prospects. It can be expected to result in two types of pressure:
1. The intermediary’s fee, or the major portion of the fee, is earned only when a deal occurs; hence, the in- termediary’s primary objective is to “make a deal hap- pen.”
2. Often the intermediary will create a sense of urgency, (i.e., a pressure for the acquirer to act in haste to avoid missing the deal).
Acquirers should resist these pressures, as well as the en- couragement to bid a higher price than the analysis of the strategic benefits and synergies of the deal warrants. For nearly all acquirers there is, at any time, an ample number of possible acquisitions. Buyers should not be rushed into of- fering too much, acting too fast, or feeling the need to do any specific deal.
• Searching for the right target.With a well-defined criteria sheet, an acquirer can search for and approach companies to determine their level of interest. This process is more difficult than waiting for intermediaries to identify targets, but it often identifies targets that are not represented by any intermediary.
Through this search, exceptional targets may be identified and competitive bidding against other buyers is avoided.
Some business valuation professionals and intermediary firms offer a service to locate and make the initial contact with companies not on the market but that fit your criteria. The ad- vantages of outsourcing include:
• The task becomes a contracted performance with a time line in contrast to something the acquirer will do whenever the time can be found.
• When a valuation firm provides this service, it can use its familiarity with the company and contact with its executives to begin the process of estimating the target’s stand-alone market value.
• The contact by the outsourced professional can sidestep the attempts of prospective targets to qualify the acquirer before the acquirer has determined his or her level of interest.
Understandably, targets want to know whether a potential ac- quirer is a cash buyer or wants management to stay. Early contacts by acquirers lead to the targets asking this type of question at a time when the buyer’s focus should be on learning more about that specific target. Appraisers can easily deflect or delay these questions by explaining that at the time they lack the authority to address them.