Is a Company Good or Bad? Evaluating Your Acquisition Prospects

How can you tell a good company from a bad company?

A lot of CEOs say that they trust their gut when it comes to acquisition targets, but unfortunately instincts and opinions aren’t enough. We need facts and metrics. We need real tools to generate quantifiable data about the companies we’re considering. M&A is a massive undertaking and relying on instinct alone to guide you is a mistake.

The Prospect Criteria Matrix

One tool we use to help objectively evaluate potential companies for acquisition is the Prospect Criteria Matrix. It starts by defining the key characteristics of a good acquisition for your strategic objectives. In each case, you want to determine a way to quantify the criterion on some kind of scoring system.

For example, “good financials” may be one criteria and your metrics may be a revenue between $25 and $35 million, and a strong balance sheet. Other criteria could include customers or geographic location.

Typically we recommend clients limit to no more than six criteria. With more than six criteria, it’s easy to lose focus on meaningful strategic aspects of the company. Each individual criterion should have multiple, measurable metrics.

Weighting Criteria

But simply scoring the criteria is not sufficient. The information you gather needs to be weighted because not all criteria are created equal. Some factors will be more critical than others. You need to sit down with your team and identify the things that are most and least important to your organization. For example, financials might be a very high priority for your acquisition strategy, so you might weight that one at 30 percent. If location might be less important, and you’d give that 20 percent.  You juggle your criteria to add up to 100 percent.

So how do you use this tool? Let’s say you have 20 companies you’re evaluating. Get everyone on your acquisition team together and ask them to rate each company based on the criteria you’ve chosen. It usually works best to use a scale of one to ten. One company might get an eight in a particular category while another gets a three. Once you’ve established the average for each category for each company, you multiply by the weighting percentages to find the weighted average.

The Prospect Criteria Matrix helps you objectively evaluate potential acquisition candidates.

The Prospect Criteria Matrix helps you objectively evaluate potential acquisition candidates.

What’s even more important than the areas where everyone agrees are those where there is dissent. If you give a company an 8 on financials and someone else gives it a 2, then that should be the start of a conversation. And because you’ve chosen measurable criteria, you can compare the data rather argue about whose “gut feeling” is right.

The tool allows you to easily prioritize companies, and it also helps to confront some of the warning signs we’ve looked at above. For instance, if your CEO is pushing a “Brother-In-Law” company, instead of having an awkward conversation about why you think he’s wrong to be so enthusiastic, you can show him the data and insights generated by the Prospect Criteria Matrix.

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