When you acquire a company, the biggest risk you face in the unknown. You put a potentially large sum of money down for results that are not guaranteed. Whether you are acquiring a company for a new technological capability, to expand your geographic footprint, or for its complementary product line – there’s always the possibility that the transaction won’t yield the desired results or that it will cause problems and even hurt your company.

In the news we hear about bad acquisitions and there is an entire book, Deals from Hell, that recounts exactly what went wrong in many of these high profile transactions. Acquisitions are inherently more risky than hiring a new employee that you could fire if you find it is not working out. Once you acquire a company, it is yours, and you’re not going to be able to “fire” it.

If Acquisitions Are Risky, Why Acquire?

If acquisitions are so risky, then why do companies do them? If done right, acquisitions can bring about great rewards and next level growth to your company. M&A is inherently a high risk, high reward tactic, but you can take steps to reduce your level of risk by using a proven M&A process. A proven process will help you identify the right acquisition so you can maximize your opportunity for success.

The Roadmap to Acquisitions

Think back to the example of hiring a new employee. Your HR department probably has a manual with a process for job posting, interviewing, and onboarding employees in order to ensure they are a good fit at your company. As we mentioned earlier, although you expect results from your new employee, if you find it’s not working out, you can always let them go. Why wouldn’t you have a process for acquisitions as well?

The process we use is the Roadmap to Acquisitions, which we developed from over 20 years’ experience helping clients grow through acquisition. The Roadmap takes a holistic perspective on the acquisition process, beginning and initial strategy all the way through deal execution and integration planning. I highly suggest using an M&A process or having a strategic plan before you begin pursuing acquisitions. This will help your reap the rewards of M&A while reducing your exposure to risk.

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During formal due diligence, which typically begins after signing the letter of intent, you gain access to in-depth information and begin taking a closer look at the acquisition target. Traditionally the primary purpose of this stage of the M&A is to identify significant risks that could impact the terms of the deal or put it in jeopardy.

However, I would advocate a broader perspective. In addition to risks, I’d encourage you to intentionally seek out hidden opportunities.  I recommend sorting your due diligence findings into three data buckets – red, yellow, and green. Red bucket items are liabilities you need to keep your eye on, yellow bucket items are acceptable risks that may be good or bad, and green bucket items are integration opportunities that could add value to the deal.

Uncovering a red bucket item doesn’t mean you automatically have to walk away from the acquisition, but it may mean you need to reassess or modify the deal. There are, of course, issues that will cause the deal to fall apart. For example, I recall discovering a pattern of under the table payments — one liability where we had to walk away.

But how in principle do you know if what you’ve uncovered is a deal changer or a deal breaker?

It really comes down to risk assessment and if you think the deal is still worth it. Fortunately, you don’t have to make this decision on your own. Confer with your acquisition team, both your internal leaders and external advisors.

Let’s say you’re confronting a clear-cut red bucket item. Here are some questions to ask: Is there a way to carve out or isolate yourself from the liability? Would modifying the transaction still fit with the strategic opportunity that’s driving your interest in the deal? Is any remaining risk worth the overall strategic benefit?

Whatever the issue, be sure to have frank discussions with the seller about it. Ask for a full explanation of what happened, and why, and how it affects the business going forward.

Once you’ve taken some time to evaluate a red bucket item, it becomes a simple business decision: Do you want to proceed with the deal or not?

At the end of the day, there’s no way to completely eliminate risk from an acquisition. After all there’s no reward without risk. But by conducting thorough due diligence and taking a strategic look at red bucket items, you can minimize liabilities and protect yourself from unnecessary hazards while maximizing your opportunity.

Photo Credit: Clover Autrey via Flickr cc

Acquisitions are one of the fastest ways to grow, but they do come with their own set of risks. Industry numbers show that about 70% of acquisitions fail, so executives are highly motivated to mitigate their risks when purchasing a company. This can be done in a number of ways.

Usually we think about hiring lawyers or advisors during due diligence who will uncover any skeletons in the target’s closet. If the target passes through due diligence without any red flags, we tend to think we’re in the clear in terms of risk.

In reality, if you wait until the formal due diligence stage to evaluate your risks beginning at due diligence, you are starting too late. By this stage you’ve already invested resources, both time and money, pursuing one deal. So it can be really hard to say “no” when red flags do appear.

In my experience, one of the best ways to mitigate M&A risk and increase your chances of success is by following a detailed and proven process. While this might sound simple, many firms embark on M&A without any written plan at all.

Let me use an example to illustrate my point.

Most companies have detailed HR manuals for hiring new employees that cover things like the job description, key performance indicators, salary and compensation, the interview process and onboarding once the employee joins the team. On the other hand, very few have an equivalent discipline when it comes to buying another company. The typical approach is more of a “we’ll know it when we see it.” Businesses just look for companies they might buy and then jump to evaluating their financials.

Companies typically pay far less for the people they hire, expect immediate results from them and can more easily dismiss them if they find it’s not the right fit. However, acquisitions cost millions or even hundreds of millions of dollars, take a long time to integrate and are very difficult to spin off if a mistake is made. If you think about it, it really makes no sense to pursue M&A without a detailed written system.

At Capstone, we’ve developed just such a process, the Roadmap to Acquisitions. It lays out each step, from developing the initial strategy all the way through to closing and integration. Our experience over the past 20 years has shown this process to be a key foundation to M&A success. Some risk is inevitable in every business initiative. The Roadmap is a sure-fire way to dramatically your acquisition risks to a minimum.

For the last couple of years, corporate America seems to have been playing it safe when it comes to growth. Currently U.S. corporations are holding on to a record $1.65 trillion in cash.

Are you in a similar position, perhaps? Cash may not be your “security” blanket but you may be unwilling to take the risks needed for growth.

Based on my daily interaction with midmarket companies, I would advise you to be proactive about your business growth. Failing to do so allows your competitors and the market to control your future. What good is cash if you don’t use it to grow your business?

Fortunately, it seems that some U.S. businesses are getting off the sidelines and putting their money to use. Many are investing in mergers and acquisitions, according to a report by the Association for Financial Professionals. In fact, this is the first year-over-year decline in cash reserves since 2011.

This trend reflects a growing confidence in the U.S. economy and it also demonstrates a profitable way to use cash rather than just letting it sit around.

But what about your company? Are you “playing it safe”? It’s not too late to take a proactive, strategic approach to growth. Here are four suggestions for putting your money to work rather than hoarding it:

  • Mergers and Acquisitions – Use M&A to grow quickly. Add a new customer base, enter a new market, or gain a new technology or capability. The core benefit of acquisition is that you have a ready-made solution you can use on day one, without building it yourself.
  • Stock Buybacks – Public companies will use excess cash to repurchase their own shares if they believe the price is undervalued. While stock buybacks don’t create any real growth for the company, they increase the earnings per share and can be a tax-efficient way to distribute earnings to investors.
  • Research and Development – For some, organic growth is a better pathway than M&A. Invest in the future: What will your customers want in a year from now and in 10 years? Use your money to develop new products and services. See how you can be best positioned for future growth.
  • Plant and Equipment Upgrades – Updating your physical assets can help you become more efficient, reduce costs, improve your services, and prepare for future growth. For example, upgrading plant equipment might improve safety and reduce down-time caused by accidents. Upgrading your software might allow you to process more orders per employee and build for scale.

Whatever course of action you decide to take, don’t sit on the sidelines or cling to a false sense of security. If you’re not growing you’re dying.

*This post was originally published on LinkedIn

In performing due diligence, I recommend you look not only for risks but also for opportunities.

That’s how I approach due diligence for our Capstone clients.  As we examine the seller’s operations and books, we place every new discovery in one of three color-coded “buckets:”

Red Bucket: Deal Changers. This is information that materially alters what you thought you were buying. These are the true surprises that can seriously affect the deal, such as a previously unknown pending court case on a key technology or a likely decline in revenue.

Yellow Bucket: Acceptable Risks. These are new items that you discover about the seller that you can live with but can’t ignore. For example, a new product that you expected in six months may not be ready to go to market for a year. You would probably not cancel the deal because of this, but it’s still something you will have to take into account and alter your plans accordingly.

Green Bucket: Integration Opportunities. This is information that adds value and synergies to the deal, usually in the form of cost savings or revenue growth. A typical example occurs in the purchasing department, where the seller may be paying a significant percentage more than you would because he is not ordering in the volume necessary to reach price breaks.

The bucket method will help you to identify risks and opportunities within the larger focus of your strategic objective. I find the bucket method allows for constructive discussion between both buyer and seller on possible solutions to any risks that may be identified.

*This post was adapted from David Braun’s Successful Acquisitions, available at Amazon.com

During due diligence, you may uncover deal-changing issues, or what I like to call “red bucket items.” Identifying these risks doesn’t necessarily mean you walk away from a deal, but you will need to negotiate new terms with the seller.

Among the ways to protect yourself as the buyer when you find major issues:

1. Ask the seller to fix the problem and continue on good faith.

For example, if you find there is broken equipment in the seller’s plant, insist that the equipment be fixed before the deal closes

2. Require indemnification so the seller is legally bound to cover the costs if the problem materializes.

Let’s say the plant equipment is very old and likely to break soon. In this scenario, the seller would be required to pay for repairs should that occur.

3. Institute holdbacks, where a certain portion of the payment price is withheld to cover the specific issue of concern.

If the broken equipment costs $100,000 to replace you would withhold this amount from the purchase price, guaranteeing resolution before making full payment. You only pay the seller once the problem is fixed.

4. Request that funds be held in escrow to cover the problem and other potential contingencies.

With an escrow account, a percentage of the purchase price is held in a separate third-party account. It is paid to the seller a certain amount of time after closing to make sure all the seller’s claims are true. This serves as a “risk shield” for the buyer.

5. Offer less money for the business.

Sometimes uncovering “deal changers” means the value of the business changes. As a buyer, taking on some risks can mean paying less for the company.

Negotiating “red bucket items” is one of those tougher tasks which may merit involving your third-party adviser. He or she can protect the relationship between buyer and seller, acting as a “marriage counselor” while investigating and developing possible solutions to present to the seller.

*This post was adapted from David Braun’s Successful Acquisitions, available at Amazon.com

 

As you go through the M&A process, you may find that advisors are both necessary and helpful to assist you. However, you must maintain your leadership role.

I find that particularly toward the end of the acquisition process, executives imagine that they should hand the reins to a more “experienced” professional. This would be unwise. I do not recommend letting lawyers and other subject matter experts take over the process entirely. It is your deal and you need to be the one making strategic decisions.

It is a lawyer’s job is to attempt to eliminate risk. However, an acquisition inherently carries risk that can never be eliminated. If you rely on your lawyer to make your decisions you may not take certain risks that would benefit the company’s growth. Advisors should advise you; your main focus is to listen to the advice and make your own decisions. As to “eliminating risk,” you should seek to reduce the risk while understanding that you cannot be completely free of it.

At the onset of the acquisition process you developed the strategic vision for your business. That vision should remain constant throughout the process.

 

*This post was adapted from David Braun’s Successful Acquisitions, available at Amazon.com

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When you think about your company’s growth, ask yourself, “What is our risk tolerance?” The answer is key to formulating your strategy.  You cannot succeed with a plan for growth that pushes too far beyond the level of risk that is acceptable in your company.

If you are the sole owner, the level of risk tolerance is fairly easy to establish.  If there are multiple owners, as is often the case, then answering the question is a little harder.

So, how do you discover the risk tolerance of your company?

From my experience as a consultant, I have found that while asking people directly about their risk tolerance yields some useful information, it is more valuable to look at what they actually do. We often misjudge our own relation to risk and imagine our tolerance is lower or higher than it actually is.

Here are two simple ways to discover your company’s risk tolerance:

1) Look at your balance sheet.

Is your company cash-rich and debt free?  That tells you your tolerance for risk is probably very low – more common than not for privately held companies.

If there is a significant debt-to-equity ratio, you have an enterprise that is willing to exploit the benefits of leverage and assume the inevitable risks that come with debt.

 2) Study your process for buying capital equipment.

If the buying process is fairly swift and is delegated to relatively few individuals, risk tolerance is probably quite high.

If the process is laborious, with complex approval procedures, risk tolerance is more likely to be low.

Knowing your risk tolerance is important because it impacts the kinds of growth tactics and financial models you will be willing to adopt.  Risk tolerance will also impact the kinds of acquisition partner you will feel comfortable with.

If you have a low risk tolerance and you acquire a company comfortable with high risk, you may experience a backwash of anxiety. Conversely, if you are fairly adventurous and buy an extremely risk-averse company, you will face constant headaches trying to move your new partner into action.

 

*This post was adapted from David Braun’s  Successful Acquisitions, available at Amazon.com

Photo courtesy of topher76 cc