Acquiring a business

If so, the acquisition of anotherbusiness may complementorganic growth and enable youto expand more quickly.There are on average 350 acquisitions madewithin the UK every month, making upalmost half of those recorded throughoutEurope. The size and complexity of thesedeals varies massively. The average deal size of acquisitions in the UK during 2008 was£110 million, lower than the £148 million in2007. Of the 4 million-plus acquisitionscompleted during 2008, nearly 93% wereunder £50 million in value and involvedowner managed businesses *

Has the time come for you to think about alternative ways ofgrowing your existing business?

Should you decide to acquire a businessyou need to think seriously about yourmotivation, as this route is costly as well as risky. You should have a clear strategy in mind and ensure you stick with thisthroughout the process. Don’t becomesidetracked by so called ‘goodopportunities’ if they don’t fit well withyour existing operation and provide theopportunity to add value. The risk mayoutweigh the reward.

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* Source: Corpfin, Monthly M&A Review.

It is common for businessesto expand via acquisition aswell as grow organically.

By amalgamating the operations of twobusinesses it can offer great benefits for both,such as:

• Increase in sales It may be possible to cross-sell your productsto your target’s customer base, and viceversa. Look for businesses that complementyour product range and widen access tocustomers.

• Improving market presence Acquiring a business within the same marketwill immediately increase your presence.Larger businesses are less risky and a bigger,better brand conveys confidence to yourcustomers. You may also be able to exertmore power on suppliers and reduce yourcost base or improve credit terms.

In the long run will an acquisition increase the value of my enterprise as a whole?

• Access to assetsYour chosen target may have a number of specialised assets you require use of.Alternatively they may have licences orpatents that you cannot access yourself.Assets also include the employees. A good,skilled work force could be lacking in yoursector, so acquiring a company with thisalready established could be a vital way ofkeeping your business running in spite of askills/labour shortage. Similarly a shortage ofphysical capacity may be constraining yourgrowth. Spare factory capacity could be acritical plus factor.

• Defence strategyAcquiring a competing business maysometimes be a good strategy to reducecompetition. In doing so it may allow you toincrease sales as well as adjust prices wherethese were previously restricted.

• DiversificationAcquiring a business that provides a differentservice or product could reduce yourbusiness’ risk to a downturn in a specificmarket. It is a common strategy for seasonalbusinesses so they are able to generateincome all year round.

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• Cost savingsCombining common functions between twobusinesses can significantly reduce the overallcost base in relation to turnover. Head office,accounting, warehousing and purchasing, areexamples of areas which could yield possiblesavings.

• Geographic expansionYour business may currently operate in alimited geographic area. Acquiring anotherbusiness may enable wider UK or overseasmarkets to be covered.

• Vertical integrationSometimes, acquiring a supplier should beconsidered. This could offer benefits ofgreater stability of supply, quantities or prices,better control over quality in addition toimproved margins.

Be wary of any negativeimplications of your strategy.Employees are not tied to acompany and culturalmismatch is one of the keyareas that leads to a failure ofacquisitions to generate value.They may choose to leave afterthe transaction for variousreasons, unless they are keyemployees tied into the deal.

Cultural clashes between staff or proceduresmay fuel this situation and can be a long and costly process to avoid. Employeeincentivisation methods (bonuses, shareoptions, shares etc.) can be key to a smoothownership transition.

Should I considerany other issues?

Funding required for acquisitions may besignificant. If you have limited free cash, thiswill put the combined business under strainand therefore increase financial risk. It iscritical that the funding structure allowsbreathing space for the inevitable integrationchallenges.

It is also key to ensure that the exiting owners are restricted in what they do post-transaction. Allowing them to set up a similar venture in close proximity couldseverely hinder your performance. Restrictivecovenants need to be put in place to protectagainst this.

So, before taking the next stepyou should clarify why youthink an acquisition strategywould be beneficial to you.

You should also analyse what strengths yourcompany has which will make that particularstrategy work and whether any inherentweaknesses may add to the risk of it goingwrong.

The next thought process should consideryourself, your team and the current positionof your existing company.

• Are there critical short-term challenges in your existing business which may makethe timing wrong?

• Do you have a strong enough management team?

• Do you have a second-tier management team who can assist and take onadditional responsibility?

These questions are important in the sensethat during the acquisition and post-acquisition integration process your attentionwill be diverted from your current businessfor a substantial amount of time. You shouldbe comfortable that this can be managedand will not harm your existing company.

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As with most major businessdecisions it is important toseek advice at the right timefrom the right people.

Bringing a Corporate Finance adviser onboard early in the process will assist. Amongst other things, your adviser will:

• Test your strategy.• Assist in gathering information and

identifying targets.• Approach targets confidentially.• Assess valuation expectations.• Negotiate a workable deal.• Assist in arranging funding, advise on the

right structure for the deal and negotiatethe best terms with finance providers.

• Assist in due diligence.• Project-manage and alleviate pressure on

your team.• Understand and take you through the

entire process.

Get an advisoron board

Advisors also offer objectivity to yourtransaction. By using an intermediarythroughout negotiation stages it willmitigate any direct conflict betweenthe two parties and assist ingenerating a positive relationship post-sale. It is important to rememberthat once the transaction hascompleted it is common for the sellerto remain in the business for a lengthof time to assist in the hand over.

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1 Finding target businesses

In our experience, target businesses haveoften emerged naturally. Approaches mayhave been made to your company,alternatively, word of mouth in your industryor commercial dealings have identified anopportunity with a partner.

However, your advisor will generally haveaccess to company databases andprofessional networks which will assist inlocating target businesses for you if you arestarting from scratch. In order for them toassist effectively they will need to know whatyour key requirements are. For example, theyneed to know your reasons and strategy forthe acquisition, size of business, sector,location etc.

Most companies are for sale, given the rightoffer and timing; therefore you should notnarrow your scope down to just those thatyou see marketed.

You should research your targets asthoroughly as possible. Invest time in thisstage to ensure your short-list is as close toyour initial criteria as possible.

The process:

2 Preliminary dialogue

Your advisor will be able to front yourapproaches in order for you to remainanonymous at this stage, if this is appropriate.This is especially important if you aretargeting businesses that are in your sector, or suppliers/customers, as it may impairfuture relations with these parties. Bear inmind that at some point however you willneed to disclose your identity.

If the target is willing to hold preliminarydiscussions use the opportunity to tee up ameeting; information is passed over morefreely and efficiently whilst face to face.Gather basic information in an attempt tosupport or disprove your theory as to whythe target is a good fit. You will then be ableto make an informed decision on whom toprogress talks with, and hence refine yourtarget list.

3 Initial offer

You are likely, at an early stage, to be requiredto make an initial offer to the target in orderfor them to ascertain whether they wish toproceed. Your advisor will assist you invaluing the business on the information youhave obtained so far.

There are many different ways to value acompany, largely depending on what sectorit is in and its profitability. However, you needto consider the benefits you will gain fromacquiring the business and whether thisjustifies the cost. In addition, you should lookto recover the purchase price and repayrelated finance in roughly 4-5 years.

At this stage, you should startto seek financial backing ifyou have insufficient funds to cover the deal. Ensure youhave a comprehensivebusiness plan which supportsyour case and justifies yourreasons for the proposedacquisition.

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Your advisor will have relationships with anumber of funders already; it will be easier toallow your advisor to approach their contacts,as they will be more receptive to your advisorthan if you were to approach themindependently. You should discuss your planswith your current bank as they will alreadyknow your history, but again only after afully-developed business plan has beenprepared.

The business plan is a key document which itis critical to get right to give you the bestchance of obtaining funding. Your advisor willhave handled this process many times overand instinctively understand the best way topresent your case and the funding sourcesthat may be interested.

4 Cementing the deal

If your offer has been initially accepted youshould seek to gain exclusivity on the deal atthis stage. There may well be a number ofdifferent parties interested in the samebusiness, especially if it is being marketed forsale. Exclusivity will provide a certain periodof time to complete the deal, without the risk of the target company being acquired byanother party.

Unless you have a close link to the targetbusiness already, let your advisor lead thenegotiations on your behalf. However, youshould approach negotiations with the aim of reaching a mutually beneficial solution for both parties.

You should establish in advance the key areasthat are imperative or critical to the deal, yourtarget price and range for negotiation andalso supportable rationale for that price orstructure.

Also, remember at this stage the emotionalaspects. The vendor may not be committedto selling, or they may have emotional ties totheir staff, customers or suppliers which comeinto play. It is critical that this stage is handledsensitively and with understanding, aspersonality clashes can destroy good dealsjust as building good relationships cancement the way forward. Honesty, integrityand openness are critical to positivenegotiations at this stage.

Once you have reached a stage of agreementon most aspects of the deal you will be ableto draw up a document known as the ‘Headsof Agreement’ or ‘Heads of Terms’.

The Heads of Agreement will summarise allmain aspects of the acquisition deal, typicallybeing price, future involvement of thevendors (if any), terms for payment of theconsideration, any earn-out elements (pricebased on future performance) and the mainassumptions made.

Although not legally binding (other than inrespect of confidentiality and exclusivity), theheads of agreement carry a moral obligationon both sides to stick to the deal unlesssomething material, and at that timeunknown, comes up during the remainder of the process.

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5 Structuring the deal

The major aspect of the deal that vendorsand buyers concentrate on is the price, andhow and when it will be paid. However, thereare far greater issues that may be just ascrucial to the deal, that your advisor will belooking at as well.

The structure of the transaction and theability to fund the acquisition cost will betheir main priority. There are typically twomethods of buying a company, a sharepurchase or trade and assets purchase.

Share purchase – this involves the shares ofa company being acquired. Thereby you ownthe physical entity of the company and as aresult you acquire the full balance sheet as itis stated in the accounts. In this case, you willbe buying the history of the company, whichincludes any hidden liabilities that are notcovered by warranties or indemnities duringthe legal process of the acquisition.

The process (continued):

Trade & assets purchase – in this case youwill buy some or all of the assets of thecompany i.e. the business and its underlyingassets. The shell, the company, would remainwith its previous owners as, typically, wouldall hidden liabilities. In this instance howeverit is critical to define exactly what you arebuying as there may be areas such asintellectual property which are a hidden assetbut critical to the business.

There are a number of reasons for adoptingeither structure, generally driven by taxconsiderations and attitude towards risk.Again, your advisor will be able to take youthrough the pros and cons of each method.

In either case current UK legislation (TUPERegulations) requires employees of the targetcompany to be taken over on currentemployment terms and there are very fewexceptions to this.

In addition to advising on suitable sources offinance, there must be a fundable structureand proposals need to be made as to whatform the consideration will take. There are anumber of options available, mostcommonly:

• CashThis is the easiest and most sought afteroption for a vendor, as they can bank it onday 1 and it therefore carries no ongoingrisk (or reward). However, the buyer maynot have the capacity to pay the fullamount up front, nor would want to as itis a high-risk approach and leaves recourseonly via alternative legal protection in thedocuments.

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• SharesIt is possible for shares in the target’scompany to be exchanged for shares inthe buyer’s company. This will not providecash up front but the vendor may beentitled to annual dividends and canpotentially gain further if they dispose ofthe shares at a later date. This option willbe more popular if your shares can beeasily traded and therefore provide a readyexit route. Shares are typically thereforeonly acceptable to a vendor if yourcompany is quoted. However, there areinstances where the vendors will continueto be employed by the enlarged groupand a shareholding provides an ongoingincentive to create further value.

• Deferred consideration, usually in the form of loan notesThis option eases the buyer’s cashflow as it allows payment to be made over anagreed timeframe, effectively a loanbetween vendor and buyer. There aremany different aspects of loan notes toconsider including interest, security etc.

The methods of payment shown above canbe used in varying combinations, as wellperformance-related consideration in theform of earn-outs.

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A detailed due diligence process is not anoption but a necessity. You are making aninvestment that may significantly affect yourfuture business as well as your personalreputation. It is important that the vendorappreciates the extent of your expectations inthis regard, from the outset. Discussion andinput by those funding the acquisition is alsoimportant before the due diligence processcommences. Due diligence investigations canbroadly be split into the following areas:

• Commercial/market• Financial• Legal

6 Investigating the target company

The process (continued):

We would generally recommend that yourprofessional advisors are involved in thefinancial and legal areas. Depending on yourin-house expertise, external advisors can alsobe employed to provide valuable commercialor market insights that may affect your viewson the business and the price. However, in-depth investigations by your own team onthe company’s operations, the commercialaspects of the corporation, including peopleintegration and the market generally arecrucial to most successful acquisitions.

Whilst there is no prescriptive degree of detailattached to the investigation process, itshould enable you to feel comfortable with all key aspects of the target’s business, bothhistorically and in the short-term future.

This process normally takes weeks rather thandays and involves as much access to thevendor’s business as can be agreed, whilstmaintaining confidentiality. In particularlysensitive acquisitions the use of advisors canhelp the purchaser gain comfort frominvestigations whilst maintainingconfidentiality for the vendor of keycommercial areas, such as the identity ofcustomers, until a late stage.

Providing no “deal-stopping” issues areunearthed through this process, theinvestigations provide the basis for thefollowing:

• Renegotiations of price if significant issues affecting your valuation of the businesscome to light.

• Appropriate legal protection to be incorporated in the Sale and Purchasecontract to cover issues raised.

• Better appreciation of the overall financial commitment required to buy and run the business. This will enable a moreinformed view to be taken of the financing required.

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Once the various due diligence proceduresare complete and the price and final structureare finally agreed, the period to completion islikely to take at least a month. During thistime all the necessary legal, and whereappropriate, financing documentation will beput in place. For you, as the acquirer, this willbe another busy period. In conjunction withyour advisors, you will need to address thefollowing issues:

• Understanding all tax issues and structuring the transaction in the most tax-effective manner for the purchaser and, asfar as possible, the vendor. This mayinvolve determining or negotiating withthe vendor the form of the considerationand the timing of payments, as discussedabove.

• Whether the vendor’s tax status (either personal or corporate) creates anypotential tax liabilities for the purchaserand how these can be eliminated ormitigated.

7 Steps to completion and beyond

• The extent of the legal protection required to cover issues raised, whether these riskscan be covered by indemnities given bythe purchaser and whether anyconsideration should be held back inescrow for matters pending resolution orclarification.

• Handling the publicity of the deal to maximise any opportunities created by theacquisition or to minimise any adverseimpact on either business.

• Securing the support of all employees, particularly those in the new business,ensuring terms are agreed and the risk ofloss of key employees mitigated.

Completion is not only the culmination ofa successful transaction but also the start of a new phase in the enlarged business.The challenges ahead are often significant,cultures are different, new strengths andweaknesses come to light and re-appraisals of the newly-enlarged operation need tobe undertaken quickly and efficiently.

A well-managed acquisitionprocess should therefore notstop at completion but havean active plan and strategyfor the integration andmanagement of the targetbusiness followingcompletion.

Whilst challenging, acquisitions canprovide great opportunities for growth andtaking your existing company to a newlevel but managing the process in the rightmanner throughout is critical to gettingthe best deal.

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