Editor’s note: In 2008 the book on acquisitions that Professor Lorraine Hendrickson-Uhlaner and I wrote was published. See reference at the end of this description. Given the inquiries received about acquisitions and in my opinion of the continuing relevance of the content of the book I decided to post this description of the book.
This book reflects the firsthand, practical experience in the acquisition of businesses by the author, me, John Psarouthakis. He has led the buying process for over forty acquisitions and has been a part of a team of a dozen others during his business career as an entrepreneur and business executive. Most of his experience comes from purchasing and selling businesses for two companies, J.P.Industries Inc. and JPE Inc. that he founded, managed, and eventually sold, as well as from the notes for the course on acquisitions he taught at the Ross School of Business of the University of Michigan as an adjunct professor of business.
Although Psarouthakis’ experience draws heavily on the manufacture and distribution of durable goods sectors, many aspects of the process are the same, regardless of the industry.
Interviews conducted by coauthor Lorraine Hendrickson with entrepreneurs involved in acquisitions for the retailing, service, and construction sectors and other published information about the acquisitions process also influence the content of this book.
This book will systematically take you through the key steps in buying any company: deciding what you want to do, finding businesses for sale, evaluating business prospects, negotiating the deal, financing the deal, closing the acquisition, and development of an action plan prior to closing the deal and taking over the business (what to do once you own it).
This book will be useful to individuals who contemplate on the idea of buying and running a business, to those who plan to make numerous acquisitions, and to those business development executives whose goal is to make relevant acquisitions for meeting the growth goals and/or for the diversification strategy of the corporation.
We believe that the book will be of most help for deals of small- to medium-size range though the basic aspects of the process described here is applicable to any-size deal and though the details will differ significantly.
EVERY ACQUISITION HAS ITS OWN REQUIREMENTS AND PARTICULARITIES. THEREFORE, ALL AGREEMENTS AND DOCUMENTS SHOULD NOT BE MADE OR USED WITHOUT THE ADVICE OF LEGAL COUNSEL. THE AUTHORS ASSUME
NO RESPONSIBILITY FOR THE USE OR MISUSE OF ANY OF THE CONTENT AND SAMPLE EXAMPLES CONTAINED IN THIS BOOK.
Description of the Book
Buying a company is a demanding, complex process requiring a wide range of skills and abilities. If you understand this process thoroughly, then you are far more likely to make the right purchase decision. Whether you are buying the corner ice cream parlor or a $100-million business, following certain steps will enhance your chances of successfully operating a profitable venture once the deal is closed. This book should help you to visualize what really goes on in the making of a business deal.
Basis for the Book
Information for the book is drawn from several sources. The book heavily reflects the firsthand, practical experience in deal making by the author Dr. John Psarouthakis. He has led the buying process for about forty acquisitions and has been a part of a team of a dozen others during his business career as an entrepreneur and business executive. Most of his direct experience comes from purchasing and selling deals for his own two companies, J.P. Industries Inc. and JPE Inc.
In the 1980s, Psarouthakis founded and built J.P. Industries into a Fortune 500 company by acquiring underperforming auto parts and plumbing products manufacturers, selling the company to a British conglomerate, T&N Plc in 1990. Next, he founded JPE Inc., which manufactured and distributed auto and truck parts for Original Equipment Manufacturer and the aftermarket. Although Psarouthakis’ experience draws heavily on the manufacture and distribution of durable goods sectors, many aspects of the process are the same, regardless of the industry. Interviews conducted by coauthor Lorraine Hendrickson with entrepreneurs involved in acquisitions for the retailing, service, and construction sectors and other published information about the acquisitions process also influence the content of this book.
The Importance of Careful Planning
A carefully planned and executed search process is likely to improve your odds of finding a company with which you can be successful. Too often, people rush into deals only to find out later that they did not purchase what they had expected. They suffer negative business consequences, such as lower than anticipated profits and sales. The alternative, careful planning may cost more initially and require more effort but is likely to lead to better business results in the long run.
Various studies have found that as high as 60% of acquisitions made fail to meet the acquisition-performance goals, ROI, ROE, etc., that were set at the closing and which influenced significantly the price paid. Just 25% met or exceeded those goals; the remaining 15% were indeterminate. There is one overriding reason for this high rate of failure and that is overpaying for the acquired company. Overpayment is a result of (1) an overoptimistic expectation of the market, (2) a higher-than-realistic estimate of internal improvements/developments, and (3) allowing of oneself into a horse race leading to an overprice, due to the bidding process that the seller has succeeded to establish. In order to avoid as much as possible the elements mentioned above, this book presents a process based on many years of experience that resulted in the acquisition of over fifty deals and equivalently the sale of such acquired companies.
Successful Acquisition Process – 16 Steps
One enters into a rather specific process when one decides to acquire a business and particularly the “right” business. You must manage and control the process if the result is to have a good chance to be the desired one. The acquisitions process involved several distinct steps and sub-steps that need to be attended to with extreme care and dealt with expertly and skillfully. These steps are the following:
- Know what you want to acquire.
- Set up criteria to guide you on what you want to buy.
- Set up a plan on how you will proceed.
- Identify/build your team that will work, do, and manage the process with you.
- Develop a network of credible sources for acquisition candidates.
- Screen carefully and thoroughly the candidates using the criteria set.
- Conduct an effective preliminary evaluation/due diligence before you spend a great deal of time and money.
- Negotiations really begin on the first meeting with the owner or his/her representatives. Preliminary agreements take place then and have those in a letter of intent.
- Have your attorney be involved early in the process and work on the letter.
- Conduct a thorough evaluation/due diligence. Look for surprises, but do not panic.
- Develop a detailed action plan and complete it before you close the deal.
- Review the value and price of the business with your colleagues.
- Negotiate the purchase agreement with the full participation of your attorney.
- Close the deal.
- Begin implementation of the action plan immediately.
- Last, but most important, meet as many people of the company as possible during the acquisition process. Do not wait to meet them after you close the deal.
Overview of the Buying Process
This book will systematically take you through the key steps in buying any company: deciding what you want to do findingbusinesses for sale evaluating business prospects negotiating the deal financingthe deal closing the deal, and development of an action plan prior to taking over the business and prior to closing the deal (what to do once you own it)
Patience: Key to a Successful Search
Perhaps the most difficult part is finding the right business that you want and having the patience to wait it out until you find the right company. The other steps, such as evaluation, financing, pricing, and closing are straightforward. We cannot overemphasize the danger of rushing prematurely to purchase a company before you have carefully followed all the steps in the process. The process is designed to identify the company that you are likely to have the greatest likelihood of operating profitably and successfully. If you have several leads going at once, you are less apt to rush yourself into the wrong deal or even prematurely into the formal due diligence process, which is the most costly aspect of the deal making, prior to closing the deal. As you run out of money to investigate companies, you will be more likely to jump at the wrong opportunity. A good way to avoid this is to carry out several inexpensive screening steps before getting your accountant and attorney involved in formal due diligence.
The importance of careful screening cannot be overemphasized and indeed is borne out by other research. In their review of acquisitions made by twenty different companies, Philippe Haspeslagh of INSEAD (a French business school) and David Jemison of the University of Texas concluded that inadequate attention to screening was a key reason for poor performance of acquired firms. Although they looked at a sample of large companies, it would seem logical that this would hold true even more for the first-time buyer.
The Buying Process as a Problem-Solving Process
Another effective way to understand the buying process is to view it as a problem-solving process. As questions or problems emerge, you try to solve them with the seller. Some deals may encounter un-resolvable problems at which point you may have to drop the deal altogether. Locating the right business is expensive and time-consuming. You want to avoid dropping a lead, especially in the late stages, just because a minor difference in price or point of view between buyer and seller creates an impasse, and yet this often takes place. Although you should heed the advice to avoid rushing into a deal, don’t drop a deal either just because of some detail. Make rapport with the seller. Negotiating skill and experience help to reduce the risk of losing out on a deal because of some minor difficulty.
Organization of the Book
This book is designed to cover the buying process in detail from the moment you decide that you would like to buy a company to the day you take over. This section describes the organization of the book and what is covered in each chapter.
Deciding What You Want to Do
Before actually beginning to shop for a company, you must establish a clear focus. What are your personal goals for buying the business? You need to consider your own experience first. Chapter 2: Who Buys Companies and Why? presents information you might consider in evaluating your own readiness for taking on business ownership, including your motives and preparation for business.
Once you have made the decision to buy a company and before beginning the actual search, you also need to decide on the type of business you are looking for. You must also establish broad criteria for your search and begin development of a business plan.
Chapter 3: Acquisition Criteria and the Initial Business Planpresents guidelines for these broad criteria. Initial criteria should fit the type of information you are likely to obtain. Typically, you are limited to very general information at the beginning: size, profitability of the business, and the industry sector. Once you sign a confidentiality agreement for a particular business lead, you are likely to have access to more detailed information about company performance, product line, exact location, and other information. As you progress through negotiations, from the signing of a confidentiality agreement to the letter of interest, letter of intent, purchase agreement and closing, your screening criteria become more detailed and your investigation more in-depth as you continue to obtain new information about the deal.
You also need to consider, early on, what you want to do with the business: fix it up and sell it, buy and keep it a long time, or build a group of businesses. This is an important decision because it affects the type of business you seek and the investors and financing you are likely to attract.
Chapter 4: Building Credibility for Business Ownership describes the credibility issue. Establishing credibility within the business-investment community is an essential step in finding the right business. Credibility is also essential to obtain financing for the deal, to attract investors, and to attract competent consultants and employees to help you before and after you buy your firm. Without it, you are not likely to succeed.
Chapter 5: Building Your Team at the Star will familiarize you with the type of members you will need at different points in the process and what to look for when hiring team members, whether as consultants, or as employees.
Finding Businesses for Sale
Finding the right business is a time-consuming process. Your success in locating the right business depends upon your credibility in the business-investment community and your patience to develop and cast a wide net to establish the flow of business leads.
Chapter 6: Casting the Net for Business Leads explains how you find leads. It describes the sources for leads as well as a recommended approach for managing your business-deal lead flow overtime. Expect to take a year or even two years before finding the right company. Rushing into the wrong deal is one of the most common mistakes buyers make. Stick to your original criteria and goals, and you will eventually find the right company. It is not unusual to sift through several hundred leads before finding the right company.
Evaluating the Business Acquisitions Prospects
Chapter 7: The Buying Process: An Overviewevaluation of the acquisition prospect is an ongoing process that begins the moment you obtain a lead from a broker. The overview of this process is presented in this chapter.
Chapter 8: Narrowing Your Search: Matching Broad Criteria of Your Initial Business Plan describes the first few steps of this process in greater detail, whether you are dealing with a private broker or investment banker. Chapter 8 will introduce you to important documents at this step, including the confidentiality agreement and letter of interest, needed to obtain more detailed information about those companies you are exploring.
Chapter 9: Preliminary Due Diligence describes the next step in the evaluation process. Once you have signed a confidentiality agreement and have access to more information about the company, you are in the position to filter out companies that might have looked attractive but upon closer inspection do not meet your criteria. Chapter 9 describes the types of information you are likely to obtain at this stage and what you want to review. If you started with several hundred leads, you may only complete a preliminary due diligence on several dozen. It is important to realize that you have still not invested much money on this stage in reviewing each acquisition candidate. Primarily, you have spent your own time to review materials, and typically, to visit the company up for sale to meet with the owner and key managers.
Once you have completed a preliminary due diligence, you may decide not to pursue a company. If you are still interested and before you actually begin to invest significant amounts of funds in conducting detail investigations, obtaining expert opinions and efforts from an accountants, consultants, lawyers, or other specialists (such as environmental protection), it would be wise to negotiate with the assistance of a skilled lawyer and sign a letter of intent. This letter protects both the buyer and seller. During a designated period, the seller agrees not to sell to anyone else. In turn, the buyer may have to agree to pay a penalty if he or she decides with no reason not to complete the deal. However, it is unwise to progress and spend thousands of dollars without some guarantee of this sort from the seller.
Chapter 10: Letter of Intent and Formal Due Diligenceprovides a detailed account of the letter of intent and the formal due diligence process, the final leg in the evaluation process.
You actually begin valuing and pricing a company from the very moment you obtain initial information about the company. If you are required to sign a letter of interest, you may be asked early in the negotiations process to suggest a price that you might be interested in paying. However, this price is nonbinding, and pricing and valuing are continually modified as you learn more about the company, up until closing.
Chapter 11: Valuing and Pricing the Company provides an introduction to this very important component of business evaluation that helps you to determine what the company worth is and what price to offer the seller for his or her company. It also discusses some aspects of the process of valuing and pricing that takes place throughout negotiations.
Negotiating the Deal
Negotiations actually begin with the very first contacts that you make with the seller and/or his or her broker. The negotiations process and general tips in the negotiation process are both described in Chapter 12: Negotiating the Deal.
Financing the Deal
Chapter 13: Financing the Acquisition describes different sources of capital and other issues you need to consider when financing the acquisition.
The Action Business Plan
As you approach closing, you must anticipate many of the issues that you will need to address once you take over—options that you want to take as you are about to own and manage the business. It is wise to develop a detailed action business plan that is to be implemented on the day of the takeover. Some of your initial business plan may be useful, but you are advised to prepare a detailed document relating more. Chapter 14: The Action Business Plandiscusses this very important aspect of the acquisition process.
Closing the Deal
Once you have finally arranged for financing and negotiating a price with the seller, and you are satisfied that you have thoroughly evaluated the prospective company, you are ready to close the deal. Chapter 15: Closing the Deal describes key issues and concerns to be wary of at this stage to assure a smooth closing and transition. It also describes the purchase agreement, the legal document that binds seller and buyer in the deal. Chapter 16 deals with the activities that should take place immediately after closing the deal at which time you own the business.
Now you own the company
Once you close the deal, you need to be prepared to go in the very next morning to meet with your management team as well as your entire staff. What you do in the first days and weeks will set the tone for your relationship with your employees for some time to come, possibly even the duration of your ownership. Remember that the chief concerns of your employees and managers may be somewhat different than your own agenda. Employees will be concerned, first and foremost, about their own job security and future with the company now that it is under new ownership. Management shares this concern and may also have more narrow issues facing them in their own departments that nevertheless they may feel requires immediate attention. An easy model to follow includes a short initial introductory meeting with management, an all-employee meeting to include all management and non-management staff, and then a third more formal meeting with management. These meetings will set in motion the planning to carry out the three objectives of the transition: addressing your key constituencies (employees, customers, suppliers and bankers), revision of the action plan, and implementation of significant changes outlined in the plan. Other meetings will follow in the first days and weeks, but it is essential to try to fit these first three meetings into the first day if it is at all possible.
As a new owner, you must be careful to listen carefully, building trust and goodwill with your new employees. Although difficult to accomplish, even negative changes such as employee layoffs can be carried out effectively if you communicate your objectives clearly, follow through relatively swiftly during the early period of transition, and remain sensitive to special needs of employees going through such a transition. Layoffs in particular need to be carefully addressed since it also affects the morale of remaining employees. It is wise to anticipate the costs of major changes such as retraining and outplacement services for employee reduction or toxic waste cleanup for environmental issues in the original action plan and in the negotiated price for the company so that you can afford to carry out these actions in the early weeks and months.
One of the easiest mistakes to make as a new owner is to override the existing management structure. You need to be very visible in the early months, making contacts at all levels, not just top management so that you can spot problems and build rapport with your staff. At the same time, if you identify problems you feel are in need of change, you should strive to work within the chain of command. Rather than act unilaterally, go to the appropriate manager or direct an employee to do so. Otherwise, you will eventually make your management team ineffectual overtime.
Most important of all, be patient. The transition may take a year or more. However, with proper advance planning, your reward is that you will increase the odds that you will realize the gains that you had anticipated when purchasing the business.
Reference: “How to Acquire the Right Business”, John Psarouthakis and Lorraine Hendrickson-Uhlaner. Exlibris, 2008. or contact Dr. John Psarouthakis for his autographed copies.