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.
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. Next, he founded JPE Inc., which manufactured and distributed auto and truck parts for OEM and the aftermarket. Although Psarouthakis’s 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) Uhlaner 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 Buying Infrastructure
It is estimated by various sources that tens of thousands of businesses change ownership every year. For an updated estimate of this high-volume activity, contact the International Business Brokers Association. To support the very high number of transactions, a rather broad and complex infrastructure exists for finding and promoting deals. Few businesses up for sale are advertised in published sources. Relying upon this infrastructure is likely to provide you with a larger number of high-quality leads to choose from and with less effort than trying to find them on your own. To be taken seriously within the business-investment community, you typically must demonstrate an understanding of the deal-making process, even if you hire consultants to assist you in the search.
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 oneself to enter a bidding war with the seller. In order to avoid as much as possible the 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 involves several distinct steps and substeps that need to be attended to with extreme care and dealt with expertly and skillfully. These steps are the following:
1. Know what you want to acquire.
2. Set up criteria to guide you on what you want to buy.
3. Set up a plan on how you will proceed.
4. Identify/build a team that will work, do, and manage the process with you.
5. Develop a network of credible sources for acquisition candidates.
6. Screen carefully and thoroughly the candidates using the criteria set.
7. Conduct an effective preliminary evaluation/due diligence befor you spend a great deal of time and money.
8. Negotiations really begin at the first meeting with the owner or his/her representatives. Preliminary agreements take place then and should be included in a letter of intent.
9. Involve your attorney early in the process and also with the letter of intent.
10. Conduct a thorough evaluation/due diligence. Look for surprises, but do not panic.
11. Develop a detailed action plan and complete it before you clos the deal.
12. Review the value and price of the business with your colleagues.
13. Negotiate the purchase agreement with the full participation of your attorney.
14. Close the deal.
15. Begin implementation of the action plan immediately.
16. Last, but most important, meet as many people of the compan as possible during the acquisition process. Do not wait to meetthem after you close the deal.
Screening and the Buying Process
Imagine several hundred leads entering a screening funnel. These are generated by the broker network that you build for your search. As the lead pool progresses through a succession of filters in the funnel, most leads are screened out by the initial filter, based on your initial criteria for size, type of industry, and profitability level. You may sign confidentiality agreements for as many as fifty companies over the course of your search. However, once you get more detailed information, you may quickly eliminate about half of this smaller group. The company might be in the wrong location, you may not be interested in the product line, or some other fact may be sent to you with initial materials that help you to rule that company out as a possible acquisition candidate. For any that still interest you, you might make an appointment to meet with the seller for further consideration. The latter procedure is typical when an investment banker is managing the deal for the seller.
Over the course of perhaps a year or two, you may further scrutinize several dozen candidates with a preliminary due diligence. In preliminary due diligence, you visit the company and obtain additional materials that help you weed out less acceptable candidates, even at this stage. For those that continue to interest you, you sign a letter of intent, which, though nonbinding, is an initial proposal to purchase the company that you present to the seller. At that point, you proceed through formal due diligence, and typically, though not always, through to a closing of the deal.
At any point in the screening process, you may come across information that leads you to a decision to abandon the negotiations for that company. For this reason, you must keep your lead flow active. That is, you continue to contact brokers and others in your network and continue to review leads. This helps to prevent the psychology of feeling compelled to go through with a “bad” deal just because you have progressed this far or spent so much time with it. Relative to the costs of owning and operating a company riddled with problems, you are still better off starting over than going through with a deal that is wrong for you.
If you have done your homework thoroughly at each step, you are less likely to reach an impasse in the later stages of negotiations, but it may happen. You may uncover a costly pollution problem, or the seller may reveal a serious product liability problem that had been hidden up to that point. Although this representation makes it appear that all the leads pass through at the same time, this is not the case. New leads continually enter the “funnel” while others drop out. Over the course of a year or two, you may screen as many as 200-300 leads. Most will drop out early on, in the screening process, some perhaps later at the preliminary or even the formal due diligence stage. A few may even get close to closing and still drop out. Eventually, if you are patient, you will find a suitable company for your needs.
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 Importance of Keeping the Leads Flowing
The importance of keeping a flow of leads going until you have closed the deal is illustrated from our own direct experience. With one company, we had several sessions of negotiating. We liked the company when we looked at it. But time moved on. Other deals were flowing into the funnel. The seller, in this case, became more and more demanding, which is his right, of course. But in the meantime, other companies entered the picture that appeared more attractive to us. We decided not to buy the company after all. Perhaps if we had not had those alternatives, we would have been more apt to go ahead with the deal, even though it would not have been a good one for us. The lesson here is a simple one: Even while you are negotiating a deal until you have closed the deal, you should keep your flow of leads coming in. It gives you another opportunity to ask yourself, “is this the deal I really should go through with?” It helps you from rushing into the deal and overpaying. This becomes especially true, late in the negotiations process. You may have already spent a fair amount of time and money on formal due diligence. But beware of escalating commitment. Don’t ever feel locked in or hooked on the deal. Just keep looking. By having several “irons in the fire,” you are less likely to get emotionally fixated on any one company.
When you start hiring lawyers and accountants to help with the due diligence, the costs can quickly escalate and thus your emotional commitment to the deal. This brings up another general guideline to keep in mind. Don’t bring in the heavy-cost items until you are pretty sure you will succeed with that deal. At any point in the process, when you encounter a serious problem, don’t proceed with any other activity until this is straightened out.
A very common problem that crops up in this category is environmental pollution. It’s not a matter of dishonesty. Many well-meaning owners are not even aware of problems that have been created in their own companies. In one lead we pursued, a company had removed some storage tanks years before and built a slab basement factory floor over their previous location. Unfortunately, the tanks had leaked into the groundwater prior to their removal. What initially started as a routine check turned into an extensive and more expensive investigation. Eventually, it was determined that although serious, the pollution problem was fairly well contained and other aspects of the due diligence process were continued. In another case, we convinced the seller to set up a “cleanup” fund of $5 million dollars, which turned out to be more than adequate to cover the eventual cleanup costs.
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 unresolvable 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. Build rapport with the seller. Negotiating skill and experience help to reduce the risk of losing out on a deal because of some minor difficulty.
Closing the Deal
Once you have finally arranged for financing and negotiated the price, warranties with the seller, you are satisfied that you have thoroughly evaluated the prospective company, and you have developed a detail action plan that you are prepared to start implementing immediately, you are ready to close the deal.
Reference: “How to Acquire the Right Business”
John Psarouthakis & Lorraine Uhlaner