April 5, 2016
Cardinal Rules for Strategic Expansion
Key Factors for Success in Executing a Growth by Acquisition Strategy
For many family business owners, strategic growth (the acquisition of other operating businesses) is a critical component in reaching financial and personal goals. For one third-generation chief executive, the overriding priority was to pass on a company to his son that was stronger than it had been when handed to him. To achieve this goal, he sought greater critical mass to combat industry consolidation; diversification of revenues to reduce reliance on key products and customers; and enhanced in-house technical capabilities to better control quality and margins.
The right acquisition can help meet all of these objectives. Strategic growth often represents a faster, cost effective and, in many ways, less risky path than continued business-as-usual. Where a company’s momentum has slowed and larger competitors are tightening their hold on the market, there may not be time to rely on internal growth. Acquiring a proven leader in an industry niche, with an established customer base and predictable earnings, reduces the risk involved in taking the business in a new direction.
There is another, less tangible but equally important, reason to make acquisitions a part of your company’s plan. Where non-family executives are involved, strategic growth can be a powerful retention mechanism. A good management team will not tolerate stagnation – growing and winning is much more gratifying than maintaining. As most owners know, truly effective managers are an indispensable part of a strong and stable business; operations, results, and indeed the owner’s lifestyle, would be very different without them.
These are some of the issues that make up the “why” of acquisitive growth; what of the “how”s? Given current levels of liquidity, this can accurately be portrayed as a seller’s market. How does the buyer ensure success in such an environment? For the family business owner, who will likely make only one or two acquisitions over a five-year period, the margin for error is slim. What follows is a summary of Bulkley Capital’s cardinal rules for strategic expansion, some of which you aren’t likely to hear from other investment bankers. Adhering to these guidelines has helped our clients design successful acquisition efforts that are executed on their terms, not those of the seller.
Buy what’s not for sale. Frankly, if the deal has a cover on it (packaged for sale by an intermediary), you are too late. The competition this circumstance implies means that if you win you lose – by paying too much. We recommend a proactive and highly selective acquisition program whereby the buyer deliberately seeks out targets that serve specific strategic goals, rather than reviewing only the companies that happen to be in the business broker’s current inventory.
Establish very specific criteria. Develop a strategic plan and define the role to be played by acquisitions within it (not the other way around). Which goals will the purchase of another business help achieve? What should be the priorities? This thought process leads to financial and operating criteria that are adhered to throughout the search for targets and serves to ensure deals are consistent with ownership’s plans for the company.
Avoid “deworsification”. Don’t diversify the business simply for the sake of doing so. Diversification of revenue, target market or customer base can be a very suitable goal, but only when it plays to a company’s strengths and represents a logical strategic step. Look for opportunities to enhance your market position and avoid the trap of spreading yourself too thin without reason.
Seek situations where price is not the only determining factor. Overpaying is a mistake that most buyers struggle to recover from; better values are to be found where the transaction meets non-cash needs of the seller. Owners without a viable succession alternative within the family may have personal priorities – preservation of culture, similar business philosophy, or continued employment for staff and management. Some sellers may wish to continue in an operating role within a larger platform, taking the business to a level they couldn’t reach on their own.
Focus on acquisitions that will have a meaningful impact. Don’t assume that smaller deals will necessarily be easier. These often bring with them greater uncertainty and less management infrastructure, and require greater effort to close. At the same time, purchases should be accretive to the value you are providing your customers and have a noticeable positive effect on earnings. Negotiating and integrating an acquisition is extremely disruptive to operations, and introduces a new element of risk. Make sure the payoff will be worth it.
Never bet the ranch. The corollary to the last point is that no deal is worth risking the base business. Avoid paying so much that debt service stifles ongoing operations, extending yourself so far that poor performance in the target’s operations will mean the failure of the base business, or acquiring a platform so large and complex that integration consumes your entire organization. Similarly, remember not to neglect the core business that has served you so well. Without the help of experienced advisors, management teams can find themselves stretched to the limit, negatively affecting day-to-day operations. The rule should be first to do no harm.
Culture is every bit as important as economics. Countless studies have shown cultural issues to be the most critical in business combinations. Ensure you fully understand the culture of the target and how it compares to that of your own company. Will your culture be able to carry the new operations forward? Family businesses bear the imprint of their owners, from work practices to management-staff relationships to customer service. Your company is an extension of your personality and part of your identity; it’s likely no different for the seller.
Sellers should “share the pain”. In structuring a deal, if possible make sure the former owner has something at stake as you move forward. This might take the form of a continuing minority ownership interest, or seller debt that is assumed as part of the purchase price. Either way, there is some future upside dependent on the performance of the business and at risk should things turn south. Imagine a third party buying your company; wouldn’t they be wise to keep you involved and motivated to help? How smoothly and quickly could you transition your industry knowledge, or your relationships with employees, customers and suppliers? This approach also encourages the seller to be forthright in what he tells you about his business.
Don’t expect smooth sailing. In our experience, every transaction will fall off the rails at least a couple of times before closing. There are just too many moving parts for everything to work according to plan. Emotions run high during a transaction and it is not uncommon for a seller to have a change of heart along the way. Due diligence is guaranteed to reveal something you didn’t know about the target and that has to be dealt with before you move forward. Extraneous factors can also play a part, such as problems at key customer accounts, negative industry events, or even natural disasters. The lesson is not to overreact but to have contingency plans at all times. Differentiate “deal killers” from bumps in the road and maintain focus on the overall strategic goal of the transaction. This applies after closing also – most acquisitions under-perform before improving.
Keep your options open. The best way to keep leverage on your side is always to be willing to walk away from an opportunity. It is easy to become smitten with a seemingly attractive target because it is familiar and available. However, this shouldn’t cloud your judgment when it comes to the details of the transaction. The right company can quickly become the wrong deal, based on the price and structure agreed upon. Remember when you are proactively seeking out acquisition candidates from a position of strength, you don’t need to swing at every pitch; maintain flexibility and wait for the right deal on the right terms.
As with so many other things in business and life, success in strategic expansion depends on taking the initiative, controlling the process, and sticking to your goals. Sitting back and waiting for the right opportunity to come knocking is a risky and directionless alternative. How can you be sure the deal that falls in your lap is right for you and your company? Instead, determine the long-term vision for your company and establish what role acquisitions will play in achieving those objectives. Then, with the assistance of an experienced financial advisor, design a strategy that utilizes specific criteria to identify a select number of complementary targets. If appropriate, construct a purchase structure that supports your goals and prepare for integration and post-purchase management of the acquired operations.
Your company is your most important asset and likely your future legacy. Acquisitions can play an important part in either building or detracting from shareholder value. Acquisitions can strengthen the platform for future generations, provided you make such moves on your terms and as part of a carefully conceived strategic plan. The health of your business is too important to leave to chance.
Brad Bulkley is President & Founder of Bulkley Capital, an M&A advisory firm based in Dallas and focused on family-owned and other privately held, middle market businesses nationwide.