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By David Braun on August 30th, 2008

Mergers & Acquisitions Daily brings a fresh perspective to the ever-changing world of M&A. As a veteran practitioner in the field, I have fashioned a new approach to the challenges of external growth — a systematic process that has resulted in numerous successful deals across multiple industries.  

In this blog I share my thoughts on topical M&A issues combined with insights from Buying Power, my forthcoming book on acquisition strategy. Our newsfeed from the markets adds daily currency to the site. Most important, I welcome your comments on my posts — so join the conversation and enjoy the blog!

To make a comment, click the TITLE of the post.

• The M&A Power Shift Continues

  Back in December, I noted (and agreed with) one author’s proclamation that in the current economy, the balance of power in M&A has shifted from sellers to buyers.  The main reason:  With the credit market in a crunch, cash is king, and cash-rich companies hold a distinct advantage.

  As these survey results show, this trend is continuing.  I believe this is true in the US as well.  Buyers are looking to protect themselves from a sour deal by adding in more escrows and earn-outs, along with more items covered in reps and warranties.  Due diligence has become more thorough.

  Good companies are choosing to sit on the sidelines rather than risk a bad deal.  Grade ‘A’ sellers are also waiting for better days, if they can, or aren’t compromising. Cash is king and the king makes the rules.
  John Dearing on “Inside Maine Business”

  I recently appeared on Jacobson & Katz: Inside Maine Business to discuss the current state of the mergers and acquisitions market, as well as the Capstone approach to the M&A process.

  You can view Part One here:

  And Part Two, here:

  To see other episodes of Jacobson & Katz: Inside Maine Business, visit www.insidemainebusiness.tv
  Video: Why Do Deals Fail?

  At a seminar on the M&A process, I discuss the most common reason that acquisitions fail - and it might not be what you expect:

  Have you been part of a failed acquisition?  What do you think was the main reason that it didn’t work? Let me know in the comments!
  Out of the Present and Into the Future

  With the shaky economy, I am constantly hearing clients talk about how to get through the tough times now.  While this is obviously a valid concern, I caution them not to forget about the future - specifically future demand.

  Future demand is king for reasons that are self-evident, once you pause to think about it. Ultimately your growth will depend on your success in meeting the needs of customers you have yet to capture. What do they want today? What will they want in the future? Business winners are the ones who best answer these two questions, especially the second. At Capstone, we put painstaking effort into market research, and go to great lengths our attempts to predict future trends.

  Once the orientation has shifted to future market demand, a tremendous clarity emerges in the strategic process. We have a basis for defining our criteria for decisions like: which direction to grow, which growth tactics to adopt, where in the market to focus and what to add to our current resources.

  Although times may be tough now, your success as a company depends largely what plans you make for the future.
  Valuation ≠ Price

  I wanted to post a quick note about the difference between the valuation of a company and the price that you pay to buy that company.  This distinction came up after a conversation I had the other day with an associate who had difficulty understanding why he was looking at paying a different amount for a company than the valuation his accountants had given to him.

  Valuation and price have different meanings and are (usually) two quite different numbers. A company’s valuation is the financial assessment of a business determined by one or more accepted valuation methods, such as Discounted Cash Flow.  Valuation’s main purpose is to figure out a ceiling for what you could pay for the prospect.

  The price is the dollar amount that will be negotiated in the acquisition agreement. Remember the core premise that every company is for sale for the right equation. The valuation will certainly form a major part of that equation, but there is no reason to assume it will be all of it.

  One of the factors that often must be mitigated is the owner’s ego. For example, your valuation methods may place the value of a company at $35 million, but the owner passionately believes his firm is worth at least $40 million. When constructing your initial offer you may have reason to take into account the owner’s expectation of what he will get for his company.

  Other factors that can force a gap between price and value include historic transaction multiples in the industry, revenue replacement issues and even the rumor mill.

  I urge you not to throw around the terms price and value synonomously.  As you can see, they are quite distinct. A solid understanding of their differences is essential when discussing dollars and cents during negotiations.
  The Prospect Funnel

  I have frequently been approached by clients after a deal suddenly fell through — a deal they had been working on for months or even years. For example, I recall a manufacturer of aviation parts that was convinced they had found from the start the “Holy Grail” of acquisition targets. They believed this prospect was the perfect fit for their external growth needs. They cast aside any other candidates and poured all their energy into the pursuit of this one company. After months of positive negotiations, the prospect abruptly got cold feet and backed out. The owner decided he wasn’t ready to sell a business that had been in family hands for multiple generations. The aviation company was left to start the entire process over.

  The lesson is clear. Have one reason for making an acquisition, but have many viable prospects. Don’t just have a Plan B — have a Plan C, a Plan D and so on. Create a funnel and fill it with likely prospects.

  The concept of the prospect funnel is that you begin by considering a broad sweep of companies (it could be dozens or even hundreds). Gradually, you filter this list through your prospect criteria, eliminating weaker prospects step-by-step. At each stage as you move down the funnel, your research becomes more detailed and your analysis more exacting. Finally, you will identify a handful worth engaging personally, and from these you will select the company or companies with whom you initiate negotiations for a purchase.
  Taking Control With a Minority Investment

  Recent news indicates that the federal government will “prop up” the major banks if they continue to falter.  This has some worried that these large financial institutions will be “nationalized”.  The government says that this is not the case:

  The strong presumption of the Capital Assistance Program is that the banks should remain in private hands.

  Simply put, the government is making a minority investment in these banks, and there is a question of how much control the government will have in these institutions.

  Similarly, when we suggest to our clients the possibility of a minority investment in a company instead of an outright acquisition, we sometimes receive push-back over the issue of control.  In fact, in two separate meetings over the past month, our clients’ expressed concern that they would “lack control” even though they would have a financial stake in the company.

  A minority investment in and of itself does not mean that the majority shareholder has total control over the direction of the company.  In fact, you can own only 1% of the company and still put yourself in the driver’s seat to get the strategic relationship and benefits you want. The issue of control comes down to the way the minority investment (or any deal) is structured.

  It is our philosophy to first find the right strategic prospect, win them over and then find a mutually beneficial solution to the deal structure to bring the two companies together.

  Concern over control should not stop you from considering minority investment, or any particular form of external growth.
  Cutting Costs and Treading Water

  I recently read an article through DealBook indicating that the Obama administration will increase antitrust enforcement during its tenure, raising the anxieties of many on Wall Street.

  In the big picture, I don’t think this increased oversight will have much impact on middle-market deals - after all, it’s usually only the really big deals that could have monopoly implications.

  What stuck out for me in the article, though, was the following statement:

  Economic downturns tend to force executives to find ways to reduce costs…

  Merging with a rival, and reaping the synergies that come from eliminating duplicative functions, is a crucial component of any manager’s recession survival tool kit…

  It’s my belief that while cost-cutting is one way to deal with a tough economic situation, it can only help you tread water for so long.

  Proactive growth proponents look at a complementary acquisition or new market entry opportunity as a chance to increase revenue and cross-sell - leading to more significant growth in the long run.

  I often find that the cost-cutting aspects of these deals are a way to get more conservative finance colleagues to sign off on the deal.  The benefits are real and helpful, but cannot by themselves lead to sustainable growth.

  Although many executives are just trying to weather the current storm, I believe that those that are bold with their growth moves will come out significantly stronger once it passes.