10 Biggest Mistakes Private Companies Make in Growing Through Acquisitions
With an increasing numbers of private companies coming on the market caused by later stage baby boomers selling their companies, the strategy of growing your business through acquisitions is becoming very viable and attractive.
In fact, if properly executed, we have seen companies use this strategy to grow their businesses 10 fold and greater in under five years.
The dynamics for growth through acquisitions is very compelling and include:
- With the increasing numbers of private companies coming up for sale, pricing and deal structuring can be advantageous to the buyer.
- Access to capital – from banks, subordinated debt providers, and private equity – is much easier if you are seen as a capable, rapid growth company.
- Word often gets out in the market that you are an “acquirer” and retiring entrepreneurs will often seek you out to help with their liquidity.
- Top talent is easier to attract.
- The synergies – both in cross selling and cost savings – can have a huge impact on your profits.
While the potential gains from this strategy are enormous, the risks are very real. Studies of public companies’ acquisitions have shown that the majority of acquisitions don’t add to shareholder value.
And given the relatively limited resources available to most private companies, these risks can be even more dangerous.
Some of the biggest mistakes we see with companies who decide to grow through acquisitions include:
- Chasing deals & taking your eyes off your business
Studies show that over 50% of buyers spend between 10 -20 hours a week searching for 6 months to a year to find a suitable business to acquire. You may think that you know all the players in your industry, so it will be faster for you, but to initiate a discussion with a variety of prospective targets, strike a deal, complete the due diligence, arrange the financing and “paper” the deal is incredibly time consuming.
But because the potential upside to a well-executed acquisition is so compelling, many private companies get caught up in the excitement of the “hunt” and the core business suffers. Acquiring companies is very time consuming and eats up a lot of your internal resources, and all this can come at the expense of your existing business.
- Getting Deal Fever – not listening to your due diligence
Deal fever happens when you’ve got so much time, energy and emotion tied up in a deal that your focus shifts from doing the right deal, to simply getting a deal done. Even seasoned private equity pros get deal fever – it’s hard not to.
We’ve seen too many deals where the buyer has ignored the negatives that came out from the acquisition due diligence process and lived to regret it.
One of the best pieces of advice on this point came from a seasoned private equity investor who told us “Some of the best investment decisions I’ve ever made were ones where I walked away from the deal”.
- Paying too much cash upfront & taking on too much bank debt
Companies do this because they either (1) succumb to Deal Fever, or (2) get too aggressive in their views on future performance.
Things always take longer than you think. And you are never 100% sure of the reaction that your new customers will have to the acquisition.
While the seller will pressure you for more cash up front, you need to structure a deal that ensures that you get what you are paying for. And in private company acquisitions, this normally requires payments to the seller that are tied into certain future performance – sales levels, EBITDA levels, key suppler support. So you’ll often see that a large amount of the “purchase price” is in the form of delayed payments to the seller, often varying with future performance of the acquired company.
You may find that your bankers are surprisingly supportive of your acquisitions, since they get to lend you more money to what they believe will be a stronger company post-acquisition. But be careful about taking on too much bank debt; if there are hiccups with the integration of your newly acquired company you don’t want to be dealing with a nervous bank manager at the same time.
- Not properly evaluating the soft points
We seldom see a proposed acquisition that doesn’t look great on paper – increased sales through cross selling, stronger gross margins from better supplier terms, and reduced selling and administrative costs from merging two back offices. All good on the financial spreadsheets – but they could be all imaginary and evaporate in a puff of smoke if you haven’t taken into account the “soft” points of the acquisitions.
And the biggest “soft” risk relates to people and cultures. Is there a culture fit between your two organizations? We see too many acquisitions stumble because the acquirer is so focused on realizing the synergies that they ignore the people issues, thinking that these will take care of themselves.
The reality is, when a company is acquired, no matter how small, there is a very high degree of uncertainty and, yes, fear. And not only in the company being acquired but sometimes within your own company as well, as roles and expectations are altered and responsibilities shift.
Remember that growth through acquisition can be fast and furious – and very disruptive for the people involved. And it’s your people that will dictate the ultimate success of your company.
- Failing to have an integration plan & ignoring the importance of the first 100 days
Your first 100 days post acquisition are critical to ensuring that you have a successful integration and that the hoped for synergies between your two companies are realized.
Like a new US President, use your first 100 days to lay out to everyone within your new organization your vision, strategy and initiatives that are required for this success.
In a change environment, people are looking for clear guidance and action. They are expecting that change is going to happen, and this make them anxious. And each day that you delay addressing their concerns, they becoming increasingly more anxious and less productive.
You should spend as much time mapping out your first 100 days as you did in doing your acquisition due diligence. While we see very few people who have the discipline to do this, those that do reap the rewards.
- Not taking the tough decisions
Restructuring experts will tell you that it’s far better to take action than it is to “wait and see”. You’ll find that some of the people that you’ve acquired, as well as some of your own people, can’t make the jump to the next level. People expect change when an acquisition occurs. If you’ve decided that a person can’t “cut it”, it’s better for you, for the person in question, and for the people around them that you take action.
Often it’s not 100% clear and you’ll be inclined to give them the benefit of the doubt for a few more months, or you’ve got too much else on the go to address an issue that is not urgent. Experience tells us that, while not perfect, it’s better to act now.
- You can’t delegate
Experienced bankers and private equity investors know that one of the biggest risks for many small private companies is too rapid growth – and entrepreneur’s inability to morph from an entrepreneur to a manager. For many entrepreneurs, the need to have their hands on all aspects of the business is in their DNA. This simply doesn’t work if you are going to double your business every 2 to 3 years.
If your are honest with yourself and realize that you have difficulty delegating key roles to others, then a strategy of growth through acquisitions may not be for you.
But if you are determined to go down the acquisition path, then reread #3 above, Paying too much cash upfront & taking on too much debt, and make sure that when the inevitable bump in the road occurs, that your debt load is small enough so as not to have your banker breathing down your back.
- Failing to upgrade your talent pool
Not all people can evolve to the next level. And growing businesses need more skilled people than stagnant companies do.
Your focus post acquisition is often on paying down the acquisition debt. So owners often say that they can’t afford to bring on new talent. But the reality is that you can’t afford not to. Rapid growth generates inherent risks that need to be continuously evaluated and monitored – without skilled people to do this, you are jeopardizing everything that you’re working for.
Consider the upgrading of your talent pool as simply another acquisition – an internal acquisition that could likely be your most successful.
- Overestimating the synergies
Synergies from acquisitions are normally found in three areas:
- Cross selling to the two companies’ customers;
- Enhanced gross margins from better buying power; and,
- Expense savings created when combining two companies’ selling, general and administrative activities.
On paper, these can look very exciting and can push you to do a deal. Experience tells us that actual synergies can fall well below anticipated synergies.
And that’s fine so long as you’ve not locked yourself into future payments (to the bank or to the vendor) that you can’t get out of should the synergies be less than expected. Stress test these synergies in a financial model back to your future debt service requirements - this will drive home the risks of overestimating the hoped for synergies.
- Going after the next deal too quickly
This is the next phase of “Deal Fever”. You’ve done your first deal (and enjoyed the “rush” of the deal) and you’re starting to see your growth vision realized, with you and your financial partners all excited about the future.
And now you want more!!
This may not be as easy as it first looks. Think about you first 100 day plan and make sure that you’ve nailed down this first acquisition before embarking on the next. Making sure that your two organizations are now acting like one and that your new customers fully embrace you will take longer than you think – so take your time and get it right. There are lots of potential acquisitions out there that are not going away. A disciplined, patient and methodical acquisition strategy is your ticket to success.
In Their Words
The MBO Group seems to have a unique ability to uncover interesting and worthwhile opportunities in the Canadian private company market. I have had the benefit of working with them in a variety of situations. They have always been able to capture the essence of what makes a project assignment or deal work in a very strategic way that others can embrace. With a rare ability to communicate clarity they are able to efficiently bring individuals as well as groups to understand what it takes to achieve success.
FCA, Former CEO & President, Marsulex Inc.