February 17, 2011 1 Comment
By Richard Hayward, Principal, HHMC Australia
There are really only two substantial ways to grow a business – organically over time, or by acquisition. Obviously growth is good for businesses but it does present risks because it puts pressure on a company’s financial and other resources. Growth can be one of the biggest killers of a business aside from no sales at all. Professor Sudi Sudarsanam, of the Cranfield School of Management in the UK, a leading author in the mergers and acquisitions field, warns firms, “must always consider the alternatives to acquisitions as a means of achieving its strategic objectives” because the risks associated with acquisitions are significant. Businesses generally look to acquisition as a means of gaining additional turnover, new clients, new service or product lines and to enter new markets. All these laudable aims can be achieved by organic means but acquisition is quicker and easier – provided you obey the rules.
Any “deal” should be able to pass stringent tests. Would-be acquirers, regardless of their size or the size of the company that’s being bought, need to answer these questions:
* What strategic aims must be achieved for this purchase to be justified?
* If those aims are achieved, what financial benefits (making profits and/or preventing losses) will be realised?
* Do the benefits represent an attractive return on the costs?
* What are the chances of the aims not being achieved and is that acceptable?
If the above points can be satisfied there are still further questions to ask:
* How is the acquisition to be implemented?
* What framework will be established for the combined venture? How will the new business be fitted in?
* How quickly will the benefits start to flow? What is the lead time?
These are all key decision points that must be reviewed before embarking on an acquisition action plan. The question of how long it will take to see the desired benefits is crucial; if you’re buying to save time, it makes no sense to get tangled up in a long and costly process of integration. The risks involved in mergers and acquisitions are intensified if these questions do not get proper answers.
Growth through acquisition is riskier than organic growth therefore before an organisation embarks on this path of growth it must carefully assess its target. Once the buying company has decided to pursue its strategic objectives by acquisition it must at least carry out a proper due diligence exercise and, with specialist advisors, undertake the necessary commercial analysis of the risk and return profile of the target. As part of the overall due diligence exercise the buying company needs to assess the following key business metrics:
Recurring profits indicate the potential durability and strength of future profits, therefore the probability that they will be achieved again. If the target company’s results are underpinned by one-off events this could highlight a potential future problem and expose the target company’s potential frailties and susceptibilities should external economic events turn against the company. In recruitment this will include a mix of temporary/contract placements to permanent placements, the quality and number of preferred supplier agreements and the size of the business.
The target company’s client base needs to be assessed for its composition and profile. A sensitivity analysis will reveal the level of reliance on too small a group of clients for business over time and the consequence to the business of losing one or more of those core clients. Of equal importance is the level of business goodwill that is attached to the owners or other key managers. While there is likely to be an earn-out period, what are the risks of losing clients through a change of ownership?
Appropriate accounting advice should be sought to determine the financial viability of the business.
* How volatile is the cash flow?
* How is the business funded?
* Is it too highly geared?
* Is it a going concern?
* Is the overall trading position of the business acceptable to justify acquisition?
Ultimately, the risk that things don’t go quite according to plan needs to be factored into any acquisition assessment, but having access to a sound, experienced advisor increases the chances of smoothing out the process, making the right decisions for the time and concluding a successful deal.