No acquisition will achieve a strategy you can’t define. It’s the most important part of the acquisition process.
Don’t be afraid to ask for advice. Talk to your board and your bank, as well as advisors and customers. They can be a rich source of insight into your competitive environment, and into your real strengths and weaknesses.
Once you’ve defined your strategy, there are some important questions to ask:
- Does it meet your strategic objectives?
- Does it exceed your required ROI?
- Does it enhance your competitive position?
- Are there any quantifiable synergies?
- How will you fund it?
Do your homework
There is no best single approach to your first contact with a potential acquisition. Sometimes a direct board-to-board level discussion is best. At other times a quiet approach from an intermediary is better.
You need to be able to start valuation and negotiation, without alerting the market. Confidentiality is essential.
Be sure you have a good, experienced advisor or lawyer. He or she will know what to focus on as key deal issues. Taking a commercial approach reduces delays.
You also need to know your financial position. That means deciding on funding.
Three funding partners
The first source of funding is equity. If you have funds on hand, your equity holders may need to agree to forgo dividends or commit more funds, and to agree to the acquisition.
Your equity providers will be the last in line to recover their funds if the business fails, so they will expect returns in line with the risk they take.
Another option is attracting new share-holders with new equity. This can provide more growth capital and deepen your investor pool and connections. But it will dilute your existing equity, and can also signal your plans.
The alternative to equity is debt, and your first source of debt finance is your bank. Banks typically provide ‘senior debt’. They’re first in line to recover funds, so interest rates reflect this. They also generally offer simple financing terms, with flexible repayment structures.
Any funding gap between equity and bank debt means you may need subordinated or ‘mezzanine’ debt. It typically has higher interest rates. They might also offer different terms. For example, capitalising the interest (payment in kind), or giving the lender equity return as well as interest (warrants or options).
Give it a WACC
It’s important to calculate your Weighted Average Cost of Capital (WACC). It indicates the rate of return required for your funders, taking into account the risk of the acquisition.
Equity has a cost based on expected shareholder returns.
Debt carries an interest cost, offset by your standard tax deduction.
Weighting these costs by the amount of each type of funding gives you your WACC. It usually shows senior debt as a good source of growth funding, as it’s cheaper than equity.
The positive side of debt
Debt has many benefits despite its cost. It doesn’t dilute your shareholder equity. It is tax deductible. It improves your immediate cash position. It currently has low interest rates.
You can use debt tactically, for example as bridging finance until you can raise equity.
Finally, it lets you make acquisitions without signalling your intentions to public markets.
But debt needs a management plan to optimise your balance sheet.
Stay close to your debt
Your loan will have an agreed review date. If your financial position has improved, you’re in a stronger position to improve your terms. A weak position can lead to higher rates.
Smart businesses reduce their re-financing risk by staying close to their bank. Start your review process 18 months out. Meet your bankers regularly and discuss your wins and setbacks. Work with them to find solutions early. Then, when it’s time for your review, there are no surprises for either party.
Acquisition is just the beginning
Debt is a small risk compared to integrating your new acquisition. Failure here can make a successful acquisition stumble after it crosses the finish line.
You may be merging an existing culture into your own, or forming a new hybrid culture. You need to actively manage the change, but keep an open mind to opportunities. Always keep your underlying strategy in mind.
Resource your post-acquisition plan with people and time. Aim to over-communicate with staff, customers, suppliers and shareholders. If they complain about hearing too much, you’re probably doing enough.
Get the bank on your team early
Too often, organisations call the bank once all the decisions are made.
Your bank can be a valuable resource. Talk to them early about your strategy. They’ve been through this process with many other businesses. They can share their expertise and lessons learned. They can even introduce or approach the owners of potential acquisitions.
They supply your transaction banking services and working capital. Most importantly they have a vested interest in your success, and that puts them on your side of the negotiating table.
If your strategy calls for growth, call for your banker.
ASB Capital Solutions work with organisations to find the best ways to fund strategic growth. They connect people, ideas and capital.
If you’d like to discuss your capital needs or your growth strategy, contact ASB’s Fergus Lee on email@example.com