How to Find Your Ideal Acquisition Target

After much thought and careful analysis, an import/export company decided that making an acquisition would be the best way to reach its long-term financial objectives. As difficult as that decision was, the next step seemed even more daunting: finding the right target. 

The prospective buyer’s M&A advisor suggested starting with a broad list of candidates that could then be winnowed down until the best target presented itself. The company got to work, listing competitors, suppliers and businesses in related industries — both those currently on the market and businesses that weren’t officially for sale.

Qualitative and quantitative

Reducing the size of a prospect list isn’t easy. Generally, buyers must perform market analysis and due diligence, scrutinizing each company on their list to evaluate its strengths and weaknesses. This is also a good time to meet management and develop relationships with the most promising prospective targets. 

Buyers should perform both a qualitative assessment of a target’s strategic “fit” with its own organization and a quantitative analysis involving relevant financial ratios. In addition to reviewing current and historical financial statements, buyers need to evaluate their targets’ budget or projected financial results. To gauge the accuracy of such projections, it’s important to understand the target company’s underlying assumptions. M&A advisors can be instrumental at this point in the screening process. 

Evaluating targets

Every merger situation differs, based on the buyer’s strategic objectives, the industry involved, general economic conditions, price considerations and other factors. Nevertheless, several issues are common to most acquisitions. When evaluating potential targets, buyers need to consider:

Seller’s motivation. Understanding why the seller is selling may help you determine whether the business is worth acquiring. For example, is the seller looking for new growth opportunities or attempting to flee a sinking ship? Is the owner really motivated to sell or just testing the market?

Time on the market. Good businesses are always in demand. If a target has been on the market for a long time, or if previous deals have fallen through, it’s important to find out why. 

Management structure. Are areas of authority and responsibility clearly delineated? Who makes major decisions? Is there a “behind-the-scenes” power structure that reduces efficiency? The management team’s strengths and weaknesses should be assessed.

Company-specific and industry risks. Is business good — and can it be better? Buyers need to identify whether any problems are affecting the entire industry or just the target business.

Reputation. To assess reputation, the opinions of customers, suppliers, competitors and employees should be sought. Stray complaints probably aren’t cause for alarm, but buyers need to pay attention to any trends, such as frequent criticism of product quality. 

Competitive strength. Current market share is only the start. Buyers also need to consider whether the company has launched, or is planning to launch, any new products and whether its research and development work has paid dividends.

Financial obligations. Debt and other obligations can prevent an acquisition from being profitable. Buyers should look for such red flags as late payments to vendors, pension or retirement liabilities, and the issuance of debt that may be exchanged for equity.

Legal risks. Does the company or any of its officers face potentially costly litigation? Are any of its competitors facing lawsuits that could eventually strike closer to home?

Suppliers. Dependence on a small number of suppliers could be risky. Buyers should ensure that the target has good relationships with these suppliers and that alternative options are available.

Employee morale. Are employees disgruntled? If so, it’s critical that buyers get to the root of the problem and determine whether an ownership change would improve the working environment — or possibly make it worse.

Perfect candidate

After evaluating prospective acquisition targets using the above checklist, the import/export company was able to narrow its list to three companies. As the potential buyer dug deeper, it decided that one of these carried more debt than was ideal and that another candidate’s accounting system was too messy to provide reliable financial data. Fortunately, the third company offered almost everything the buyer was looking for and it made a successful offer.

© 2015