How to buy a company - 5 buy-side M&A pitfalls to avoid
In my last post about how to sell a company, I wrote about seven strategies to get a deal done, but promised a follow-up about the converse - how to buy a company. I've been the buyer on a few transactions over my life, but I've attempted to be the buyer on a few more. What went wrong for those deals I didn't call off myself? Those of you that are either investors or work at an acquisitive company will appreciate the top five things I learned that could have saved one of those lost deals.
Pitfall #1 - Time kills deals. Sometimes the right deal comes along, and you don't move it quickly enough. Nothing kills a deal like too much time elapsing, so the quicker you work to get to a closing, the more likely that it closes.
Pitfall #2 - Don't let the lawyers kill it. Some of the best advice I've received on M&A transactions has come from attorneys, but if you leave it to only the lawyers to speak together during the process, your deal could end up dead. Instead, here's what I do - engage socially with the company you're targeting, get to know the people involved. Then loft a pre-term sheet to the executive without any legalese, just bullet points with the salient deal structure and value items. Before you do this, and even without a legal doc, you will want to consult with your attorney to get "gotchas" that could kill the deal later out of the way upfront (see next bullet point.) Then, when you have a general agreement, shake hands and send a real term sheet drafted by your lawyer. Throughout the process, stay in touch with the target company on a regular basis, keep the conversation going, and make sure that the mood stays positive. Without this vigilance on your part, someone could get spooked or take something the wrong way, so get out in front of it with honest and personal touch points.
Pitfall #3 - Agree on the edge case assumptions. There are lots of assumptions you're making about a deal and probably don't write down, but when you're starting a process with a target, it's important to validate your assumptions and make them part of the earliest discussions. For example, you may be looking at a company with $10M in sales and $2M in earnings. A smaller company like that might not have a full accounting staff, audited financials, or a predictable process for booking new business. If the primary valuation driver in this case is sales and earnings, you might include items like this in a preliminary term sheet:
$12.4M enterprise value based on assumptions below. We arrived at this figure by multiplying the operating income of the company across Q4 2014, Q1 2015, Q2 2015, and Q3 2015 by 5.6x. That multiple is slightly higher than we've seen for other companies in this size and industry, and forms the basis for our valuation.
Our offer is to buy 90% of your company. The other 10% we want you to reinvest in continued growth in the form of equity on par with all other members of the management team.
We've assumed that the revenue you stated of $10M in the prior 4 quarters includes a mix of 75% new business and 25% upsell business, and that you recognize the revenue on an accrual basis using GAAP standards.
Operating income of $2,215 for the last 4 quarters is assumed to include all your existing costs of doing business and that you haven't postponed any expenses you would normally make, nor recently classified certain items as capital expenses that would be normally, or in the future, operating expenses.
We've also assumed that your level of capital expense in the business not to exceed 2% of gross sales. If it's different, the valuation might have to change.
Pitfall #4 - You only work one side of the table. Successful transactions and negotiations are usually a win-win, so at some point during the process, you need to put yourself on the other side of the table and design a deal that everyone can live with. What's most important to the seller? What would it take for you to include it? It's often not price.
Pitfall #5 - You don't get emotional. If you're not used to dealing with people on an emotional level, or you are devoid of emotion yourself, you may not fully grasp the subtle clues that could signal trouble and give you the chance to course correct. To get a deal done, you have to want to get a deal done, and behind all the legal docs and due diligence paperwork is a human decision maker or two that needs that emotional connection to build trust. There are other ways - I favor transparency and truthfulness throughout, and the opportunity to demonstrate those values - but they aren't a substitute for a shared passion for success.
Of course, even after you get a deal done, the real work has just begun - making sure you get a positive ROI on your investment. But that's the subject of another blog post. Stay tuned.