Written by Paris Aden
Takeaway: An Acquisition Program uncovers more proprietary acquisition opportunities that make strategic sense and are available at better valuations.
A proactive acquisition strategy is not a new concept for private equity or strategic buyers, but it may be an unexplored option for small or mid-market businesses that want to break through to become a more dominant players in their industry.
To achieve this growth, an Acquisition Program that uncovers passive sellers at reasonable valuations works in concert with conventional sourcing strategies and can produce significant strategic and financial benefits. The benefits of developing a pipeline of proprietary acquisitions are manifested through superior valuations, strategic choice and increased activity levels.
The Benefits of Proprietary Deal Flow
In the pursuit of an acquisition, business owners can approach companies that are “listed” for sale or they can target businesses that they believe would be a good fit, regardless of whether they are currently on the market. The latter strategy of developing proprietary deal flow offers a number of benefits over the possibility of entering into a competitive auction process. Let’s review these benefits in more detail.
Draw “On the Fence” Targets into Dialogue
For various reasons, most companies have no knowledge of, interest in, or desire to auction their company today. However, many of these are passive sellers that would entertain an approach from a serious party. Typically, at a given point in time, active sellers represent a fraction of the available acquisition opportunities. We have tracked target response rates and our experience suggests that 15-80% of a given target universe (depending on the industry, geography and target size) are passive sellers who welcome an approach from a professional, motivated and well-funded suitor.
Find the Best Targets
Developing an Acquisition Program allows a company to focus on potential acquisitions that make strategic sense, not just what’s available. Targets are selected based on strategic priority and the highest expected synergies. This fit reduces the likelihood of the target considering an auction process once the initial approach has been made and a relationship cultivated with the vendor(s).
Control the Process and the Pace
The vendor and their agent drive the process for auctioned targets, including schedule and access. With a proactive approach, the acquirer controls the pace of target approaches and the transaction process. This enables sufficient time to conduct proper due diligence and develop a relationship with the vendor(s) and management.
Flexibility to Apply Risk Mitigating Structures
In auctions, there is little flexibility in terms of form and structure of consideration. A proactive approach may facilitate risk mitigation through structured consideration (VTB, earn-outs, other contingent structures), which can be an effective means to close any valuation gap with the vendor.
Avoid the Winner’s Curse
Winner’s Curse relates to the winner’s tendency to over pay for a business when participating in an auction. Also there’s a good chance your competitors were involved in the same auction as well. If you “win” the auction, your competitors will know the details of the business and may have an idea of how much you paid.
Value Enhancement of an Acquisition Program
For many vendors, price is not the sole consideration when selling. In sourcing and acquiring proprietary targets, mid-market businesses can experience significant Economic Value-Added (EVA) by acquiring at lower multiples than those paid for targets involved an auction process. If the acquirer can also increase target margins through cost synergies and sales through distribution synergies, the EVA increases even more.
Negotiating leverage is critical to valuation and terms. Typically this advantage is enjoyed by the vendor in an auction. In proprietary deal, inverse auction dynamics arise. When an Acquisition Program is in full-swing, it will often generate a pipeline of proprietary targets, each vying for your time and focus. It is much easier to move past sticking points with vendors when you (and possibly they) know that others are in the queue. Conveying, whether subtly or directly, that you are reviewing many opportunities creates some competitive tension and urgency for the vendor.
Accelerated consolidation that can be realized with an Acquisition Program improves return on capital for the acquirer. If the EVA from acquisitions is realized at a faster pace, IRR is enhanced. Faster completion of the consolidation phase allows the acquirer to gain first-mover advantage over competitors and to move towards integration much more quickly.
Acquisition Programs enable maximum strategic choice and optionality. Where there is a pipeline or inventory of opportunities, you can decide when and where you will focus time and effort. Targets can also be sequenced optimally according to corporate priorities.
Ancillary Benefits of Acquisition Programs
There are also ancillary benefits of systematically approaching acquisition targets, aside from actually completing deals.
Gather Proprietary Market Intelligence
An Acquisition Program provides access to target information that is not publicly available. It can enhance your understanding of which industry players are consolidators and which are sellers (including why and when they are sellers). Potential acquirers can also assess best practices employed by targets through due diligence.
Running parallel discussions enables comparison of one target against another; for example, financial and operational benchmarks and fit of product/service offering with the acquirer. Acquisition Programs also facilitate prioritization of targets based on their attributes and strategic fit with your platform.
Assessment of Consolidation Opportunity
This process provides valuable intelligence on the future extent of an industry roll-up strategy. If you can work through the target universe in one year with a proactive approach instead of five years with a more reactive approach, it informs decisions on whether to 1) continue to pursue acquisitions and secure financing and other resources to support them, or 2) shift strategies if the consolidation opportunity has been fully explored and is more limited than originally thought.
Seeing more proprietary acquisition opportunities that make strategic sense and/or are available at better valuations, while being able to significantly mitigate risk by having more control over the process, are some of the reasons to consider making proactive acquisition sourcing part of your growth strategy. However, committing to pursue such a strategy alone does not ensure success. Implementing a state-of-the-art process that maximizes results requires significant planning, resources and skill.
Process matters. Our team has worked with some of the most successful industry consolidators and private equity funds. We have seen first-hand the difference between processes that get results and those that disappoint.