Researching Target Companies
The acquisition of companies should be not be a scattershot approach, since the acquiring entity will end up with a jumble of unrelated businesses. Instead, a serial acquirer typically builds a database of the companies competing in the market in which it has an interest. This may be organized as a matrix, with each company categorized by such factors as revenue, profitability, cash flow, growth rate, number of employees, products, intellectual property, and so forth. The database will never be complete, since privately-held companies in particular are not willing to reveal information about themselves.
Nonetheless, there are many sources of information that can be used to continually improve the database, such as public company filings, personal contacts, third party reports, and patent analysis. The acquirer should also maintain a listing of the acquisitions that have taken place in the industry recently, with particular attention to the market niches in which they are most common. This is useful for discerning the prices at which other sellers might expect to be sold, since everyone in the industry reads the same press releases, and so is aware of the acquisitions. A recent upsurge in prices might indicate to an acquirer that the market is overheated, and so is not worth participating in during the near term.
The Initial Contact
The first step in the acquisition process is the initial contact with a prospective acquiree. There are a number of methods that an acquirer can use to scout out possible acquisition candidates. Here are several of the more common methods:
- Discrete contact. One of the better ways to buy a business is the discrete inquiry. This is initiated by a simple phone call to the owner of the target company, requesting a meeting to discuss mutual opportunities. The wording of the request can vary; use whatever terms necessary to initiate a one-on-one discussion. The intent is not necessarily an immediate offer to buy the company; instead, this may simply begin a series of discussions that may last for months or even years, while the parties become accustomed to each other.
- Joint venture. One of the better methods for determining the best possible acquisition candidates is for the acquirer to enter into joint venture agreements with those companies who might eventually be acquisition candidates. The creation and management of these joint ventures gives the acquirer an excellent view of how well the other company operates, thereby giving it more day-to-day operational detail than it could have obtained through a standard due diligence investigation. The arrangement may also make the owners of an acquisition candidate more comfortable with how they would be treated if acquired.
- Third party. There may be situations where the acquirer does not want anyone to know of its interest in making acquisitions within a certain market. If so, it can retain the services of an investment banker, who calls target companies on behalf of the acquirer to make general inquiries about the willingness of the owners to sell.
The Non-Disclosure Agreement
If the target company concludes that it may have an interest in selling to the acquirer, the parties sign a non-disclosure agreement (NDA). This document states that all information stamped as confidential will be treated as such, that the information will not be issued to other parties, and that it will be returned upon request. These agreements can be difficult to enforce, but are nonetheless necessary.
The Letter of Intent
Once the NDA has been signed by both parties, the target company sends its financial statements and related summary-level documents concerning its historical and forecasted results to the acquirer. Based on this information, the acquirer may wish to proceed with a purchase offer, which it documents in a letter of intent (LOI) or term sheet. The acquirer should request an exclusivity period, during which the target company commits to only deal with it. In reality, many sellers attempt to shop the offered price around among other possible buyers, which violates the terms of the exclusivity agreement. When this happens, the acquirer may elect to walk away from further discussions, since the seller has proven to be unreliable.
The acquirer then sends a list of due diligence requests to the target company. This topic is addressed in the Due Diligence article. It is entirely likely that the target company will not have the requested information in a format ready for immediate distribution. Instead, it may take a considerable amount of time to find some documents. In addition, since the target was not necessarily preparing itself to be sold, it may not have audited financial statements. If so, the acquirer may want to wait for these statements to be prepared, which could take about two months. Audited financial statements give some assurance that the information in them fairly presents the financial results and condition of the target company.
The due diligence process can require a number of weeks to complete, with a few stray documents being located well after the main body of information has been analyzed. Once the bulk of the information has been reviewed, the due diligence team leader can advise the senior management of the acquirer regarding issues found and any remaining areas of uncertainty, which can be used to adjust the initial calculation of the price that the acquirer is willing to offer. The usual result is a decrease in the price offered.
If the acquirer wants to continue with the acquisition, it presents the seller with the first draft of a purchase agreement. Since the acquirer is controlling the document, it usually begins with a draft that contains terms more favorable to it. The attorney working for the seller must bring any unsatisfactory terms to the attention of the seller, for decisions regarding how they can be adjusted. If the seller does not retain an attorney who specializes in purchase agreements, the seller will likely agree to terms that favor the acquirer.
The parties may not agree to a deal. A serial acquirer should have considerable experience with which types of target companies it can successfully integrate into its operations, as well as the maximum price beyond which a deal is no longer economically viable. Thus, the acquirer should compare any proposed deal to its internal list of success criteria, and walk away if need be. Similarly, since the acquirer likely has a hard cap above which it will not increase its price, the seller must decide if the proposed price is adequate, and may elect to terminate the discussions.