Mergers and Acquisitions
It’s easy to get carried away in the excitement of merging, selling or acquiring a business. But, as Carlo Pasqualini warns, if you don’t do your homework before mergers and acquisitions you probably won’t realise expectations and the deal might even be disastrous.
Every day it seems there’s a new corporate takeover with media headlines predicting the new big move. So it’s no surprise that recent figures have shown there were 705 mergers and acquisitions (M&A) in Australia in the first 11 months of 2006, totalling $53.9 billion (based on Thomson Financial data sourced December 1, 2006).While there is a fair amount of hype around the deals at the big end of town, it’s important to note that 573 deals so far this year had a value of less than $50 million each.
That’s around 81 percent of all the transactions that took place this year. In the past, smaller businesses might not have been the prime targets that their larger counterparts were; however, the evidence suggests that smaller enterprises are as active as ever in the M&A marketplace, both as buyers and sellers.There are several reasons why we are now seeing such an abundance of activity. First, accelerated consolidation in markets including the retail, consumer, industrial and energy sectors, is forcing smaller players to either grow in scale to compete or be acquired by a competitor.
Second, a larger number of Australian businesses are family- owned and managed and, over the next five to 10 years, many baby boomers will be retiring. Research conducted by Deakin University on behalf of KPMG and Family Business Australia has found that 38 percent of survey respondents will be looking to sell their business on the open market when they retire.Third, the Australian capital markets have been extremely buoyant over the past few years and many companies have healthy cash flow and strong balance sheets leaving them with surplus funds to acquire other businesses. Fourth, low interest rates and favourable loan conditions have meant that debt has been relatively cheap as a means to fund acquisitions that achieve growth targets. Finally, we have all read about the billion dollar private equity bids, but not many people are aware that private equity players are also working in the smaller end of the market, usually rolling up several similar smaller businesses in different states into a single national operation.
In this environment it would be easy to get carried away in the buying frenzy. This article will look at the details you will need to contemplate when selling your business, as well as those you need to consider prior to acquiring a business. We will also look at the importance of planning the integration between your current business and the acquired business well in advance of finalising the deal.
While the sale process varies from one situation to another, there are a number of items that are common regardless of the specific circumstances of the sale:
* Appoint advisers: seek external assistance by appointing an experienced merger and acquisitions expert, a tax adviser and a legal adviser. Selling a business is a complex and demanding process. Using experienced professionals to assist will lower your risk and give you greater confidence and help maximise the sale price.
* Planning: plan for the sale process well in advance to avoid unexpected issues arising later in the process. This includes ensuring that your books and records are up to date and that your business has strong controls and business processes. Sophisticated buyers, particularly private equity houses, demand a high standard of recordkeeping.
* Preparation: compile information that will be needed by prospective purchasers in the form of an Information Memorandum setting out details of the business’ operations, opportunities, customers, suppliers, employees, and financial performance. Avoid providing information that can’t be substantiated or backed-up. This will only serve to create doubt in the minds of potential purchasers as to the validity of the information overall.
* Research: identify parties who are likely to have an interest in your business, such as competitors or new market entrants.
* Sale process – pursue a structured sale process with a timeline as this allows competition to be generated between prospective purchasers. Also ensure they each sign a confidentiality agreement.
* Indicative offers: have prospective purchasers lodge indicative offers setting out how much they are prepared to pay and other key terms and conditions of the offer.
* Heads of agreement: this is a plain-English document setting out the commercial and some legal terms of the proposed sale and is used to ensure that the major aspects of the sale have been agreed upon by the vendor and purchaser.
* Due diligence: conducted by prospective purchasers to identify any issues regarding the acquisition. For example, is the financial information provided accurate? What risks are involved in buying the business?
* Sale agreements: these are the final legal documents drafted by lawyers and contain comprehensive details of the sale including warranties/indemnities regarding the accuracy of information provided. A formal sale process can take anywhere between three and nine months to complete, but can be well worth it, especially if you can maximise the value from the sale.
There should be solid strategic reasons for purchasing another business. Questions you should ask yourself about a potential acquisition are:
* Will this purchase enable me to access new markets in new geographies? * Will this purchase improve our buying power?* Will this acquisition give us access to intellectual property or improved processes and systems? * Will this acquisition enable us to achieve efficiency gains through improved use of facilities, distribution channels, and personnel? * Will this acquisition lead to the loss of a competitor, thereby allowing us to increase margins or market share?
* Will the increase in my top-line result in a worthwhile increase in my bottom- line?
A significant number of business investments and acquisitions fail to deliver against their promised benefits. In many cases, this is due to an inflated purchase price based on unrealistic expectations of future earnings. Evaluating the uncertainty associated with earnings forecasts and understanding the reasonableness of underlying assumptions can often be challenging.
Therefore it is important that you perform your own due diligence.Financial analysis that relies mainly on management assumptions and internal information can overlook the many other commercial issues that impact on a business and its growth expectations. Analysing a business within a broader commercial context will give you a better feel for its prospects and greatly improves your judgment. So it is important to consider commercial aspects such as market dynamics, competitor behaviour, new product opportunities, technological developments, customer and supplier expectations, and the regulatory environment, in the due diligence process.Getting assistance from professionals during the due diligence process is highly recommended.
Allowing a trained professional to make an impartial assessment of the business may save you heartache (and money) later. When buyers see an opportunity that is exciting, they are not always objective, and so getting outside assistance keeps the due diligence process balanced.A recent KPMG survey, The Morning After, found that more than two-thirds of deals failed to enhance value with 43 percent being value-neutral.
The reason most mergers don’t achieve the value expected from the deal is that the integration process is not properly planned and implemented. For example, if you purchased a business for its talented employees or intellectual property, but the star employees left soon after the acquisition (taking the intellectual property with them) then the value of the target is reduced. You need to have an integration plan before you sign the
deal otherwise you risk losing some of the assets or synergies that the deal is intended to generate. Typically, we believe you have 100 days to complete the integration once the deal has been completed. The areas you will need to consider integrating include: workforce, IT systems, company cultures, company history, and client and product profiles.
The cultural differences between organisations are significant challenges that are often overlooked. For example, although the second biggest post-deal challenge to The Morning After respondents was a difference in organisational culture, 80 percent of companies were not well-prepared to handle this. From our experience, the top three actions that people would approach differently in the next deal were to plan earlier, perform cultural due diligence, and set up a dedicated team to handle the post-deal work.
Tips for acquirers to mitigate that Morning After feeling:
* Identify and investigate post-deal issues prior to completion.
* Use the time prior to completion of the deal to commence post-deal management. This will give you a head start.* Set up a dedicated team to manage post-deal activities.
* Obtain control over the finance and reporting systems as early as possible after completion of the deal.
* Identify the cultural issues early and plan how to manage them .
*Anticipate and plan for management and leadership issues early, then monitor them closely after completion.
*Maintain a balance between delivering long-term value to the business while still ensuring the day-to-day business performance meets your expectations.
* Whether you are buying or selling a business, it is important to do it for the right reasons at the right time. By following a few rules and getting the appropriate people, internal resources and professional advisers involved from the beginning, it should be an exciting experience regardless of which side of the transaction you are on. Carlo Pasqualini is a partner in KPMG’s Middle Market Advisory practice.