The better alternative is for the acquirer to take matters into its own hands and actively seek acquisitions. This is harder work and takes longer but often results in a better understanding of the target business, its people, culture and issues. Perhaps most importantly, it avoids an auction sale where the buyer is chosen only by the highest bid - not the best match.

Why make an acquisition?

The benefits of well-planned acquisitions are widely recognised. But what are the reasons for an acquisition? When a business reaches a certain size, an acquisition can help it move to the next stage more quickly and effectively than through organic growth. But there are other specific business reasons to consider.

Increase market share

An acquisition can help rapidly increase market share both geographically and in terms of turnover. For example, a magazine publisher may purchase another company to expand its existing stable of titles. Car dealership groups may acquire new dealerships to broaden their geographical footprint. Extra turnover and gross margin is added to the existing business without any material increase in overheads.

Diversify activities

Many acquisitions stem from a desire to diversify. By branching out into new areas, businesses hope to decrease the risk of over-exposure to one particular market. Many farmers have diversified away from core farming activities to expand into land management or leisure. Other businesses choose to diversify into complementary activities - so a business providing catering and security may choose to add, for example, cleaning services.

Vertical integration

An acquisition can help a business move up or down the supply chain - vertical integration. This can deliver numerous benefits and enhance sales. However, the risks include competing with your existing customers or suppliers.

Operating synergies

Acquisitions can often deliver cost benefits, for example, when buying a manufacturing plant or a service which is currently outsourced. This generally gives only a one-off benefit - you can only cut the cost once. So care needs to be taken: are the savings real or are there likely to be unforeseen, compensating costs?

The case for acquisition

Once the decision to start acquiring has been made, a business should develop acquisition criteria that reflect its commercial objectives. The purpose of the acquisition criteria is to verify and document the thought processes behind the acquisition strategy.

Once completed, the criteria can be circulated to professional advisers and contacts to generate ideas for acquisition targets. Equally the targets may be well known to the purchaser - indeed they ought to be if the target operates in the same area.

So what needs to be covered in the acquisition criteria?

Business activity

The criteria need to cover the types of activity you're looking for. The less general the criteria, the greater the chance of success. Advisers generally respond better when they can easily match the criteria to a company they are advising.

Management

Management is a crucial part of any acquisition strategy. Many businesses are sold by owners looking to retire - so will need senior management input going forward. The target may have junior management who are able to step forward under the new regime. Thus it is often useful to state that there will be opportunities for them in the future.

Size

Size is one of the main criteria for the buying business. Too small and the acquisition is unlikely to be worth the costs and management time. Too big and it will unbalance the existing business.

Location

This is particularly important in an acquisition to increase market share in a specified area, or if the buyer intends to manage the business from its existing head office - in which case, good communication links are essential. Overseas expansion requires detailed local knowledge and brings additional challenges, particularly in managing the target.

Funding

For the buyer, a significant factor is the method of funding. Bank funding will come with strings attached, chiefly around cash flow covenants. Equity funding, such as through private equity, will have even more stringent return requirements.

Using an adviser

A financial adviser provides a useful buffer between the target and buyer, adding real value to the process and helping to ensure that good relations are maintained between the buyer and the seller. Before you decide to go it alone, remember that the adviser is familiar with this world; acquirers are often not.

The pricing conundrum

Pricing is not an exact science and although a rational argument can be made to justify a price, it always comes down to negotiation. An acquisition should not be made simply because it is cheap, but because it makes sense.

Common methods of valuation include: net asset value; entry costs versus cost of acquisition; discounted cash flow; price/earnings ratio; turnover ratio; and synergistic savings.

In many ways, each method of valuation is a cross check and should not be relied upon on its own. The key value is what the business is worth to the buyer rather than what the seller wants to sell it for.

To sum up

Acquisitions mustn't be left to chance - a good acquisition is not simply a cheap one. By setting clear acquisition criteria, using the support available and applying skilful negotiation, businesses can find the right match. But this is just the beginning of the acquisition process. Ultimately, it is the commercial and cultural fit that will determine the outcome long after the acquisition is complete.


If you're thinking about acquiring a business now or in the foreseeable future, contact Brian Livingston on 020 7131 4914 or email This e-mail address is being protected from spambots. You need JavaScript enabled to view it to assess and discuss your options.

Disclaimer

By necessity this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Article correct at time of writing.

Note to editors

About Smith & Williamson

Smith & Williamson is a leading firm of accountants and business advisers. The entrepreneurial and growth business sector is one of its key areas of focus and clients include both private and quoted companies, ranging from early stage to mature businesses with values of tens and hundreds of millions.

In addition to accountancy services, the firm offers an unusually broad range of expertise including tax, investment management, private banking and financial advisory services. It operates from offices in London, Belfast, Birmingham, Bristol, Dublin, Glasgow, Guildford, Salisbury, Southampton and Worcester. Nexia Smith & Williamson is the audit practice of Smith & Williamson and is an independent company.

Smith & Williamson Corporate Finance Limited. Authorised and regulated by the Financial Services Authority. A member of the London Stock Exchange. A member of M&A International

Smith & Williamson Limited. Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.

Nexia Smith & Williamson Audit Limited. Registered to carry on audit work and regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.