By Shari Caudron
Dick Blaudow launched Advanced Technology Services Inc. (ATS) in 1985. His strategy? To grow the Peoria, Ill.-based industrial- and computer-services company as quickly as he could through internal growth. His approach worked well for a number of years, but by 1993 growth at ATS had leveled out. To get back on the fast track, Blaudow, president, changed his strategy. His new tactic? To add products and services, expand the company’s geographic presence, and obtain specialized management talent by buying other companies with those capabilities.
He completed his first acquisition in 1994, his second in 1995, his third earlier this year, and the ink is now drying on his fourth strategic acquisition. By purchasing other companies, Blaudow has been able to grow his company from 325 employees and $35 million in revenue in 1993 to approximately 1,100 employees and $100 million in revenue today. The plan for growth has worked so well that Blaudow is now negotiating to purchase two other companies and he expects to complete between one and three acquisitions per year for the next several years at least.
Why has acquisition worked so well for Blaudow? “I can sum it up in one word,” he says. “Speed. The market is changing so rapidly that in order to achieve a leadership position we need to broaden and build depth in our product lines and we need to achieve critical mass with a nationwide presence. The only way to do this quickly is to find other companies that already have the strategic elements we need.”
In a highly competitive marketplace, Blaudow is one of the many small-business owners who have discovered that the best fare for a growth appetite is acquisition. In fact, when it comes to manufacturing companies, acquisition may be the best growth strategy going — for two reasons. One, although there is a mania surrounding IPOs for technology-based companies, the public currently does not have much interest in buying stock in small manufacturing firms. Because small manufacturers cannot look for an infusion of cash from stockholders in order to grow, they have to find other ways to expand the company’s capabilities. Increasingly, they’re looking to buy other businesses in order to meet growth demands.
The second reason acquisition makes sense for small manufacturers is that the market is going through a period of consolidation in many industries. This leaves business owners in those industries with a choice: to either be a consolidator or be purchased by one. Furthermore, consolidation begets consolidation, explains Patrick Winters, vice president of Duff & Phelps LLC, an investment-banking firm based in Chicago. “If your customers are consolidating and getting larger, they are going to be demanding more from their suppliers,” he says. “For example, they may want national as opposed to regional suppliers.” Consequently, even if your own industry is not in a period of consolidation it may soon be driven to it by customer demands.
Given these pressures, it’s not surprising that acquisition activity has been running at fever pitch for the last couple of years. We’ve all heard plenty about such megamergers as the $13 billion Honeywell-Allied Signal deal or Berkshire Hathaway’s $2.14 billion acquisition of MidAmerican Energy, but even small industrial companies have gotten into the acquisition act in a big way.
According to Mergerstat, a division of Houlihan Lokey Howard & Zukin, a Los Angeles-based investment bank, in 1998 there were 866 deals announced that were worth $25 million or less. This is a 275% increase from just five years ago, and these numbers represent only acquisitions that were made public. Countless other small companies have gobbled up competitors without gaining the attention of merger watchers.
With all the buying and selling that is going on, you may wonder if now is a good time to make an acquisition or not. In a good market, wouldn’t values be overly inflated? “It is regarded as a good time to sell,” Winters explains, “but that doesn’t mean it is a bad time to buy. There is a tremendous amount of capital coming into the private-equity markets so it is not a difficult time to get private financing for these ventures. In fact, if you’re looking for an equity partner to help you make an acquisition, it is a pretty healthy market.”
Given that money is available, sellers are eager to cash out, and competition is intense, you may be feeling pressure to start playing the acquisition game. But be forewarned: Popular wisdom has it that only one out of three mergers is successful in achieving strategic objectives. This is because too many executives rush into the process without completing the due diligence required to make these unions work.
Making a sensible and strategic acquisition requires careful forethought and planning just like any other major business decision. Here, then, are 10 things you’ll need to do in order to make acquisitions that add value.
1. Determine the strategic reason for the acquisition. Photon Dynamics Inc., based in San Jose, is a $31 million company that makes flat-panel display equipment for sale to customers in Asia. In 1998 the Asian economic crisis caused the company’s sales to plummet from $8 million to $400,000 in just one quarter. The crisis was a wake-up call, explains CEO Vincent Sollitto. To survive, the company had to geographically diversify its revenue stream and find other markets that could take advantage of Photon’s technology and research-and-development capabilities. The most efficient way to do this, Sollitto explains, was to acquire a company that already had these capabilities. Armed with a clear understanding of its needs, in August Photon acquired CR Technology, a $9 million X-ray and optical inspection equipment company that offers “clear synergies” for both companies.
As Sollitto’s experience indicates, the first step in making a sound, strategic acquisition is to know exactly what kind of company you are looking for and why.
“Don’t buy something for the sake of buying something,” explains Paul L. Schaye, managing director of Chestnut Hill Partners LLC, New York. “Buy something that fits and makes sense.”
Some of the reasons for acquiring companies are to accelerate growth, add product lines, diversify into new markets, expand your geographic presence, acquire capable management, gain new technical capabilities, and garner a larger slice of the existing market.
2. Establish an acquisition team. “Conducting an acquisition involves many steps and phases,” explains Z. Christopher Mercer, CEO of Mercer Capital Management Inc., Memphis. “Targets have to be identified, qualified, and contacted, and you have to present your case to potential sellers.” Because of the time and attention necessary to complete a successful acquisition, experienced buyers suggest forming an acquisition team that includes several representatives of your executive staff as well as consultants who have knowledge about the industry.
“Just as a company needs marketing, technology, and operations people to run effectively, it also needs all those sciences and schools to be involved in evaluating potential purchases,” adds Duff & Phelps’ Winters. “Different professionals are going to raise different concerns and issues.”
3. Differentiate yourself from other buyers. Because small-business owners have strong emotional attachments to their companies, they tend to closely scrutinize potential buyers. And why shouldn’t they? In today’s market, sellers have the luxury of being picky. “Virtually all of my clients are contacted by someone on a fairly routine basis to assess their interest in selling,” Mercer explains.
To differentiate yourself from other buyers, he suggests making your company look as attractive as possible. “An attractive acquirer is profitable and has a good reputation, strong management, a solid strategy, and good operations and technology,” Mercer says. Successful buyers also maintain consistent contact with executives at companies they are interested in purchasing. “Even if an ideal prospect told you ‘no interest’ six months ago,” he adds, “she will one day change her mind. Stay in touch and be there when she does.”
4. Research compatible companies. Once you’ve determined the strategic reason for an acquisition, you can develop a list of criteria for judging potential companies. The list might include such things as financial size, geographic influence, technical capabilities, and management experience. The best way to find companies that fit your criteria is to use your existing personal and professional networks. Talk to customers, call consultants, ask suppliers for references, and make inquiries at trade shows. “When looking for private companies to acquire, a lot of research comes by word of mouth,” explains Winters.
5. Conduct the necessary due diligence. Once you’ve compiled a list of companies that meet your criteria, the real work begins. Finding a company that would be a good fit requires careful investigation, analysis, and assessment. Some of the questions you’ll want to answer are:
What is the culture of the company? Is this a family-owned business where the boss knows everybody by name and policies are developed only on an as-needed basis? Or is this a professionally managed firm where business-minded employees follow strict guidelines and procedures? Is this a union or nonunion shop? How will this impact your company? What do suppliers, customers, and employees think of the company? What is the existing technology base? How broad is the customer base? What are the financing arrangements like? Does this company have significant financial arrangements with banks or is it free of debt? Will the purchase of this company affect your own customer base? By merging with a competitor will it decrease the likelihood of a customer using your company as a sole supplier? “You want to make sure there is no cannibalization of customers when you bring two companies together,” Winters says. Why is the seller selling? Owners of small businesses often care about more than money when selling their companies to others. Discovering those concerns will help you determine whether or not the company would be a good fit with yours.
While much of this information can be gathered by talking to company owners, you’ll want to verify it with customers, suppliers, and, if possible, employees.
“The importance of due diligence cannot be overstated,” says Tom Horgan, former CEO of Maxwell Technologies Inc., San Diego. In the last three years Maxwell has acquired seven companies, growing from 550 employees and $101 million in revenue in 1996 to 1,200 employees and $179 million in revenue today. “The true test of a solid acquisition strategy is the ability to say no, he says. “After establishing your criteria and researching a potential company you should be able to know for sure if a deal will work or not.”
6. Acquire an accurate valuation. Obtaining an accurate valuation of a company is not something you should do yourself. An investment banker, CPA, or appraiser should be retained to help with the valuation process, even if the seller has already determined an asking price. Even though you’ll want to seek assistance in determining the value of a business, you should learn how business values are determined.
According to Mercer there are six factors that are weighed in business valuation decisions. These factors are growth potential; risk/reward characteristics; alternative investments, which involve comparing private companies to publicly traded securities to determine a realistic alternative investment; the present value; expected earnings; and the underlying rationality of the markets as a whole.
7. Prepare your own company for growth. As you move through the acquisition process, you’ll want to be thinking about what the newly combined company will look like, and whether or not your company will have the ability to accommodate the increased capacity. “If you’re a $10 million company and you want to make a $5 million acquisition, you need to be thinking what a $20 million company will require two years from now,” Mercer says. When companies double, virtually every management, financial, and operational system has to change.
8. Have a business plan for integration. The work involved in acquiring another company does not end when the papers have been signed. In fact, the hardest work of all comes when it’s time to integrate the companies. “During the buying process everyone is on their best behavior,” Chestnut Hill Partners’ Schaye says. “But there is a big difference between dating and marriage.”
People who’ve been through the acquisition process a few times say that integration is made much easier when all the details regarding integration have been specified and agreed upon in advance. Questions that should be answered include: Will the selling company be integrated into the parent company’s existing structure, will it operate as a wholly owned subsidiary, or will it run as an autonomous business unit? What will happen to the management talent of the selling company? Will any department or functions be phased out of the existing company? How quickly will this occur? How many people will lose their jobs? Will they be offered assistance in finding new ones? How will salaries and benefits be managed? Who will be responsible for day-to-day business decisions?
While technical and operational details like these can be managed with relative ease, it’s much harder to deal with the cultural integration of two companies. The process can be made much easier, however, if you purchase a company that has similar values and operating styles.
“When we purchase a company, we make it clear that our culture will predominate,” explains Rick Travis, vice president and general manager of ATS’ computer services division. “We don’t focus on integration. We focus on assimilation. By thoroughly assessing companies upfront we make sure that we are buying companies whose cultures are already similar to ours.”
9. Communicate. Even if you have acquired a company with a similar culture and developed a rock-solid plan for integration, employees will be nervous about the merger. The best way to manage the uncertainty is to communicate completely and often. “The second we sign a deal, I make myself available at the seller’s workplace to answer questions,” ATS’ Blaudow says. “My HR and operations people are also there to provide face-to-face communication. Furthermore, we instantly link employees at the company to our intranet and internal e-mail systems.”
It’s also important to maintain extensive communication with customers and suppliers — not just after the sale has been complete, but during the entire acquisition process. “In the past, we did not manage customers expectations well and we learned that customers can drop off quickly if you do not stay in touch with them,” Blaudow says. “The customer might have been very loyal to the selling company, and if they don’t know ATS they might not transfer that loyalty to us.”
10. Don’t be in a hurry. Looking back over the last six years of acquisition activity, Blaudow says the number one lesson he has learned is not to be in a hurry. “When you [are] in a hurry you hear what you want to hear and tend to overlook things,” he says. “I did this during my first acquisition, and I’ve since had to close down the company because it was not a good fit for us. Now we have a very extensive due diligence checklist for all aspects of a business we are considering.”
How long should an acquisition take? “We’ve done acquisitions in weeks, and we’ve done them over a period of several months,” Maxwell’s Horgan explains. “It varies a lot.”
But Horgan and other small-business executives with acquisition experience agree that regardless of how long an acquisition takes, now is a good time to consider one. “Many entrepreneurs have been building value in their businesses and are looking for an exit,” he says. With the right timing and approach, your company can provide that exit opportunity while also adding to your company’s growth potential.