Overall merger and acquisition activity is subdued these days -- down from more than 11,000 transactions in the U.S. three years ago to two-thirds of that for all of last year. Halfway through 2003, the dealmaking pace remains sluggish, despite recent upticks in activity.
Yet there are abundant opportunities to grow by acquisition, and many industry sectors are ripe for consolidation. There is also plenty of capital sitting on the sidelines -- north of $100 billion, by some estimates -- and no shortage of dealmakers ready to match-make. Although valuation multiples have fallen, bringing plenty of "business for sale" signs down with them, determined company builders still have both eyes open for the chance to buy out a competitor or acquire a business whose product portfolio or regional reach can create significant market leverage. They're well aware that if they don't make such moves quickly, rivals could come in with winning bids.
Businesses often don't have the finances on hand to buy when they need to, and they'll turn to the capital markets to meet those needs. But growing successfully by acquisition involves much more than purchasing power. It involves the right kind of approach to the complexities of dealmaking -- an approach that comes mostly with experience.
Many an executive has learned the hard way that when the merging of two businesses doesn't go smoothly, talent soon quits and projects drag out. Several solid studies report that as many as 75% of all acquisitions actually destroy shareholder value instead of achieving cost and/or revenue benefits. But studies by consultancy Bain & Co. show that the patterns followed by leaders of successful mergers look much different: they "follow the money" by targeting the integration opportunities that will generate the most new value; they stress fast implementation over perfection; and they focus most of their resources on keeping the base business running smoothly -- particularly early in the transition.
Entrepreneurs approaching an acquisition for the first time stand a far better chance of modeling those successful moves if the funding partner they select can prove solid experience with merger and acquisition activity and provide comprehensive counsel on themes ranging from acquisition-pricing strategies to post-merger integration disciplines. Overall, the partner will bring "hands-off" strategic guidance and a robust network of contacts in business and in the financial community; ideally, the firm will have strong expertise in the growth company's industry. One firm that successfully drew on both funding and guidance is American Dental Partners, Inc., one of the largest U.S. providers of dental practice management services, with 400 doctors located in 17 states.
As group practices became the sector's preferred business model, founder Greg Serrao saw an opportunity to bring financial and management discipline to the fragmented dental-care business. His idea was to use an affiliation model, acquiring selected assets from each practice in exchange for taking on all administrative and business aspects. The approach allowed the affiliates to focus solely on care delivery.
Serrao knew he could not get acquisition deals under way at the pace he wanted without external funding. So he began looking for a primary partner that shared his company's values. Serrao and his team went where pools of available capital were deep: to private equity markets. (In the second half of 2002, the private equity sector accounted for more deals than any other group -- roughly 11% of total M&A activity, according to MergerStat Inc.)
At least as important was the partner's non-monetary role. Serrao actively sought support in structuring and valuing deals, building a management team, and refining his company's strategic direction. The "sounding board" role was also important: Serrao was eager to work with a firm that would listen to his ideas, ask plenty of "why" and "how" questions, and respond with suggestions that would help him consider the long-term implications of his intentions.
The firm he chose -- Summit Partners - - brought expertise and a broad business network as well as access to capital. Summit took a seat on American Dental Partnersâ board, investing $14 million in the company in January 1996 and helping arrange $75 million in bank financing. The company used the funds to finance start-up infrastructure -- phone service, salaries, rent, etc. -- and to acquire assets in 50 large group dental practices. (Revenues grew from $53 million a year in 1997 to $147 million in 2002.) And it used Summit's contacts at once: for instance, when Serrao had specified the attributes of the managers he wanted to hire, Summit combed its business network to identify strong candidates.
Serrao clearly understood the concepts of critical mass and market leverage that underlie much merger and acquisition activity. Industry research bears out the "bigger is better" calculus: the latest private company deal multiples from NVST.com/DoneDeals show that transactions valued between $10 million to $50 million command price/EBITDA ratios of 9.7 compared to 5.5 for transactions of less than $10 million.
Like most entrepreneurs, the American Dental Partners founder would not have welcomed pressure to acquire just for the sake of growth. "You want to make sure you bring in a partner who's not going to micromanage," he says. Company builders who sense that a potential equity partner may push too hard for acquisitions just to spur growth will be smart to delete that firm from the shortlist. The critical point is this: the entrepreneur runs the acquisition show, and must be comfortable with all likely deals.
Regardless of who identifies acquisition targets, it's incumbent upon a business's founders to take ownership of every potential deal. That is likely to mean spending significant time at a target company's facilities to develop a real understanding of the terms of the deal.
Every acquisition is a risk, of course. The trick is to manage the risk, and a proven way for entrepreneurs to do so is to ally with an equity partner that brings extensive deal-making experience and contacts as well as access to capital. Even well-financed acquisition deals face long odds if they proceed with inadequate guidance. And a deal that turns bad can be much worse than no deal at all.
The following 10 questions will help you get the most out of your private equity partners as you consider strategic acquisitions:
- How can I be sure I won't be urged to buy something I don't want to buy just for the sake of growth?
- Describe how you've helped your portfolio companies to complete successful acquisitions, and say what you'd do differently with those deals today.
- How well are those businesses doing now?
- How do you provide cash for acquisitions?
- How do you get additional partners to provide financing if we need larger amounts of acquisition capital?
- What's your philosophy on using cash versus equity to buy?
- Tell me how quickly we can respond to acquisition opportunities.
- What will you do to help me evaluate potential acquisition targets?
- How can you help the transaction go smoothly?
- What will you do to help facilitate the post-merger integration?
Martin J. Mannion is a managing partner of Summit Partners, a global private equity and venture capital firm that invests in growing, profitable, privately held companies with proven business models, records of revenue and earnings growth, and the leadership capable of sustaining that growth. He can be contacted at: 617-824-1010, or firstname.lastname@example.org.
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