Today's unprecedented market climate presents a daunting mixture—tight credit, negative growth, great uncertainty, and severe stock market volatility. With consumers weighed down by debt and with businesses seeking to cut expenditures, companies are finding it harder to grow organically.
For some companies, growing via acquisition may be an especially attractive option in this market environment. In many industries, the same forces that are restricting organic growth—the credit crunch and the recession—have also separated the strong from the weak. While companies with high cost structures or heavy debt loads are struggling, leaner and better capitalized companies are positioned to take the lead in growing through consolidation.
Since it has become nearly impossible to unlock value via an IPO, acquisition may be attractive to privately-held target companies, as well. The National Venture Capital Association reports that in the United States, 260 venture-backed companies were acquired in 2008—the first time that number has slipped below 300 in five years. Yet IPOs were even scarcer: only six venture-backed companies were brought to the public markets last year, the lowest number since 1977.
In Europe, the market also has been severely affected. The value of buyout deals fell 60% from a high of '‚¬184.9 billion in 2007 to '‚¬73 billion in 2008. According to a recent report by the Centre for Management Buy-out and Private Equity Research, the value of private equity deals in the fourth quarter of 2008 fell to levels not seen since the third quarter of 1995 (£989 million). We can expect a further downward trend for 2008.
At my firm, we are working closely with the management of a number of our portfolio companies on acquisition strategies. We have found that strong businesses can take advantage of lower multiples to eliminate competitors and to increase market share. If your company is considering growth through acquisition, we would offer six essential principles to consider.
#1: Be prepared to pay with cash
Acquistion financing has become a critical challenge, especially with bank debt now much harder to obtain. Publicly traded companies have lost one-third or more of their market capitalization, thereby reducing the value of stock as a currency for acquisition. Still, companies that have strong balance sheets and deep liquidity hold a major advantage: buyers with the cash to close promptly can distinguish themselves from the competition.
Bear in mind that you may not have to fund acquisitions solely from cash already on your balance sheet. If you are a profitable, growing company, you also may be able to tap private equity capital for your acquisition strategy.
#2: Stick with targets you know
This volatile, uncertain period is not the time to buy unfamiliar companies. However, it may be the best time to acquire businesses that you have been following for some time, and that are now available at more attractive valuations. Look for companies that have been affected by market dislocation or financial pressure, but that are otherwise sound. If there are problems, make sure they can be fixed, given the constraints on credit and cash flow in a slow-growth environment. Even at very low prices, some of your targets may be more trouble than they are worth.
#3: Understand counterparty risk
One key element of your due diligence is counterparty risk. Though the company itself may be sound and adequately capitalized, can the same be said of the individuals and businesses on which it depends? Are its customers facing credit constraints that may affect demand? Could problems along the supply chain impact the company's ability to make its sales targets?
#4: Set a clear path to return on investment
Before you close on an acquisition, ask yourself the following questions: How long should it take to recoup my investment and begin reaping positive returns? Is there any way to accelerate that payback? Are there risks that might make that payback period longer than expected? Being disciplined about acquisitions is always a smart strategy—one that is even more crucial during periods of economic uncertainty.
#5: Walk away if the price is too high
Prices for target companies have dropped, at least in theory, since the economic downturn began. Still, some shareholders, especially those in closely held businesses, may not be eager to sell at what they view as fire sale prices. If there is no pressing need for liquidity, they may prefer to wait for better times. As a buyer, you should expect seller resistance and build in time for longer negotiations. If the price is too high given current uncertainties, refuse to pay it.
#6: Take your time and choose carefully
In heated markets, buyers are often pressured to act quickly, rushing through due diligence and putting an offer forward before another acquirer can act. By contrast, the current market environment demands that buyers slow down and proceed cautiously. Make sure the acquisition really fits your strategy, take a hard look at pricing, and, most important, do not allow an acquisition to jeopardize your core business. A poorly chosen acquisition can distract your team and consume your capital at a time when you need most to focus.
By applying these guiding principles, you can focus your acquisition strategy in today's challenging markets. Remember that depressed acquisition multiples create opportunities for stronger companies to consolidate share and eliminate competitors. Although less plentiful than before, capital for financing acquisitions is still available for well-run companies.