How to find and vet the right M&A target

It’s a new year and your executive team is focused on growth. Not just organic growth, but inorganic expansion — through an acquisition. You may be a seasoned buyer or new to the deal-making game. Either way, where do you begin? How do you find the right target?

“You may have to find a company that is not for sale — that is really overlooked a lot of times,” noted Chris Smith, national managing principal for Growth and Transformation at Grant Thornton LLP in Bellevue, Washington. “A lot of times we think we should only be looking for companies that are for sale, and that may not be the company that you need.”

That’s one blunder to avoid. But buyers make other mistakes when seeking potential acquisition targets: They don’t have clear ideas about why they want to buy and what they hope to gain; they downplay things like culture, seller motivation, company reputation, or management structure; or they don’t ask the right questions during the initial due-diligence phase.

“Sometimes they don’t go deep enough and ask enough questions, and are too reactive,” said James Metzger, founder of Metzger Business Search, an M&A consultancy and business brokerage in London. “You have to be thorough.”

According to Grant Thornton's 2019 Deal Value Curve M&A Survey Report, which polled more than 100 mergers-and-acquisitions professionals, 81% of respondents stated they “have a clear stage-gate process for vetting, approving and pursuing transactions”. That’s admirable, but the trouble is that only 59% said they are “disciplined in adhering to this stage-gate process”. And what's more, 57% of their deals delivered less than 75% of their expectations, according to Grant Thornton. This is cause for concern and an indication that buyers perhaps aren’t snagging the right targets to help them grow. And it’s particularly concerning for finance leaders, who not only help find potential targets, but must analyse them as well for synergies and risks.

So how do you find good targets for your company and then properly assess whether they are a fit? Smith, Metzger, and others offer the following guidance:

Know your company. Before you embark on strategic M&A, define your growth strategy. Where do you want to grow? How do you want to get there? What is the direction of your company? How quickly do you want to scale up? “Be clear on the rationale for the acquisition in the first place,” Metzger advised.

Establish a wish list. Also, before searching for targets and interviewing candidates, create a catalogue of criteria: geography, how much you can afford, and what you expect in terms of financial performance. “Be clear on the target size, revenue, profitability, headcount,” Metzger said.

By doing this early, you “in theory strip out the emotion of the decision”, Smith noted. “The more you can be prepared by having your criteria locked upfront, the easier these acquisitions can flow through. It’s like a filtering system.”

Don’t go it alone. You may think you can fly solo by finding and assessing targets, but it’s best to seek expert help during the list-generation phase. “If you try to do it yourself, quite often the seller will clam up and will not part with information because they see you as a competitor,” Metzger said. “You need a third party to get the best results.”

Choose help wisely. The advisers you hire will ultimately dictate potential acquisition candidates, so be diligent when seeking out investment bankers, business brokers, M&A advisers, or even law firms. Some advisory firms have specific industry expertise. Others focus on distressed companies. “Understand that the investment bank or company that you are using to do list generation and sourcing is an important step,” Smith advised. “Choosing the right partner is already starting to set the table for the quality or types of candidates you are willing to begin talking with.”

Understand seller motivation. Leaders sell businesses for numerous reasons: They want to retire, know the time is right, or in some cases, see their company is in peril. Whatever their reasons, find out early, as this will also impact things like management structure, employee retention, and customer satisfaction. In addition, noted Rolf Popp, founder of Rolf Popp Pro Consult GmbH, an M&A consulting firm and business brokerage in Wϋrzburg, Germany, “Motivation is an indicator of how flexible a buyer will be in the negotiation price.”

Calculate culture. Deals aren’t just about numbers, so before you sign a nondisclosure agreement and proceed with due diligence, determine whether the target fits culturally. “Culture is, of course, important because you are buying the employees with special know-how and experience, and if you lose them because you do not understand the culture, you are probably losing a lot of the value of the company you bought,” Popp said.

So, talk to the target’s leadership, and conduct research on Glassdoor, Fishbowl, and other social media platforms to see what employees say about their employers. “Cultural alignment is by far the most overlooked, and cultural alignment includes leadership and philosophy,” Smith added. Ask yourself, “Can these two ecosystems exist?”

“If you are actually in a different geography, you might have to accept a different culture,” noted Peter Lloyd, an M&A specialist at Metzger Business Search.

Cut your list. Once you establish your criteria — around geography, culture, financials — and do initial screening as to why the target is willing to sell, “Say, ‘OK, how do we take that list from 15 down to five,’” advised Smith. From there, enter the next layer of diligence, where you ask higher-level questions about the target’s growth rate and margins, and its employees and leaders.

Go with your gut. While this may seem simplistic, it’s crucial that you are energised about the business you are going to buy, said Popp. Can you envision yourself as a leader of this newly merged entity? Do you get the stomach flip? “There must be real enthusiasm about a company and what they do,” he noted. “If not, then it won’t be the right target.”

Broaden your horizons. Don’t simply look for businesses ripe for selling. Some brokers, like Metzger’s firm, “generally find businesses that do not seem to be on the market”, he said. Once you’ve listed your criteria for growth and what type of company you want to buy, just know that your desired target is out there, somewhere.

“Don’t wait for something to be for sale,” Smith advised. “Everything is for sale.”

— Cheryl Meyer is a freelance writer based in the US. To comment on this article or to suggest an idea for another article, contact Drew Adamek, an FM magazine senior editor, at Andrew.Adamek@aicpa-cima.com.