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Friday, May 27, 2022

Entrepreneur’s Notebook—Prepare a Checklist Before Setting Out to Buy a Firm

You’ve made the decision: You want to buy a business. But before you go any further, it is essential to describe what you’re looking for carefully enough that your search efforts are well directed, but not so narrowly that you overlook qualified targets.

Defining both the ideal and the essential characteristics gives those making the acquisition decision (the stockholders, professional advisors, board of directors, etc.) a common blueprint for finding and evaluating acquisition candidates.

The first step in developing acquisition criteria is examining your strengths and weaknesses. While this step may seem obvious, many buyers fail to examine themselves adequately and, consequently, develop flawed acquisition criteria.

Next, review your strategic plan. Where do you see your company in three years? In five years? In 10? What will it take to get there?

If you don’t have a strategic plan, prepare one. Some business owners are hesitant to articulate a strategic plan because they feel too constrained by it. However, it is important to remember that a good strategic plan evolves as the company, industry and overall economic climate changes.

Thirdly, after you have a realistic and complete picture of your business and a vision of its future, list the qualities that you’re seeking from the acquisition candidate.

Reaffirm goals

Developing a checklist can reaffirm your goals or bring part of your strategic plan more clearly into focus. You may also discover something about your business or your goals that you may not otherwise have known.

No candidate will have every quality, but it is important for your checklist to be as comprehensive as possible. Some of the items, such as the range of acceptable purchase prices, will be essential. Others, like the acquisition of capital assets, may be attractive but not essential in this acquisition.

Many, but not all, of these qualities will be specific to the industry. While each acquisition is characterized by a particular set of needs, we have prepared some guidelines to help develop your acquisition plan.

-Level of sales and profit margin. Do you want a business with smaller volume and a high margin? Would you consider a company with a higher sales volume than yours?

-Financial strength. Does the company have assets that are undervalued? Are there inventories that can be used as collateral for financing? How much pre-acquisition leverage can you accept?

-Geographic location. Where do you want to buy? Is that the only acceptable location? Will any efficiencies of scale you plan to achieve materialize only if the target is within a certain area?

-Purchase price, financing and terms. How much can you pay? Do you need seller financing? Are you looking for an earnout? What financing resources will you use? How much value will the acquisition create in the eyes of the lender?

-Management strengths and weaknesses. Can your current management assume responsibility for the target’s operation? Will you need to retain the existing management after the acquisition? Are there specific management strengths you need to complement your business?

-Market and market strategy. Is the acquisition designed to increase your market share? Is there a particular segment of the market you want to capture? Do you want to diversify your market strategies or expand your market research capabilities?

-Number and strength of competitors. If the acquisition is planned for diversification, who are the target’s competitors? Are they new to the market? Are they gaining or losing market share?

-History and reputation. Is the acquisition candidate a family business? Will it be difficult to persuade the owner(s) to sell or the key employees to remain? Are you looking for a business with a strong reputation? Do you need name recognition?

-Property, plant and equipment. Do you have facilities that are idle? If so, are you planning to acquire clients and liquidate the property, plant and/or equipment to finance the acquisition? Has the equipment been well maintained? Is it paid for?

-Operational efficiency. Are you looking for ways to increase efficiency in an area like order fulfillment? Do you have a highly efficient operation that could be exported to the target?

-Liability issues. How will the acquisition affect your product liability insurance? Are there proposed changes in safety or environmental regulations that affect your industry? Will the target have difficulty complying? Can the target help you comply with new regulations?

-Trademarks, patents or proprietary technology. Do you want to acquire trademarks or patents to increase the price you can charge for your products, or to increase your market share? Do you have proprietary technology that would streamline the target’s operations or provide a low-cost improvement in the quality of its products?

-Research and development. Do you want to spread the cost of your R & D; investment over a broader product or earnings base? Are you looking for new developments?

The successful acquisition begins with a concrete description of its purpose and a flexible yardstick with which to judge potential candidates. However, the above questions are only the first chapter in the acquisition story. Once the criteria have been established, candidates must be identified and then the due diligence process must be organized.

Thomas J. Cuccia, CFA, ASA, is vice president of FMV Opinions Inc., a national business valuation firm. He can be reached at tcuccia@oc.fmv-opinions.com.

Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.

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