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What Acquisition Criteria Are and How To Develop An Acquisition Strategy

Posted by Ryan M. Newburn | Apr 19, 2021 | 0 Comments

Developing acquisition criteria is essential for any business considering acquiring another company to increase shareholder value. Once a company determines that an acquisition is the most cost-effective way to increase its value, the key to developing an effective acquisition strategy is determining the acquisition criteria the company will use to evaluate target companies.

By formulating this acquisition criteria, the acquiring company will be better able to determine which company to acquire to increase that value. There are many steps that go into this process, each of which the company should carefully think through in order to ensure that the acquisition leaves your company more valuable and efficient than before the acquisition.

Why do companies acquire other companies?

Companies will acquire other companies for many reasons. Whether the company seeks economies of scale, to diversify its portfolio, to gain a more significant market share, or reduce overall costs, companies must evaluate the companies to acquire before actually making the acquisition.

Some other reasons why a company might acquire another company include:

  • Entering a Foreign Market – When a company wants to expand operations in another country or another state, buying a company that already has a presence in the foreign market is potentially the easiest way to enter that market. The acquired company will already have the personnel, brand name, customer base, and other intangible assets to help the company start off in the foreign market.
  • Growth Strategy – If a company maximized its physical or logistical processes, it might be beneficial to acquire another company to expand its capabilities. Further, newer companies could bring in a new revenue stream to increase the company's bottom line.
  • Decrease Competition – Companies sometimes acquire other companies to eliminate the competition.
  • Gain New Technology – Some companies seek to purchase other companies if the other company already has new technology implemented to increase efficiencies and eliminate the need to spend time and money to develop the new technology itself.
  • Synergies – By combining two companies either through a merger or acquisition, studies show that the combined company's overall performance efficiency tends to increase while costs across-the-board tend to drop. This positive result comes from the companies leveraging off of each other's strengths.
  • Increase Supply-Chain Pricing Power – If a company buys out one of its suppliers or distributors, known as a vertical merger, the company can save on margins by setting its own prices. This can reduce costs as the company often is able to ship out products at a lower cost.

What are Acquisition Criteria?

While no one set of acquisition criteria will fit perfectly with every company or make every acquisition successful, there are steps that companies can take to ensure that each deal has its own strategic logic. Acquisition criteria or investment criteria is a defined set of parameters or requirements that the acquiring company seeks in the company it hopes to acquire, known as the target company. Companies will often develop criteria to make the process of finding and qualifying new opportunities for target companies more efficient. Acquirers often have the most successful deals when they have specific, well-thought-out value expectations for the target company they acquire.

Having clearly defined requirements allows the company to focus on the qualified target companies and quickly eliminate the potential deals that are not a good fit for either the acquiring company or the target company.

Determining this criterion will allow you to:

  • Reduce the risk of acquiring a company that does not strategically fit with your short-term and long-term goals
  • Proactively seek out target companies rather than waiting for potential opportunities to present themselves to you
  • Align your company's management and shareholders on future potential acquisition opportunities

Given these benefits, it is always essential to develop strategic plans for what the company will ideally look like in three years, five years, and ten years.

How Does A Company Develop Acquisition Criteria?

After deciding that your company will acquire another company, the first step is to then develop the actual criteria and requirements you will use to evaluate which target company. While it is unlikely that a target company will meet every requirement on your list, it is crucial to rank the criteria to have an idea of what the most critical objectives are and can navigate through the processes more efficiently.

To do this, the company must ask itself the right questions to develop criteria. These questions should usually fall under general, operating, and financial categories.

For general criteria, the company should ask itself:

  • Does the acquiring company want to maintain management positions?
  • How important is the geographic location of the target company? Does the company want to target a specific area?
  • If the acquiring company is willing to accept less than 100% ownership of the target company, how much is the acquiring company willing to accept?
  • How will the companies determine if the corporate cultures are compatible?

For operating criteria, the company should ask itself:

  • Is there a specific product or industry the acquiring company wants to target?
  • How important is market share?
  • What distribution channels does the ideal target company have?
  • What type of advanced technology does the ideal target company have?

For financial criteria, the company should ask itself:

  • What are the expected revenue and growth rates?
  • What is the ideal debt-equity ratio? What is the acceptable debt-equity ratio?
  • What multiple is the acquiring company looking to pay? Will that multiple be based on EBITDA, revenue, etc.?
  • How will the acquiring company finance the acquisition?
  • Would the acquiring company be willing to pay an earn-out?
  • Does the acquiring company expect the acquisition to be accretive immediately?

What are some examples of acquisition criteria?

Once you've answered the questions listed above, you should create a list of criteria (generally, try to keep this criterion limited and be realistic). Again, most target companies will not meet all of the requirements, which is why a ranking system will be essential to analyzing which target company to acquire.

A significant requirement will be the availability of target companies. This criterion may not be entirely possible to measure precisely; however, completing an analysis as to whether the company would be interested in being acquired is crucial.

Some other vital criteria should include:

  • Size – is the business large enough to justify the price of the acquisition? How large do you want the company to be that you acquire?
  • Profitability – is the business profitable, and how much will it either enhance or dilute profit margins?
  • Geography/Region – if you are hoping to expand into a foreign market, how big is the target company's presence in the foreign market?
  • Type of activities/product offerings – is the target company a competitor or adjacent to your company? Will acquiring the company enhance or detract from your current business model/services/product?
  • Customer Segmentation – will acquiring this company allow your company to target new customers? Will it allow your company to strengthen its current position with existing customers? Which is more important?
  • Synergies – will the company cultures coexist well together? How important is maintaining your current company culture and the target company's company culture?
  • Assets – what assets does the target company already have? Are they what your company is missing?
  • Potential Value Creation – likely the most crucial criteria is examining what the potential is for value creation. This can come in improving the current company and/or providing immediate cost savings to the buyer.

The list of acquisition criteria will come down to answering the questions of why you seek to acquire the target company, what the target company can bring to your company, and what is the most cost-effective, risk-mitigating way to achieve those goals.

Rules to Abide By When Seeking An Acquisition

Bruce Nolop, executive vice president and chief financial officer of Pitney Bowes, wrote an article in the Harvard Business Review that explains the most essential rules to abide by when buying other companies. He explains that the company has been able to formulate these principles after completing more than 70 acquisitions and increasing the company's revenue by more than 25%.

Stick to Adjacent Spaces

The first principle is to "Stick to Adjacent Spaces." Pursue acquisitions in fields that are logical extensions of the company's current business. If the long-term goal of the company is to expand product lines, this can be completed incrementally. However, to begin, start with a core acquisition and then dive into an aggressive expansion deeper into the product category. This idea of adjacent acquisitions directly correlates with increasing shareholder value, whereas diversification in non-related areas may actually reduce shareholder value.

Manage Acquisitions Like Investments

The second principle rests on the idea to manage acquisitions as though you are managing portfolio investments. This applies more to larger companies that have the capabilities to acquire multiple small companies. However, the idea is that a safer approach is to acquire various smaller acquisitions rather than one or two significant acquisitions. This portfolio approach allows the company to more efficiently manage the target companies and also be able to hedge the risk of one of the acquisitions not being as valuable as expected. This approach allows the acquiring company to produce more predictable financial results over a certain period of time.

Know Your Company's Goals and Needs

Another critical principle Nolop discusses is that the acquiring company must be clear on what the criteria are and how it will judge the target companies. Again, what exactly are the goals for the acquiring company in terms of growth potential, management, and financial objectives? Is the company looking for a target company that fits neatly into the business or the market you are already in? Or would the target company build on and take the company to a new (though adjacent) business activity or area? Make this distinction early on so that you know what to look for in the target company.

Completing Due Diligence

Once you've found the best target company for your company's goals and needs, you must perform thorough due diligence to identify and eliminate the potential risks of acquiring the target company before completing the transaction. The key is not to use standardized checklists that you can find online. Instead, you can use one as a starting point but hone in on the most important details for your company in particular.

Some of the key elements of any due diligence search will include evaluating the target companies':

  • Financial data and information
  • Corporate data
  • Products
  • R&D
  • Manufacturing
  • IT Infrastructure
  • Distribution Processes
  • Marketing Expenditures
  • Customers
    • Key Customer Relationships
      • Percentage of Sales
      • Product Areas
      • Geographical Areas
      • Contract Terms
      • Customer Pricing
    • Competition
      • By product area
      • By geographical area
      • Estimated present and future market shares
      • Advantages/disadvantages by the main competitor
    • Markets
      • Key success factors in the industry
      • Barriers to Entry
      • Regulatory Conditions
    • Strategy
    • Legal Information
    • IP Rights
    • Any Environmental Factors
    • Acquisition/Disposition
    • Tax Matters
    • Governmental Regulations
    • Required Filings

These are just a handful of the categories that acquiring companies should analyze for target companies. An experienced law firm can help complete this due diligence and help start the process in general.

Contact An Experienced Law Firm

An experienced law firm will be able to assist you with each of the steps required to acquire a company successfully. These steps include:

  • Helping you establish an acquisition strategy;
  • Determining the most crucial acquisition criteria;
  • Narrowing down the target company opportunities;
  • Completing the necessary due diligence; and
  • Finalizing the transaction by drafting and filing paperwork to legally binding the transaction, negotiating the terms, conditions, and payment.

M&A lawyers will guide you throughout the entire process while also handling all of the paperwork and negotiations when your company is acquiring another company.

A knowledgeable law firm will help your company increase its value through a multi-tiered acquisition strategy. Once the transaction process is complete, the terms should be clear, transforming your company and the target company into one company.

Contact us now to learn how we can help you throughout your acquisition process.

About the Author

Ryan M. Newburn

Ryan Newburn is a business and legal expert trusted by Executive Teams and Boards of Directors to apply sound business principals to solve legal and financial problems. Ryan's practice focuses on mergers and acquisitions, financings, corporate formations and corporate governance in a broad range of industries including energy, distribution services, healthcare, medical devices, and technology. Leveraging his formal business training and years of practical experience, including as an executive at public and private companies, Ryan has advised hundreds of companies in dozens of industries of unique legal and financial issues.

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