The evidence seems overwhelming: M&A approaches to growth outperform organic-growth strategies by a significant margin.
Research by McKinsey in 2021 found that two out of three companies practicing programmatic M&A outperform their peers. And in 2023 research, the management consultancy found that programmatic dealmakers completing more deals outperformed those making less deals.
However, programmatic M&A, by its very nature, should not involve a “spray-and-pray” approach. It should be guided by your strategic goals, whether this is achieving greater market share, diversifying, entering new geographies, accessing new technologies, or even completely reinventing your business model.
Unfortunately for SMEs, identifying acquisition targets that align with their strategic goals is arguably a steeper climb than for large investment banks. SMEs lack access to transparent financial data on potential targets, and they will (most likely) not have the same sophisticated AI-powered predictive analytics tools.
Here is our four-step guide to improve your chances of identifying prime acquisition targets.
1. Define your acquisition strategy – standalone, tuck-in, absorption or transformational.
The first step for identifying the right acquisition targets is to define your strategy – are you looking to achieve a standalone, tuck-in, absorption or transformational deal?
Absorption deals involve acquiring businesses that complement their existing operations, generally in the same industry or with similar products or services. The acquisition might focus on a target company with the capabilities to bring key outsourced activities under the company’s own roof. It may also involve acquiring a similar company in a new region to expand the company’s geographic reach.
By contrast, transformational deals involve acquiring new markets, channels, products, or processes in a way that fundamentally changes the resulting entity.
“Businesses need to disrupt themselves or be disrupted”.
Transformational deals are becoming increasingly important in a fast-moving world, as businesses need to disrupt themselves or be disrupted. This may mean leaving challenged sectors and speeding up digital transformation. They need not be big or expensive; their defining characteristic is that they reinvent a company’s operations.
For F&B companies, this may mean expanding into fast-growing categories such as health-and-wellness and GLP-1-optimised products. For digital marketing companies, this may mean acquiring companies with high-growth specialisations such as influencer marketing or e-commerce. For a manufacturing company, this may mean buying a company with strong R&D capabilities or automation solutions.
One memorable example was Amazon’s transformational purchase of Kiva Systems in 2012 which changed their fulfillment process by bringing robotics to their warehouses. The trend continues to the present day, as headlines surface in recent months of humanoid robots being used across the company’s sprawling operations.
2. Define your target screening criteria in line with your deal thesis.
Searching for a business without first defining your screening criteria is akin to throwing the metaphorical spaghetti at the wall. Key criteria should cover ownership structure, revenue, profitability, IP portfolio, product portfolio, industries served and customer profiles.
Start by determining an affordable price range that aligns with your budget. Consider your preferences for the size of potential acquisition targets, which may be measured in terms of market share, revenues, or net asset values.
In a similar vein, you may also wish to think about your preferred transaction structure, such as acquiring shares versus assets, earnouts/deferred consideration, LBOs, etc.
“Searching for a business without first defining your screening criteria is akin to throwing the metaphorical spaghetti at the wall”.
You should also establish your expected profitability requirements, including EBITDA, net margin, and free cash flow expectations. For SaaS companies, relevant metrics might also include annual recurring revenue (ARR) or monthly recurring revenue (MRR).
Beyond financials, you should assess your expectations from the workforce, considering leadership skills, cultural fit and employee churn. Define marketing criteria: customer base, brand leverage and uniqueness, geographic reach, and distribution channels.
For relevant industries, specify R&D requirements like patents and product pipelines. Establish production criteria, including facilities, workforce, manufacturing methods, and capacity.
3. Use online portals and trusted intermediaries like Hilton Smythe.
Buyers can use a range of online portals to source mid-market opportunities, including:
- BusinessesForSale.com
- MergerVault on BusinessesForSale.com – designed to connect high value buyers with the lower end of the middle market
- Daltons
- Rightbiz
- Smergers
- Foundy
Sellers often hesitate to disclose financials and operations to strategic buyers due to fierce historical competition and fear of compromising their position if a deal falls through. For this reason, buyers must recognise sellers’ need for strict confidentiality assurances.
Using NDAs and neutral intermediaries like Hilton Smythe can better enable information sharing, even with reluctant sellers. Those buyers who show empathy and follow a structured approach to initiate dialogue are more likely to access crucial information.
4. Critically assess your target, both for its standalone asset quality and its joint value-creation potential.
The importance of thorough due diligence cannot be understated: according to Bain’s 2020 Global Corporate M&A Report, almost 60% of executives attribute deal failure to poor due diligence that did not identify critical issues.
There are two aspects to the M&A due diligence process. Firstly, you need understand the target’s standalone asset quality; and secondly, you need to understand the combined value-creation potential.
You may wish to evaluate prospects through traditional corporate finance models (NPV, IRR) and strategic frameworks (SWOT, Porter’s Five Forces). However, cold computations alone are unlikely to say much about long-term strategic alignment with your company goals.
Key questions to ask on both sides include:
A seller’s motivations can also often reveal crucial insights about future risks for buyers. If driven by industry disruption, these motives can foreshadow challenges for today’s consolidators. Conduct objective assessments using in-house resources or external advisors, and ensure evaluations are reviewed by experienced professionals with transaction expertise.