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Understanding Acquisition Targets

Key to any successful acquisition is selecting the right target before initiating the process; but what makes a good acquisition target? Here’s what you need to know.

Bringing another business entity into the fold remains complex and time-consuming, whether it’s your first, second, or even third acquisition. With £144.9 billion in deal value in 2022, the UK market may have cooled, but prime acquisition opportunities remain.

Key to any successful acquisition is selecting the right target before initiating the process; but what makes a good acquisition target, and what’s the best way to identify a target? If you’re ready to expand your firm, here’s what you need to know.

What does target mean in acquisition?

Targets in an acquisition are nothing more than a company you wish to acquire. As a buyer, you’re looking to craft a shortlist of potential candidates that align with your vision and goals.

This is something that will be unique to every company. You may select a target based on your desire to expand your market share or acquire a new ground-breaking technology from a hot startup.

During the targeting process, you’ll craft a shortlist of candidates before eventually ranking suitable choices based on their pros and cons.

What is a good acquisition target?

It’s well-known that up to 90% of acquisitions fail for whatever reason, but this isn’t something confined to UK SMEs. According to McKinsey & Company, as many as 10% of large-scale acquisitions fail annually.

Of course, not every problem can be foreseen.

For example, NVIDIA’s attempted takeover of UK semiconductor company Arm Holdings faced huge regulatory hurdles and government attention due to concerns about the UK’s technology sovereignty. In February 2022, the $40 billion takeover collapsed due to an inability to overcome these hurdles.

It demonstrates that even identifying a great target doesn’t guarantee a successful acquisition, but will dramatically increase your chances.

In other words, a good acquisition target is a combination of one that aligns with your goals and has a high likelihood of success.

How do you identify targets in an acquisition?

Identifying targets is often the second longest part of the process after due diligence. Spending time on targeting sets the tone for a successful acquisition from day one. This includes analysing not just companies but the industry landscape.

For example, private-equity group Terra Firma acquired the UK music company EMI in 2007 for £4.2 billion. Unfortunately, due to the rise of digital music distribution, the acquisition saw Terra Firma report a £757 million loss by 2008.

Could this have been avoided?

Potentially so if both Terra Firma and EMI had anticipated the radical changes sweeping the music industry at the time. This demonstrates the need to conduct your research and avoid rushing into acquisitions based on reputation and assumption alone.

So, how should you begin selecting your targets?

Step one – Set your criteria

The first step is to know what you are looking for. This is the fundamental first stage because it defines which type of acquisition you want. Consider what will enhance your business by asking questions like:

  • Are we looking to expand into a new market?
  • Do we want to offer our customers something new?
  • Are we seeking to access a specific customer demographic?
  • Is there a bright new technology we want to take advantage of?
  • What type of acquisition are we looking for? (horizontal, vertical, conglomerate, etc.)

Generally, entrepreneurs should be looking to achieve a balance between broad and specific. Go too wide and risk not finding the right partner, but go too specific, and you might not find a single suitable candidate.

Step two – Set a budget

Hard bargaining is to be expected during an acquisition, but avoid overpaying or it could dilute the value of your deal.

One such example is the notorious £112 billion acquisition of Mannesmann, a German telecommunications company, by its UK counterpart Vodafone. Whilst it made Vodafone one of the largest telecommunications companies in the world, the acquisition faced countless challenges and led to massive write-downs and adjustments of the acquired assets.

The lesson? Set a firm budget, decide on your wiggle room and stick to it when evaluating the cost of a potential acquisition.

Don’t forget post-acquisition integration costs. According to a study, 78% of successful M&A companies spent 6% of the deal value on integration.

Step three – Dig into potential targets

With your battlelines drawn, it’s time to dig into potential targets directly. Your strategy will vary based on whether you’re looking at companies for sale or approaching a company directly.

Let’s discuss both.

The direct approach

Companies might not be on the market, but everything is for sale in the business world. This is why a good acquisition search includes a target list to approach. Typically, the best way to search for ideal candidates includes the following:

  • Companies House Direct
  • Trade bodies
  • Web searches
  • Company websites

You can even attend trade shows or consult your professional network for tip-offs on which companies could be exciting prospects.

Companies for sale

Believe it or not, finding companies that are available for sale is more complicated. Unlike buying a house, most business owners choose to conduct sales privately and with complete confidentiality.

Some entrepreneurs actively put out press announcements indicating they are seeking to conduct an acquisition. Local newspapers and classified websites are popular avenues for business owners going down this route.

Moreover, you may want to consult a corporate advisor for extra intelligence to support your search. It can take time, but looking for companies for sale will likely lead to the right acquisition as firms approach you.

How do you analyse an acquisition target?

Analysing your acquisition target tells you what you need to know about a company’s suitability. Although you might not have access to exact figures at this stage, basic research into a company’s condition can tell you enough to know whether a target has promise.

Let’s examine some of the crucial factors in analysing an acquisition target.

1. Alignment

Firstly, any target must align with your goals, whatever they are. Only you can explain the purpose of a potential acquisition. Some of the most popular reasons include:

  • Increase your market share.
  • Remove a competitor from the landscape.
  • Expand your range of products/services.
  • Acquire intellectual property.
  • Access talented employees.

If your choice doesn’t align with your goals, return to the drawing board and think again.

2. Growth

Target companies will always have higher growth than non-target companies. Sometimes, you may consider a target because of its growth potential.

For example, Meta acquired Instagram in 2012 for $1 billion. Today, its brand value alone is valued at $33 billion, with many figures putting the total value of Instagram at $100 billion.

It shows that buying on potential can be highly profitable.

3. Profitability

As with growth, profitability is a big deal. When purchasing an established company, you want to know about its profitability and the potential for profitability.

Obviously, this factor may be based on guesswork if you’re buying a new startup; but, buying companies with a history of profitability can vastly increase your chances of success.

4. Leverage

Leveraged businesses have more significant amounts of debt, which can provide a prime opportunity for acquirers.

Heavily leveraged companies often require cash injections and may actively seek out people to acquire them to allow their firms to keep going.

5. Liquidity

Lower liquidity, or cash flow, could also present golden opportunities for companies seeking to make new acquisitions. For the same reason as heavily leveraged companies being attractive, low liquidity could also indicate financial issues.

Whilst low liquidity and high leverage may appear like a company on the decline, if you can see the potential within its business structure, it could open an acquisition opportunity.

6. Valuation

The valuation of a company is a vital part of the due diligence process because it’s a notoriously tricky job. Unfortunately, in the age of unicorn companies, this has only grown more difficult.

Finding a company with a promising future that isn’t overvalued can allow you to access an opportunity the competition has overlooked.

Since valuations are not an exact science, this is where bringing in an independent business valuation professional can pay off.

Above all, identifying and analysing targets should start and end with the support of a professional team built around you. At Hilton Smythe, we support entrepreneurs in defining their acquisition strategies and negotiating the ins and outs of the acquisition process.

If you want to expand your operations with an acquisition, speak to our team today.

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