M&A Strategy – what should you be asking? Dr Christoph Thierolf, Head of M&A
There comes a time for almost every business when you’ve done as much as you can at the size you are. You’ve saturated your current markets and growth is slowing. You realise that if you are going to grow further then you need to take a major strategic leap, whether that’s a merger, an acquisition or private equity financing.
With at least half of M&A transactions estimated to fail to yield their anticipated results, this can be a daunting step. So what are the questions you need to be asking to make sure your next move is the right one and managed on your terms? Below are some of the most important issues for European small and medium-sized enterprises (SMEs) to consider on the path to M&A activity.
1. What’s our medium to long-term strategy?
First off, assuming that future growth is seen as desirable, what does management agree to be the most effective means to achieve it? Will growth be best achieved by expanding the same offering into new markets and territories, or by expanding the offering itself into new products and services?
Simply expanding what you already do into new territories is, generally, the easier proposition (unless your business is in a sector such as healthcare service provision, which is hard to expand beyond its own highly regulated market). The question then is whether you can build your market presence on your own or need a strategic partner in other markets to provide your distribution platform.
Expanding your product offering is a bigger challenge. Many European SMEs – for example in the engineering sectors – have developed a prominent regional or even global market position by being specialists in a niche market. They therefore need to consider how they can now find a partner or franchise to broaden their product or technology portfolio without diluting their core expertise.
2. Which new markets should we be considering?
Global expansion is easier than it’s ever been in terms of supportive cross-border legislation and interested overseas investors. But when you have the whole world to consider, identifying which markets to target still requires substantial analysis.
Developed markets where demand is already strong are often also saturated markets where your long-term growth opportunities may not merit substantial investment. On the other hand, less developed markets can offer strong growth potential but you may have greater political, market and economic risks to contend with.
Before entering any new market, it’s crucial to take the time to assess the specifics of the country or region in terms of its regulation but also production, cultural and environmental aspects.
Bear in mind it’s very difficult to understand the structure of a market from outside. We ideally recommend that a firm free up resources to spend some time physically in a target market. If that’s not possible – as is often the case with small firms – make connections with similar businesses operating there and learn from their experience.
3. Which markets will support our value chain?
While a partnership in an emerging region such as Latin America, for example, can provide a vast new customer base – the issue is whether it can also deliver all the quality you expect. In many cases, broadening into new territories can be an opportunity to secure resources and manufacturing on even more competitive terms. But you need to be sure that any move is genuinely enhancing your value chain, not compromising it.
4. How can we ‘test out’ the waters?
Particularly for family-owned businesses, considering merger or acquisition can seem a huge step and one that firms will frequently defer. We often advise clients to start a very open discussion with a potential partner, invite them to their home market or travel to theirs. Once you’ve understood the business you can think about the potential structure of any partnership.
The key is to test out a very modest agenda initially – say, for a specific product or a small new customer market. Once that appears to be working well, the next step might be to form a joint venture, then ultimately progress to a structural consolidation.
A challenge is retaining the control over the areas you want in terms of product or marketing, but still giving your new partner sufficient freedom so you can fully capitalise on their platforms, ideas and market capabilities. This requires an agreement that makes clear each firm’s respective roles and responsibilities and what will be managed jointly.
5. Do we agree what ‘success’ looks like?
While it’s important to be open-minded about the form of an initial agreement, any test partnership should nonetheless involve clear targets and key performance indicators (KPIs) to measure whether the relationship is proving successful.
The lead times in new markets are such that sales-based or client acquisition-based KPIs can take a year or more to filter through so patience is required. Nonetheless, clearly-defined and jointly-agreed indicators that can be tracked and reviewed will put a partnership on the right footing. Moreover, any potential partner who resists the implementation of clear performance metrics should be treated with caution.
6. Do we recognise when a partnership isn’t working out?
Just as firms can be resistant to branching out, companies that do take the leap can be equally slow to acknowledge when a relationship has hit problems or requires a substantial revision of terms.
Assuming you have agreed on a sound plan and appropriate KPIs, it’s crucial to act if something goes wrong, management fails to agree or targets are persistently missed. Do not waste precious time trying to justify a failing partnership because of the effort and resources already spent on the venture.
7. Do we recognise when it’s time to merge formally?
For family-owned SMEs in particular, a merger or a takeover can be a contentious prospect with emotion often clouding commercial judgement. Questions that will determine whether an outright merger, acquisition or disposal is prudent include:
• What is your long-term plan and will any other option other than merger/takeover achieve it? Are you looking at a merger simply to solve temporary rather than permanent issues (e.g. a cyclical downturn)?
• Is there already a clear strategic fit between your plan and that of the potential partner/acquirer or will massive compromise be required to make both plans work together?
• Is the other party negotiating from a position of strength – or are they seeking this transaction to solve their own issues?
• What genuine level of interest are you seeing from the other party – is the CEO or owner involved in initial approaches and follow-on discussions? Are you happy with the quality of leadership?
Don’t expect merger negotiations to be without their challenges. But discussions should be constructive and keep moving forward. Alarm bells should ring if issues repeatedly cannot be resolved.
8. Are we in the position to successfully conduct an M&A transaction?
Do you have enough management capacity, sector expertise, valuation and procedural know-how to conduct a complex transaction within a tight timeframe? It is always advisable to get professional, such as M&A and legal, support to structure and complete a transaction, as it is rarely the core competence of a company and its management. The success of the post-merger-integration depends heavily on the early identification of potential risks and conflicts in order to efficiently address them beforehand and/or in the contractual agreements.
9. What are the implications if we turn down an offer?
If you receive such an acquisition offer, consider not only what will happen if you accept it - but what would be the impact if you don’t.
Bear in mind that if you reject an acquirer, it might still seek out an alternative investment opportunity with another party. If so, is it more sensible to accept an offer than face the prospect of a new, enlarged competitor? This is a particularly important question if you are operating in a sector that is already on a consolidation trend.
A seller’s market
Ultimately an M&A transaction should only take place when you are confident it presents a strong commercial and cultural fit. The good news for European SMEs is that demand for high-quality acquisitions – particularly among US and Asian investors – is at a multi-year high with valuations still peaking. This reflects both the increased efficiency and improved financial position that companies have achieved post-credit crisis and the sustained high levels of market liquidity that provides them solid acquisition power.
M&A activity is likely to continue to be strong through the cycles. In short, European SMEs are enjoying a seller’s market since years. This being the case, companies can afford to take the time to ask the right questions and demand good answers before they take that next big strategic leap.