The Buy-Side of M&A

 The Buy-Side of M&A

HOW TO MAKE SUCCESSFUL ACQUISITIONS

Photography by Jonathan Garza

 In the world of M&A, there are two categories of acquisitions: financial and strategic. In the financial transaction scenario, it’s usually a private equity firm buying a majority stake of a company, placing it in their portfolio, growing it over several years and then selling it again at a profit.

Kevin Fincher, Phil Callahan, Jim Gerberman, Julie Miller and Brian Bedford were speakers at the Enlightened Speaker Series breakfast in Austin.

The other category of transaction is a strategic buy. According to McKinsey research, companies entering strategic deals are typically looking to buy a business for one of six reasons:

  1. Improve the performance of the target company
  2. Remove excess capacity from the industry
  3. Create market access for products
  4. Acquire skills or technology more quickly or at a lower cost than can be built in-house
  5. Exploit a business’ industry-specific scalability
  6. Pick winners early and helping them develop

This growth strategy of strategic buying was explored at a recent Texas CEO Enlightened Speaker Series event in Austin.

The Growth Strategy: From Hardware To Software

The first panelist was Phil Callahan, Director of Business Development for Silicon Labs. Now a publicly traded company in the semiconductor industry, Silicon Labs was founded as an incubator by three Austin engineers. Today, Silicon Labs is a $700 million company with 1,300 employees. Callahan estimates one-third of their current employees have come from acquisitions. “While there has been very successful organic growth within the company, mergers & acquisitions are very integral to our profitability as well as our overall growth,” said Callahan.

Silicon Labs operates four main businesses, and the Internet of Things is now their focus for growing the company. Callahan says his company is about connecting things. “The trend today is going from interconnections from cell phones to interconnections with everything,” he said. All that interconnecting creates big data, and as a result, Silicon Labs is changing from a traditional integrated circuit hardware-based model, to a software systems model. “That is changing our financial model somewhat, and it’s changing how we look at acquisitions,” said Callahan.

As a result of their evolving strategy, Silicon Labs has made six tuck-in acquisitions in the last five years with businesses based in the UK, Finland, Norway, the United States and Canada. “We’ve found we have to go where the talent is,” observed Callahan.

While most deals focus on EBITDA, contracts, earn-outs, valuations and market multiples, “Some of the earlier transactions didn’t go as well as we might have liked in merging cultures because we didn’t spend as much time on it as we should have, and we learned a lot from that,” Callahan said.

Want Your Deal To Work? It’s The People

Speakers Julie Miller and Brian Bedford founded MillerBedford after leaving the corporate HR world at Motorola. Their firm works with clients on human capital issues like culture, leadership and strategy.

Bedford sees four parameters driving a decision to buy a company: market, technology, financials and people. But the issues surrounding people seem to always come last. “People is the final part, if it happens at all,” said Bedford.

In preparing their presentation, Bedford found research from Bain & Company in a survey of business executives who have managed through a merger. That survey showed culture clashes are the main reason deals fail to realize their promised value.

Miller addressed the issue of merging cultures. “Obviously, you’re acquiring a company for a reason, and you don’t want to squash what’s good about that company out of them,” Miller said. “That is what tends to happen in so many instances.”

To merge cultures, MillerBedford starts by diagnosing their differences in order to bridge gaps, ending with something better than the individual cultures the firms started with. To define a culture is a four-step process. First is defining the core values by answering the question, “What’s important to us?”

The second step is to bring those core values to life by defining what they are. Miller shared an example. If a core value is holding people accountable, employees may bring that to life by showing up to meetings on time to demonstrate they understand what accountability means to their company.

The third step is to weave employees into the fabric of the organization. “If you have things linked to your performance management system, work systems and training systems that reinforce the culture you want to keep and to hold, that’s the teeth that makes that happen,” Miller said.

The fourth step is modeling the way. Employees, and especially senior management, need to demonstrate what people should do from a cultural standpoint.

Bedford said the most common way things happen is the laissez faire way — the acquired company is left to get on with business, and nothing is done to absorb the new company into the larger organization with things left as they are.

Setting The Target

An engineer, former CEO and now investment banker, Jim Gerberman of Corporate Finance Associates has worked with companies to create and implement acquisition strategies.

Gerberman reviewed three lessons he shares with companies to develop a strategy. The first is the importance of knowing what creates value for a company. Using an example of a company with $100 million in revenue, Gerberman started by mapping out strategic alternatives via a SWOT analysis. Once the framework is developed and what needs to be accomplished is determined, the strategy emerges. The next step is to set the path to implementation based on the type of company, size and location.

The second lesson Gerberman shared is about the acquiring company’s message: it must be both compelling and uniquely authentic. An acquiring company needs to be clear when describing the kinds of gaps, needs and opportunities they are pursuing. “We want to be transparent about the identity of the acquirer, what their strategy is and what their needs are, and we also want to be knowledgeable about the companies we’re reaching out to,” said Gerberman.

Before approaching a company for acquisition, Gerberman prepares what he calls an investment thesis. The purpose of the investment thesis is to give the targeted company a sense of why an acquisition is being explored and why a company may want to buy them. With a company that’s not for sale, Gerberman says it is important to offer things that are unique and compelling.

The third lesson Gerberman shared is the importance of your time. Having standards and measurement systems for understanding what’s important is key to using everyone’s time effectively.

Buyers, Sellers & Taxes

“Understanding who your seller is has a lot to do with how your deal is going to go,” said Kevin Fincher, senior manager of tax services at RSM US. Fincher said there are three types of sellers: a family-owned business, a VC or angel-owned business or a private equity owned business. In the case of working with family owned businesses, acquirers will be dealing with emotion, which may override rational thought.

“They always think the value of their company is far greater than what the metrics show,” Fincher said. “Be mindful of this when dealing with a family owned business.” The opposite side comes from a private equity firm, where they know the value of a company and are likely to be firmly entrenched in that valuation.

While owners may say they are not interested in selling, Fincher says everyone has a number. When a company wants to buy a business, they will come in with a high number, and once the letter of intent (LOI) is signed, Fincher sees businesses being nitpicked during the negotiation to get the valuation back down.

Fincher talked about a new acquisition trend being used to get into the capital markets without going through an IPO — a reverse acquisition. “There’s a trend in the life sciences and medical device fields where there are publicly traded shells where a company had previously done an IPO, and unfortunately, their technology or their IP failed,” said Fincher. “Those companies become appealing to those who want to do that reverse merger and become publicly traded without going through an IPO, and they get access to the capital markets.”

When it comes to the structure of the deal, Fincher said buyers want to buy assets and the seller wants to sell stock. Companies don’t want to buy a corporate entity because if they do, they pick up any contingent liabilities that might pop up. With stock acquisitions, acquirers pay a premium for good will; and with a stock acquisition, the buyer receives no tax benefit. On the other hand, with an asset deal, the acquiring company can create an intangible asset and amortize it for tax purposes.

Sellers want to do stock deals because of capital gains treatment. And, said Fincher, “If the seller is a qualified small business, and they are taking advantage of the 1202 gain exclusion, they can exclude up to $10 million of the gain . . . it’s tax free.” In that scenario, the seller is not going to move off of a stock deal. In looking for balance for both parties, “We work to negotiate people to the middle, which oftentimes will impact that purchase price. You want a beneficial tax structure to both sides,” noted Fincher.

Back To People

In the Q&A following the presentations, the questions turned to the issue of people and culture. When Callahan was asked how they eventually got it right at Silicon Labs, he said they now use a more disciplined process where HR and their leadership teams get together very early in the acquisition.

Gerberman noted, “Don’t underestimate the importance of the incentive system you have and how that drives behavior.”

Bedford took an alternate view, reminding attendees it might be time for the founder to retire so the company can move forward.

Thank you to our 2017 Enlightened Speaker Series Sponsors:

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