Is it time for your family business to make an acquisition?
Growing through acquisition has a bad reputation because countless studies have shown that buyers tend to overpay for businesses. In other words, the real winners in many corporate transactions are the sellers, not the buyers.
That said, there is some evidence that acquisitions during a recession are more likely to be accretive. A recent study by Brian Salsberg of global accounting firm EY indicates that companies making acquisitions in the depths of the 2008 financial crisis generated superior returns for shareholders than peer companies that waited until the storm passed before making acquisitions. Not surprisingly, the study attributes the superior returns to the ability of buyers to pay bargain prices during the crisis. Motivated sellers and fewer competing bidders tip the negotiating scales in favor of eventual buyers. As our colleague Jeff Davis is fond of saying: “Bought right, half right.”
In our experience, many family businesses are reluctant acquirers. In addition to the fear of overpayment, family businesses are wary of the cultural challenges that can arise in the integration phase. Since families often avoid having non-family shareholders, traditional equity financing is assumed not to be available, so if the family is debt-averse, significant acquisitions may not be financially feasible. However, these concerns need not be absolute obstacles for your family business making an opportunistic acquisition while others sit on the sidelines to wait out the pandemic.
We recommend that directors cast a wide net when evaluating potential acquisitions. As we noted in last week’s post, directors should take this opportunity to think more broadly about the portfolio of assets owned by their family business. Are any pieces extraneous? Are there any pieces that are missing? For family businesses that have hesitated to make acquisitions in the past, the missing pieces do not have to be big, nor do they have to be existing competitors. It may be helpful to expand your list of potential acquisition opportunities to include five categories of targets (with an obvious nod to Michael Porter’s five forces framework).
- Competitors. Competing firms are the most obvious acquisition candidates. Competitors offer the opportunity both to cut costs and enhance revenue through improved pricing power. The downside is that because the potential benefits are transparent, a competitor may be able to extract a larger purchase price.
- Suppliers. All of us who have shopped in vain for toilet paper or Lysol during the past six months have a new appreciation of the importance of having a reliable supply chain for critical inputs. Are there risks to your supply chain that can be mitigated by an acquisition?
- Customers. Where does your family business sit in the value chain from raw material to the end user? Would an acquisition of a customer allow one of your business segments to capture a greater proportion of the overall value created in your industry?
- Substitute Products/Services. Your family business competes against both other companies that provide the same product or service you do, and companies that offer products or services that your customers could reasonably substitute for what you offer. Acquiring such a company can help to round out your product line/service offering and reduce the risk of your family business.
- Innovators. This requires a higher degree of risk tolerance, but are there companies developing a product or service that could disrupt your business in three or five years? If you can’t beat ‘em, you may want to buy ‘em. While the unicorn tales populate the headlines, they are rare. Many innovators are intrigued by the opportunity to sell now rather waiting years for a unicorn-type event that, statistically speaking, will likely never materialize. Especially during a downturn, you may be able to reap the benefits of someone else’s development efforts at a reasonable price.
Of course, it is possible to make a bad acquisition, even during an economic downturn. Your family shareholders may not have the appetite for a “transformative” deal, but a smaller acquisition that enhances your overall portfolio may well be doable. The main thing is to be deliberate. Even if you are not ready to cut a check today, you and your fellow directors should be thinking about your acquisition strategy. Call one of our experienced professionals for some outside perspective.