Regardless of the global pandemic, mergers and acquisitions continue with robust activity. High levels of cash reserves reinforced by strong fund raising, low interest rates, and confidence in the economy’s emergence from COVID-19 all contributed to these acquisitions, which are expected to continue in the New Year. If you’re a business owner thinking about an acquisition, borrow from these best practices.

Some companies make buying other businesses a central element of their strategies. The knowledge gained with each acquisition prepares them for the next, enhancing their chances for success. Referred to as serial acquirers, they are pros and have mastered the process of acquiring businesses. Here are their best practices to borrow from when considering a first-time acquisition.

  • Strategic focus. Only pursue transactions that are right for strategic objectives, and don’t waste time investigating businesses that don’t fit the business focus and goals.
  • Investment thesis. Successful serial acquirers articulate how they plan to create value over time and how potential acquisitions will contribute to that value.
  • Experienced buyers. Serial acquirers typically assign the responsibility for seeking and negotiating acquisitions to specific executives and outside advisors, providing plenty of time to accomplish those tasks. This isn’t work for amateurs or dabblers.
  • Abundant discipline. They follow a disciplined process to evaluate the attractiveness of a potential acquisition and are not afraid to step away from a transaction that isn’t ideal.
  • Clear principles. These companies evaluate acquisitions based on agreed-upon principles and walk away from transactions if they spot any deal-breakers.
  • Planned integration. The best acquisition can fail if the two companies are not integrated effectively, so successful acquirers develop standardized processes that consider business operations and focus on culture and people.

Options and considerations for funding and deal structure
Business leaders fine-tuned in the art of mergers and acquisitions know where to find capital for funding when needed. In a competitive acquisition market, acting quickly is the difference between being able to take advantage of a great deal and losing out to another acquirer. Lining up a responsive and reliable source of funding should be a first step in the process. There are several options.

Working capital. Most companies don’t have an overabundance of working capital but may be one of the lucky businesses with an unusually high amount of cash and other short-term assets to fund an acquisition. Having the ability to pay cash immediately will make your offer more appealing to the seller. 

However, using cash in full as acquisition funding may not be the most prudent strategy. First, it can eliminate a cushion that might help your company through an unforeseen crisis — the business equivalent of “saving for a rainy day.” Second, the costs of most acquisitions don’t end when the deal is signed. Integrating a company into your organization may require additional investment for operations, such as technology.

Acquisition loans. There are many potential sources for acquisition loans. New acquirers often turn to local commercial banks because they have relationships with loan officers. However, commercial banks may not be comfortable with the risks associated with acquisitions, or perhaps don’t fully understand the industry, so they may charge higher rates or insist upon unfavorable terms.

A specialty lender that works directly with companies in your industry could be a good option, if that’s the case. These lenders have a solid understanding of how companies are structured and operate, along with a strong familiarity with the nature of income streams to approach the underwriting with realistic expectations and a full understanding of inherent risks. For example, Oak Street Funding can structure funding for multiple acquisitions based upon future revenues generated by the acquisitions and are not restricted by the federal limits on business loans.

Equity. If a business owner has the ability and a willingness to offer equity to the seller, it may be an attractive way to fund part or all of the transaction. That’s especially true if the seller’s leadership intends to continue working in the business. Presumably, a company will be worth more after the acquisition, so there may be additional equity to distribute. Offering equity will keep the seller involved in the business to tap into their expertise and business relationships. When taking this approach, it may be beneficial to engage an independent third party to provide an objective valuation for the combined company.

Earnouts. If a seller is planning to leave the business when the deal closes, find ways to ensure they will continue to take steps to keep the business thriving, such as earnouts. Here’s how it works. Pay part of the sales price upfront and then make a series of payments based on the acquired company’s future revenues.

To illustrate the concept, suppose you agree to pay a third of the company’s value to the seller upon closing. Then, for each of the next five years, you pay the seller an amount equal to 20% of the acquired company’s revenues. Sellers often appreciate this approach because it provides payments over several years and may offer tax advantages. It also gives an incentive to support the new owners because their future business growth depends upon the success of the transaction.

Whether your business uses acquisition for growth or you’re thinking about a first-time acquisition, use these concepts as guidance when working with your lender.

Rick Dennen is the founder, president & CEO of Indianapolis-based Oak Street Funding, a First Financial Bank company with customized loan products and services for specialty lines of business including certified public accountants, registered investment advisors and insurance agents nationwide.

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