Dave Millier has made a virtual second career of spotting companies ripe for acquisition. The CEO of Toronto-based Sentry Metrics Inc. has completed buyouts of six tech firms, fuelling the growth of his computer network security business from sales of $540,000 in 2005 to a projected $5 million this year.
Yet, even after executing so many acquisitions, Millier sees buying a business as a very hard thing to get right. “You really have to have your eyes open going into a deal,” he says. “You need a clear understanding of your goals and a contingency plan, because it may fail.”
Millier points to one painful lesson he has learned: pay as much attention to a seller’s personality and motivations as you do to his business model. Millier admits that when he bought one consulting company, he overlooked signs that the owners were reluctant to honour their contractual obligation to stay on for a year to help transition their clients to Sentry. “After we closed the deal, they got into another business that they much preferred, so they didn’t uphold their end of the agreement,” he laments. The sellers were so anxious to walk that they did so despite having to give up a big payment. And Sentry lost 70% of the acquired company’s clients.
Like Millier, many business owners have discovered how easy it is to make a serious mistake when buying a business. Don Lenz, a managing director at Toronto-based investment- management consultancy Newport Private Wealth, points to the shockingly high failure rate in buyouts: at least 50%.
That makes the odds of a successful acquisition even lower than those of a long and happy marriage. But don’t despair. You can steer clear of the most common acquisition mistakes by asking yourself these seven questions:
Do my senior managers have what it takes to work in the post-merger entity?
When Peter Byrne entered Alberta’s privatized liquor-retailing business in 2001, he used acquisitions to build a major new player. Byrne, CEO of Edmonton-based spirits retailer Andersons Liquor, knew that many acquirers fail to properly integrate a new property. So, before his fi rst deal, he took a hard look at whether he had the executive talent required to do so.
With any luck, an acquirer will fi nd some of that talent within the firm it’s buying. Byrne did fi nd a few great managers, typically, store owners nearing retirement, who no longer wanted the hassle of running their own business—and, unlike most entrepreneurs, were prepared to become employees. “When I look at our frontier of supervisors,” he says, “every single one of them came from acquisitions.”
Still, as Byrne had expected, most of the sellers were independent operators with no experience in running larger operations. Instead, he drew on his own extensive finance and management background at franchisors and other larger businesses. He also recruited several chartered accountants and others with big-company experience. As well, Byrne hired two acquisition managers, whose duties include managing the business handover, such as meeting the seller’s clients and learning the fi ne details of their operating procedures. This careful approach has allowed Andersons to absorb 38 liquor stores successfully and grow to 2010 sales of $48 million, versus less than $14 million in 2005.
How quickly can the seller provide important information?
Lenz advises tracking how long it takes the target’s owner to produce key fi nancial or other documents. If she’s desperately scrambling to assemble the materials you need for due diligence, that suggests the fi rm has poor bookkeeping or administrative systems. Chances are, it’s also sloppy in other areas.
What do clients think of the firm?
Millier carefully analyzes an acquisition target’s key financial metrics, such as revenue growth, outstanding receivables, payables and longterm debt. But he pays even more attention to the target’s relationships with its clients. Millier always requests a list of the seller’s customers, then selects several whom he thinks would be the most challenging to work with. He then meets with these clients and peppers them with questions.
Millier does this to assess how the company is treating each of these clients and what has gone right and wrong along the way. Above all, he wants to fi nd out why hiccups have occurred and how the firm has responded. “The fact that the clients are still there is a good indicator that the company has been able to handle these issues,” says Millier.
He says how well a firm manages customer relationships demonstrates the strength of its management, employees and business. The insights that Millier gains from meeting with these clients help him gauge whether these relationships are likely to continue and grow once his company takes over—a key factor in determining whether the acquisition target can help boost Sentry’s sales.
Which financing arrangement can the seller accept?
For those buyouts in which Millier wants the seller to stay on during a transition, he generally negotiates purchase agreements combining small cash payments with share options that encourage the seller to keep working hard to build the value of her former company. But there are numerous ways to structure a deal. These include straight cash deals or performance-based agreements that require the company to meet specifi ed targets before the seller can cash out.
No matter which arrangement you have in mind, you can learn a great deal about a seller’s motivations by asking which type of deal she would be willing to sign. If she’s not open to anything but a pure cash deal, why is she so anxious to get out of there?
Would the business collapse if the CEO took a long vacation?
It’s essential to determine whether the potential acquisition has a well-defined division of labour among its management or whether the CEO is responsible for all major duties, ranging from HR to sales. If it proves to be the latter, it’s time to run away screaming.
“A CEO needs to delegate properly and have a management team around him or her,” says Lenz. It’s diffi cult to replicate a company’s success—or improve its financial performance—if an owner has failed to develop systems to transfer crucial knowledge to employees.
How long do I want the seller to stick around, and in which role?
Typically, you’ll want the vendor to stay on for a specifi ed period after the deal closes to help ensure a smooth transition. But, says business broker Doug Robbins, you are likely to run into some differences with the seller over how to run the fi rm. For that reason, you won’t want the seller sticking around for too long.
Robbins, president of Hamilton-based Robbinex Inc., recommends a two-tiered agreement in which the seller remains intensely involved in the company for a short period, then available to offer advice and answer questions for several years. Typically, he recommends a five-year management contract that keeps the seller engaged full-time for the first 90 days. The seller then drops down to being available for up to 20 hours a week for the next 90 days, and fi nally to up to six hours per month for the remaining 4½ years.
Why so long? Robbins says you may not have any interaction with the seller after the fi rst six months, but you should retain the right to consult with the vendor if necessary. A provision giving you even limited access to advice from the previous owner for the rest of a five-year deal could offer valuable insights if, say, you run into a slump in your sector or lose some key clients.
How engaged are the seller’s employees?
Another key factor Millier considers is the strength of a prospective acquisition’s culture and how its team would fi t in at Sentry. To make this assessment, he gets the seller’s blessing to take some of the target’s potential employees out to dinner under the pretext that Millier plans to partner with their company, not acquire it.
During these meals, he asks questions aimed at shedding light on the employees’ role in the target company and how excited they are about any new technology or other innovations the business has in the pipeline. Critically, he watches how the workers interact with each other for signs that they work together effectively and would mesh well with his own firm.
“If you’re looking to grow,” says Millier, “corporate culture will make or break your company.”