Here's Your Acquisition Checklist for Robust Growth Organizations using debt to buy growth makes their balance sheet inefficient, particularly if the target company has less ability to generate cash flows
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The success of an organization's inorganic growth strategy largely depends on two factors – deliberation and execution. Deliberation usually takes a back seat as there is pressure from leadership to execute the growth agenda. As a result, organizations often end up with an inorganic strategy that has misgivings. While deliberation may be a slow and iterative process, organization leaders need to embrace it and fight the impatience to simply execute. Deliberation, rather than paralyze, enable decision-making.
Deliberation – Check M&A Strategy
An organization pursues M&A primarily for three reasons. First, to penetrate new clients and markets. Second, to acquire "hot-skills" that are in short supply. Third, to buy a product or technology which is a potential disruptor in an industry. All these reasons must translate into future "profitable growth".
Ideally, the "Buy" decision should not always be an organization's first resort. Deliberative leaders perform simulations of "Buy" versus "Build" to understand which strategy unlocks higher value for the business. Many times, leaders might decide to "Hire" through a partnership to meet the desired objectives. Essentially, the reasons to "Buy" must be compelling.
Unlike other buying decisions, M&A is a risky one. At each stage of a complex buying process, organizations are faced with a "Go" or "No-Go" decision. These decisions require to be backed with evidence, data and analysis. For example, the right target market should be identified based on addressable size and growth rates. Concentration levels, entry barriers and switching costs are important considerations to target the right industry. Similarly, identifying the target company with the right business mix and solid fundamentals may not be enough. The target's market perception, business processes and people culture, are some of the intangibles that will also drive growth. Hence, it is critical to deliberate sufficiently on all these decisions.
Execution – Check for Red-Flags
Once a target company is down-selected, and term-sheets are signed, the transaction teams execute the due diligence process. In practice, apply the 80-20 rule and focus on the colloquial "big items". Here are the common red-flags that may lead to "deal-breakers":
Pipeline and Backlog: A weak pipeline and backlog are indicative of a risky revenue profile. Ideally, the target company should demonstrate a pipeline of 25-40% of the combined revenues forecast for three years.
Client Attrition: The rate of client attrition or churn puts downward pressure on a target's top-line, particularly if it outpaces new client additions. The acquirer should investigate for hidden "bad jobs" which might not be reported in the target company's MIS, resulting in possible future client attrition.
Client Acquisition Costs (CAC): Growth is normally accompanied by an increase in acquisition costs like marketing and sales expenditures, mainly in a crowded market. The acquirer should map CAC growth viz. revenue growth trends to assess risks associated with the target's revenue model. For example, LTV/CAC of less than three for a SaaS company is a red flag.
Skills: Target companies usually exalt the skills of their key employees. The acquirer should perform competency mapping of skills with the gaps identified during the deliberation stage.
Key Employees retention: Acquirors should enquire what it would take to retain key executives after the acquisition and build incentives into the purchase price.
Promoter's incentive: Promoters are drivers of business growth in their companies. Post-acquisition, promoter attrition causes uncertainty in the acquired business. It is thus important to structure a deal which balances promoters' ambition and acquired growth objective. Promoters displaying frustration during due diligence and negotiations are more likely to exit early from the earnout period.
Finally, acquirers should figure out the financing mechanism of an acquisition. Organizations using debt to buy growth makes their balance sheet inefficient, particularly if the target company has less ability to generate cash flows. A case in point is Walmart's $16bn debt-financed acquisition of Flipkart. Flipkart, likely, burns cash faster than it grows. The US retailer will probably infuse cash into Flipkart to keep it growing and plan to bring efficiencies in its business model.
Eventually, it always boils down to generating "profitable growth" for the long-term. A carefully deliberated and well executed M&A strategy can help organizations, to that end.
