Corporate Finance – Glynn Reece.

Acquisitions stimulate more adrenaline, egotism and irrationality in senior executives than any other corporate activity. Yet this urge to beat the competition and do the deal at any price is one of the main reasons why acquisitions fail to deliver shareholder value. Overpaying is not the only danger …

Diversification or focus is often a problem. Diversification strategies are successfully implemented where companies have used cashflows from an ex-growth business to finance the acquisition of a business in a different high growth sector.

Focus (buying businesses in the same or a directly related sector) is the more modern fad, with definite advantages.

It is easier to identify and target companies. The acquirer’s knowledge of the sector and the target should significantly reduce the business risk in an acquisition and an acquirer will be able to wring more benefits from a merger with a related business.

Paying the right price is vital.

Eager acquirers often forget that formal auctions of businesses are structured by the vendor’s financial advisers to create a bidding competition which will inflate the price of the business significantly above its real intrinsic value.

Advisers are adept at revising forecasts and finding benefits to justify the high price. Acquirers are further comforted by the theory that states ‘the value of a business is the price that someone is willing to pay for it’.

The financial structure of deals and acquisition financing are critical to the future success of the company under its new ownership. If the deal is both overpriced and has been financed largely through debt, a double jeopardy is created that will usually end in disaster. Leveraged structures can increase an acquirer’s returns on equity but generally speaking, equity financing supported by modest amounts of debt is the best approach.

And don’t forget acquisition culture. Some acquirers give the management of acquired companies almost complete autonomy. The acquirer nurtures a ‘family’ culture encouraging group companies to trade with each other and generate business opportunities for each other. Other acquirers take over full operational and strategic control of the business. In this situation the acquirer usually only requires a transitional ‘handover’ from the existing management.

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