In last month’s article, we discussed the first three of 10 biggest mistakes buyers make when acquiring businesses. In this article, we examine mistakes #4 to 6 of the 10 Biggest Mistakes Buyers Make when buying businesses.
Mistake #4: Not having a defined acquisition budget
Just like the adage, “A failure to plan is a plan for failure,” entering into discussions to acquire a business without defining your acquisition budget is a recipe for disaster.
I realize sometimes acquisitions are “opportunistic” and unplanned. However, before you enter into serious negotiation on price and terms, you need to determine what you can afford to spend and what you are willing to spend, as well as how you will finance the purchase, before you make an offer.
As mentioned in last month’s article, a common mistake (#2) is not having your acquisition financing in place before you go deep into the acquisition process. Once you have an idea of what you can borrow or finance, you will more readily be able to set your acquisition budget.
Not planning on borrowing money to finance the purchase? You still need a budget, which might be determined by your desired return on investment (ROI) or your risk tolerance (which is tied directly to purchase price).
Working without a budget may lead buyers to either overvalue the deal (see mistake #5 below) or to underestimate the amount of financing necessary for the transaction.
Recently, a buyer asked for our assistance in negotiating a deal to acquire a direct competitor. When we inquired of both the buyer’s acquisition budget and financing plans, we were told, “Don’t worry about it, money isn’t an issue.” Fortunately for the buyer, we did worry, as we tend not to be believers when we’re told money isn’t an issue (because it almost always is). We helped the buyer craft a budget which was critical because, in doing so, we learned it would have been impossible for them to acquire the competitor without severely impairing their own business.
Before you go searching for acquisitions, or as soon as one finds you, spend time to develop your budget and set your parameters on how you plan to finance the acquisition, then make sure you don’t commit mistake #5 below.
Mistake #5: Falling in love with the deal and/or busting your acquisition budget
Once you develop and define your acquisition budget, do not break it, no matter how much you “love” the deal you are considering. We have seen too many buyers make the mistake of rationalizing paying more than they can afford or want to spend, only to regret the decision.
It is never a good idea to convince yourself to spend more than you can afford, even if banks and lenders are willing to give you the money to do so. Just because you can afford it doesn’t necessarily make it a good deal or a wise decision.
We have witnessed many acquirers overvalue the synergy (see mistake #6 below) in the deal or just build in extremely optimistic projections (i.e., “believing their own lies”). We all read the stories of buyers who overpay for deals based on rosy pro-forma projections developed by their own deal team and advisors. Such deals rarely perform as expected.
Why are buyers willing to overpay and bust their budgets? Often it is because buyers are afraid to say “no” and walk away from a deal. It takes real courage to cut your losses and walk away, especially when you’re close to making a deal (or have invested a significant amount of time and/or money into the process). However, “stretching” to complete a deal is never a good idea.
No matter how much you love the deal, if you have to go beyond your budget to get the transaction completed, it probably isn’t a good deal for you…unless your budget is artificially low, of course. But, convincing yourself it is a good deal at a price/cost greater than your budget only leads to problems for you in the future.
Mistake #6: Overvaluing synergy
In acquisitions, synergy is often described as 1+1=3. Wouldn’t it be nice if it were that easy?
Far too often, we’ve seen buyers significantly overvalue or overestimate the impact of synergy on the acquisition. Whether measuring economies of scale, cost savings, or other synergies, it is imperative for you to be realistic in your assessments.
We were recently working with an acquirer who was convinced they could improve the earnings of the target seller significantly through cost reductions earned from higher volume purchases from a common supplier. We spoke with the supplier and learned both buyer and seller were getting the maximum discount available, thus no cost savings.
Furthermore, as we examined the buyer’s employee benefit package, it was much more encompassing and expensive than the package provided by the seller to its employees. Any potential savings the buyer might see in volume purchasing would be outweighed by the additional costs associated with the buyer’s enhanced benefits package (which it would have to offer to the seller’s employees).
Based upon our review, we determined the buyer was overvaluing synergy by more than 75%, thus overvaluing its offer by at least 50% and blowing away its acquisition budget. Upon review of the data we provided, the buyer followed our recommendation and made a lower purchase offer than originally planned, and was very pleased when the seller accepted the offer.
Buyers also tend to overestimate how quickly cost savings and synergies will be realized. We have a saying, “It costs twice as much as expected and takes twice as long to complete.” This adage rings true regarding the impact of synergy.
It takes time to effect change and impact earnings on the company you will acquire. Do not be afraid to be aggressive with your post-close integration plans (see next month’s article), but do not overestimate how long it will take to realize the benefits from these changes.
Next month, we wrap up the series on the 10 Biggest Mistakes Buyers Make with mistakes #7 to 10.
