Strategic acquisitions: how to unlock the benefits
Gregg Pendlington of Dow Schofield Watts’ corporate finance team explains what type of deals can be considered strategic and how to structure them to achieve the best outcomes
A strategic acquisition can transform a business in a number of ways. As well as enhancing value through combination synergies, it can provide instant access to new markets with strong potential for growth (thus enabling the business to steal a march on competitors).
Where a small firm becomes part of a bigger group, it can result in an immediate uplift in value – a factor known as multiple arbitrage and a key benefit of a buy and build strategy.
A strategic acquisition can also be defensive, protecting a company’s market position from competitor attack.
A traditional view could be that strategic acquisitions should be vertical rather than horizontal because it’s not transformative to acquire another version of your own business. However, a horizontal acquisition can still be highly strategic if it involves acquiring a key competitor, or a business that holds something important such as a key contract, supplier relationship or technical know-how.
A good example was the sale of Manchester-based Bollington Wilson Group, a leading insurance broker, on which we advised. As the buyer, AJ Gallagher, was strong in the South Bollington made for a compelling strategic acquisition which enabled it to supercharge its presence in the North, whilst unlocking many other combination synergies at the same time.
What is the best deal structure?
To achieve the right structure, you need to start with the overall corporate strategy in mind. Who are the stakeholders? Perhaps a private equity firm? Exiting management? Ongoing management? What are their aspirations and how does it align to the corporate strategy?
A deal structure can involve retained loan notes / deferred consideration and equity to incentivise management and ensure everyone’s interests are aligned. An earn-out, growth shares or a bonus scheme can be additional structures to encourage the on-going progression of the enlarged business.
Simple structures work too. If the buyer is already familiar with the sector and management aren’t key – for example in a retirement scenario – then a 100% cash purchase can work. In that scenario the target company can be integrated into the main business straight away, unlocking all of the combination synergies without the burden of ongoing structuring and earn out conditionality slowing things down.
Strategic acquisitions can have a downside, or reverse synergies, too. There are many transactions that were deemed ‘strategic’ but hindsight has shown things differently. If management can’t explain the rationale in simple terms, then it probably isn’t highly strategic! In some cases, it could even lead to value destruction for the acquirer, particularly if their capital structure is stretched.
Which companies are best suited to a strategic acquisition?
Companies which are best placed to benefit are those with scale and depth of management. For example, a horizontal acquisition where purchasing power is a key synergy will derive the best pricing discounts from suppliers if the acquirer and target are of sufficient scale.
Bigger companies also have the right management infrastructure – including HR and project management teams – to ensure acquisitions are successfully integrated.
However, a smaller buyer with the right financial backing can achieve similar benefits with a reverse takeover of a bigger company. In some cases, a small firm can transform its business overnight by adding scale, route to market and depth of management all at the same time.
If you would like to know more contact Gregg via email at [email protected]