Middle-market
merger and acquisition activity surged in 2006 as more and more
companies made acquisitions an integral part of their growth strategy.
Dollar volume in U.S. M&A activity topped $1.2 trillion in the year
that just ended, a record. And according to a recent analysis by
Deloitte & Touche LLP, more than $400 billion of that amount can be
attributed to deals valued at less than $300 million.
As M&A activity surges, many middle-market companies are forced
onto a steep learning curve. Companies often decide that they want to
make acquisitions first and then realize that they do not have the
internal resources to manage the process. What then? Some hire
consultants, others learn by doing (often through mistakes), while
others systematically build an M&A capability themselves.
A certain percentage of these companies end up building their
acquisition capacity by working with a private equity partner like
Summit Partners. At Summit, we invest in companies and help them pursue
their growth strategies, whether through acquisition or internal
growth. Since our founding in 1984, we have raised nearly $9 billion in
capital and have invested in more than 285 businesses. Partners from
our firm usually sit on the boards of directors of these companies, and
if the company's strategy incorporates acquisitions, we will often be
members of acquisition-related committees of the board as well.
Based on my firm's experience, the process of building an M&A
capability involves four key steps: (1) developing a strategy; (2)
assessing company readiness; (3) building the acquisitions capability;
and (4) executing the strategy and monitoring results. Let's look at
each in turn.
Developing a strategy
The first questions are the fundamental ones. What are your
company's strategic objectives, and will acquisitions help achieve
these objectives? Is your strategy to gain market share, to acquire
promising technologies or to fill holes in your product line? Which
companies can help you reach these strategic goals? Are these target
companies likely to agree to being acquired? Are there alternatives to
buying a target outright, particularly in technology-related
businesses? If so, you may be able to buy just the intellectual
property or the research and development team instead of the entire
business.
Technology companies make up an interesting segment of the
middle-market M&A universe. One of their most common strategies is
to acquire a competitor. If your most direct competitor is smaller and
there is no No. 3, why not buy the smaller company? Immediately, you
become the dominant player in your niche. We have seen this sort of
transaction at a variety of technology-related companies.
Another common situation arises when a competitor has intellectual
property that appears to be valuable but has run out of resources to
properly market it. In some cases, the product may not even be
finished. It may be 70% to 80% completed and clearly at a stage where
the acquirer's own R&D team can finish it. The acquirer can either
buy the whole company or, in some cases, simply buy the intellectual
property in question.
A third common scenario occurs when a technology company wants to
establish a presence in a new area where it lacks internal expertise.
In this case, the company may look to buy a competitor's R&D group.
We have seen situations where an entire product development group was
laid off at once, and a competitor immediately stepped in to hire the
team, perhaps also assuming the lease or acquiring the facilities where
they worked, along with other assets. This allowed the acquiring
company to gain instant expertise in a new area, without the headache
of integrating a whole company.
Outside of technology, we see a fair amount of M&A activity in
markets that are fragmented, particularly in healthcare services. These
sectors are composed of many small competitors, all with similar
financial characteristics. Companies that systematically acquire these
targets can become very skilled at assessing opportunities as well as
integrating operations and managing other facets of the transactions.
Essentially, they perform the same transaction over and over again.
Assessing company readiness
Once you have defined your strategy, you will need to take a hard
look at your company and assess whether you have the resources
necessary to execute M&A transactions. One key question is: What
size transactions can your company handle appropriately? There is no
rule of thumb here. While it is rare to see a smaller company acquire a
larger one, it does periodically happen -- especially in the current
credit climate, where financing is relatively easy. We advise companies
to think carefully about what size deal they can realistically handle
from an operational perspective and to make an honest assessment of the
available financing.
Companies should first consider how much cash they have on
their balance sheets -- and how much they may be able to borrow against
their balance sheets, too. How much you can borrow is ultimately up to
your potential lenders; how much you should borrow will of course
depend on your own assessment of financial risk. Our general objective
is to structure transactions that are anti-dilutive over the long term
-- and even better, over the short term as well. This means projecting
earnings per share, or EPS, growth without the acquisition over the
next several years, then comparing that against the expected EPS
including the acquired business. Sometimes, rapidly growing companies
buy a slow-growing business at an inexpensive price, which does not
dilute earnings over the first year. Yet, over time, the slower-growing
acquisition slows down the company's overall EPS growth, and so on a
comparative basis, the transaction looks dilutive in later years.
If you are a public company, it is usually easier to tap the value
of your equity, whether by issuing more in order to raise cash or by
exchanging some of it for ownership in the acquired company. In some
cases, however, acquired companies are willing to take equity in
private firms as well. One situation where private company equity
becomes particularly attractive is when you are considering a near-term
initial public offering. The acquired company's team assumes that they
will get stock in your still-private company at a lower valuation; when
the IPO goes through, their stake will then increase in value.
Timing is another key consideration. Some companies raise capital to
finance acquisitions in advance, while others seek capital only when
the acquisition is under agreement. Companies generally obtain more
attractive terms when they have a specific deal under agreement, since
financiers have a better understanding of the transaction they are
funding. The main downside is time pressure. In some cases, arranging a
loan takes too long, and the transaction falls through. At other times,
a financing source takes advantage of the pressure facing the company
and provides less attractive terms than usual.
Rollup companies -- those that acquire numerous smaller competitors
in a fragmented industry -- usually have the financing lined up in
advance. Companies with more opportunistic, occasional M&A
strategies, however, may wait until the deal is finalized to raise
capital.
Over the past several years, the lending environment has been
supportive for companies developing acquisition capabilities. Banks and
other lenders have offered loans that minimize dilution, provide large
amounts of leverage and offer minimal amortization, all at reasonable
interest rates. Easy credit has contributed greatly to the growth in
middle-market M&A. Readiness is not simply a matter of arranging
financing, however. You also need the right people, with the right
skill sets, within your organization. Do you have the ability to source
and negotiate transactions, and then to integrate your acquisitions
quickly and effectively?
Building the acquisitions capability
This brings us to the need for a dedicated corporate development
capability -- a department, though often a small one, where dealmaking
skills reside.
Usually, the effort starts with the CEO, who believes that one part
of the company's growth strategy should be through acquisitions. He or
she develops the overall strategy, determines how large the
acquisitions can be and decides how these transactions will be
financed. However, at some point, the CEO must delegate part of the
corporate development work to a partner who can execute on the
strategy.
Although some companies can find the right person for this role
internally, most will have to look outside to locate the candidate with
a unique set of qualifications, including:
• Marketing skills: The savvy corporate development officer
identifies opportunities and then goes out into the market to act on
them. This often requires an ability to persuade business owners to
sell their companies, product lines or divisions to another firm.
• Transactional skills: These skills are many and varied; they range
from valuation and analysis to some knowledge of contract law to an
ability to negotiate and a knowledge of how integration ought to work.
Because this type of knowledge is typically developed over the course
of numerous transactions, many organizations look for people who have
worked at an investment bank, a private equity firm or in a corporate
development role at another organization.
• Operational skills: At the same time, the corporate
development officer should understand the company's products and/or
services, as well as how an acquired company's offerings would fit
within a combined organization. The corp dev team needs a good rapport
not just with senior management, but also with product marketing and
product development groups.
Usually, firms will start by hiring one corporate development
officer who has broad experience across these three primary areas. As
the function grows, companies may later add analysts and other
personnel to augment their efforts.
Finding the right initial corporate development officer is a key
step, but being able to integrate that person into the larger
organization is equally critical. A recent survey by Ernst & Young
LLP found that a majority of corporate development officers report to
the "C" suite (37% to the CEO and 41% to the CFO); however, they also
maintain close ties to the board and other strategic areas of their
companies.
The business development officer has to be both a team player and an
initiator. On the one hand, he or she has to implement the CEO's goals
and vision. But this person also must have the creativity and
aggressiveness to act independently. Corporate development officers do
most of the traveling involved in M&A activities, so they must be
prepared to make decisions and handle issues that arise in on-site
negotiations. In addition, the corporate development officer interacts
with all the important areas of a company -- finance, product
development and marketing, sales and operations. The diverse skills
needed for the job are very similar to those required at the CEO level,
so it is no surprise that corporate development officers often move
into the CEO slot.
Executing the M&A strategy
Once a corporate development capability is in place, the company can
begin executing its strategy. Senior management is typically involved
in this process, as well as the board of directors, product marketing
and development groups. The corporate development office coordinates
all aspects of this process.
Most companies start with relatively small deals, using these
transactions to gain experience and work the kinks out of their
process. As they experience success with smaller deals, they gain the
experience and confidence to pursue larger transactions. A successful
program also increases the size of the company and its resources,
putting more cash on the balance sheet while increasing borrowing
capacity and the value of the company's equity.
Moreover, more people in the business development group may already
have been through the process of acquiring companies and integrating
them several times. As the group expands, it often takes on new
responsibilities -- not only for acquisitions, but also for joint
ventures, intellectual property and product acquisition and
distribution deals. The process will evolve as the M&A effort
becomes more sophisticated. Many companies create a subgroup of their
board -- an acquisition committee -- to evaluate deals along with the
CEO and corporate development office.
An essential part of the process is setting expectations
for success in each deal and then benchmarking post-transaction
performance to these standards. Criteria will vary from company to
company, and from deal to deal. But some of the most common
considerations include:
• Is the transaction dilutive or anti-dilutive? Here you look at the
projected EPS growth of the combined companies, as compared with EPS
growth of the acquiring company by itself.
• What is the expected internal rate of return on capital used to finance the acquisition?
• How will the transaction affect future borrowing capacity? Will it prevent you from making another acquisition?
• What sort of market share growth do you expect?
• How much do you project in cost savings?
• How many new-product introductions do you expect after the
transaction? What percentage of revenue should come from these new
products?
• How is the transaction performing against budget?
Once these standards have been determined, the board and corporate
development group must monitor progress according to these terms. The
corporate development officer will often be the main person in charge
of integration.
He or she will meet regularly with the board and/or a smaller
acquisition committee to keep them informed of the acquisition's
success. Setting realistic expectations -- and monitoring against them
-- is a critical part of deal success.
A successful acquisition strategy is largely a function of
execution. For the most part, acquisitions fail because of avoidable
errors -- incorrectly pricing a transaction, taking on too much debt,
failing to uncover significant issues in due diligence or
underestimating the amount of time and effort needed to integrate
acquired companies. But with the right expertise, proper discipline and
strategic focus, M&A can be a significant contributor to growth.
Building a corporate development group is the first step on that path
to success. - Bruce R. Evans
Bruce R. Evans (bevans@summitpartners.com)
is a managing partner in the Boston office of Summit Partners, an
international private equity and venture capital firm. Since joining
Summit in 1986, he has helped build corporate development capability at
multiple portfolio companies. He has served on more than 25 boards,
including those of optionsXpress, Pediatrix Medical Group Inc. and
Unica Corp.
How Unica became acquisition-ready
In March 2006, Unica Corp. bought Sane Solutions LLC, a North
Kingstown, R.I., provider of Web analytics solutions, for $23.6 million
in cash and stock plus $4.2 million in assumed liabilities. The deal
followed a smaller acquisition, that of MarketSoft Software Corp., a
provider of lead management solutions that we bought for $7.3 million
in cash and the assumption of certain liabilities in December 2005.
Neither were huge deals in the M&A world. But they are emblematic
of our development of an acquisition capability at Unica.
Unica develops software that allows companies to track their
marketing efforts and improve them through ongoing feedback. Our
software helps companies manage marketing content, handle the
complexity of dealing with multiple marketing channels and address
customers' desire for greater control of their communications with
companies. The goals for our acquisition program mirror our corporate
goals: to maintain and to extend our leadership in the enterprise
marketing management space. After my arrival in 2005, we began to
develop that program.
Working with the CEO, the senior management team and the product
marketing and management groups, we created a three-year road map to
identify additional functionalities that we believed were critical to
our product line. We identified acquisition targets -- each having
technologies that we might want to add in the future -- and then set up
a process to continually monitor hundreds of these companies in
competitive and adjacent market segments. Together with company
management and product groups, we then set priorities for acquisition
targets.
Unica considers four types of acquisitions:
• Tuck-ins, which add functionality to our core product offering;
• Adjacencies, which extend our solutions into related market segments;
• Competitive take-outs, which increase market share by removing competition;
• Geographic expansion deals, which extend our reach internationally.
Unica identified Sane Solutions as an acquisition candidate through
this systematic process. Sane Solutions, we saw, would be an adjacency
transaction that would enable us to expand our core capabilities with
additional online customer behavior and Web analytics. It offers our
customers a way to integrate data about online and offline consumer
behavior, helping them to understand, for instance, how consumers view
online information about products and then make purchases in stores.
When we first approached Sane Solutions, the management was
considering whether to raise money or sell the company. They had
already approached an investment bank, and a number of firms were also
pursuing them. Sane Solutions chose Unica because we could compete
better in the Web analytics market and could provide them the
opportunity to leverage their software in the broader enterprise
marketing management marketplace.
We continue to look for opportunities to build product capabilities,
broader product offerings and market share through acquisitions,
periodically re-evaluating our three-year road map. M&A has become
an integral core competency at Unica -- one that helps us to better
serve our customers, and also our shareholders. -- David Sweet
David Sweet is senior vice president of corporate development at Unica Corp.
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