For those who have decided to sell their business, doing the necessary research on how to attract buyers can be daunting, if only because of the paucity of publicly available information. Fortunately a just-released, high profile report has done much of the legwork and reveals what makes some businesses far more likely to become active acquisition targets than others.
The ‘Attractive M&A Targets: Part 1 - what do buyers look for?’ report by City of London University's Cass Business School and virtual data room software provider Intralinks examined 9,445 medium to large individual private firms between the years 1992 and 2014. The research findings provide predictive insights into which companies are likely to become acquisition targets and what the most telling financial indicators are.
The most notable finding is the fact that private target companies were found to be significantly more leveraged than private non-target companies. The report states: ‘...our study finds that private target companies on average have over three times more leverage, as measured by their debt/EBITDA ratio than private non-targets. This difference appears well-established and has persisted over the five M&A cycles since 1992.’
The next most important attribute common to many acquired private companies is their size. It appears that when it comes to acquisitions, size does matter. Private target companies were found to be significantly larger than private non-targets. The report reads: ‘pre-2008, private targets were on average 14 per cent larger, as measured by their total sales, than private non-targets. Post-2008 the difference in size between private targets and private non-targets increased dramatically: private targets are now almost 2.5 times larger than private non-targets indicating that acquirers of private companies see size and scale as a significantly more important measure than before.’
Philip Whitchelo, vice president of strategy and product marketing at Intralinks, explained: “We found that high leverage and large size are the two most statistically significant predictors of a private company becoming an acquisition target.”
Why leverage?
Highly leveraged firms are an attractive option to private equity investors because high leverage ratios provide a greater opportunity to buy or invest in large businesses. Put simply, high leverage usually means lower valuations and private equity firms are often in the position to take on risk. Highly leveraged businesses with the potential to improve offer the opportunity to create value.
The Cass/Intralinks report found that the companies in the top two deciles for leverage had a 28 per cent chance of becoming an acquisition target. The researchers found a striking relationship between rising levels of leverage and the probability of becoming acquisition targets. The report states: ‘In our regression analysis, high leverage is the most statistically significant predictor of the probability of a private company becoming an acquisition target.’
On average, private target companies have over three times more leverage than private non-targets (as measured by their debt/EBITDA ratio). This difference is well established over five consecutive M&A cycles since 1992.
Investors in highly leveraged private companies are looking, ideally, for a business that possesses strong management teams, good employees and the potential to flourish with increased investment.
A typical example of a highly leveraged business being snapped up by an investor was the takeover of Panasonic Healthcare by KKR a few years back. The director of the Cass Business School’s M&A Research Centre, Professor Scott Moeller, explained that Panasonic Healthcare had a “high probability of becoming an acquisition target” based on both its size and its levels of leverage.
Following the takeover, Panasonic’s president Kazuhiro Tsuga, stated: “we highly respect KKR’s industry expertise and its capability to provide necessary growth capital”.
At the time of the deal the Financier Worldwide publication explained further why investing in Panasonic Healthcare was a wise move: “In each of the last two financial years Panasonic has lost more than $7.5 billion. By contrast Panasonic’s healthcare division generated sales of $1.06 billion in the financial year ended March. The unit’s strong performance is even more impressive when considered within the context of Panasonic’s wider economic outlook”.
Why Size?
Firms that are larger, in terms of their total sales, are more attractive to investors and buyers as they offer the opportunity to acquire a business with a substantial market share, established management structure and solid customer base.
The appeal of a large business is perhaps most noticeable in the energy industry, which is among the most active industries when it comes to M&As. The Cass/Intralinks report explains that energy firms are, in fact, among the most likely to become targets for acquisition - with twice the likelihood of being snapped up by a buyer than firms in other industries.
Intralinks spoke to the head of M&A in an Italian public firm, who explained: “The size of the business is most important to us. We believe in maximising our energy capacity and so acquiring bigger energy producing assets makes us more renowned in the energy industry. Thus we are able to overcome competition and achieve a greater market position.”
Overall, private companies in the top and bottom deciles for sales are 29 per cent more likely to become acquisition targets than other businesses.
Using this information when looking to sell your business
If you are looking to sell your business, realise the process takes time. Ensuring your company is in the very best condition to attract buyers could take years, so forward planning is essential.
Analyse whether increased borrowing will help you build sales and how the cost of interest will be covered. The research suggests that there may be a case for building sales at a faster pace than profits if a trade sale is part of your strategy.
Understand where your company sits in its own business cycle, your industry’s business cycle and the general economic cycle. If possible, time your sale to coincide with the peak of its cycles.
Streamlining your operations and making necessary improvements to your accounts ledger can help to clearly demonstrate that you are in a solid financial position. Consider small changes that can improve your financial position. Reduce stock levels, rework contracts, get rid of unnecessary equipment and even look at reducing costly and ineffective staff perks. At the same time, if you have high levels of debt, the report suggests that keeping your staff and management team loyal and strong is an essential part of attracting investment.
Timing is key to maximising your chances of attracting a buyer and getting a good price for your business. With foresight, planning and attention to detail, you will be able to ensure your company stands out in the market and attracts buyers.
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