The buyer usually initiates contact with the target company. The best method for doing so is a direct call between the presidents of the two companies. This allows for a brief expression of interest, which can be discretely broken off if the target’s president is not interested. If there is some interest, then the presidents should meet for an informal discussion, after which their management teams can become involved in more detailed negotiations. If the buyer’s president has difficulty obtaining access to his counterpart, then it is best to only leave a message regarding a “strategic transaction” or “strategic alliance,” and wait for a response. Offering to buy someone’s company through a lengthy voice mail may not be considered a serious offer, and will be discarded. A formal letter containing a purchase offer can be misconstrued as notice of a hostile acquisition, and so is to be avoided.
If there is an agreement to exchange information, then both companies must sign a non-disclosure agreement (NDA). Under the agreement, they are obligated to treat all exchanged information as confidential, not distribute it to the public, and to return it upon request. Otherwise, even if the acquisition does not occur, the buyer will retain all information about the target, and could use it for a variety of purposes in the future. Worst case for the target, its confidential information could be spread around the industry, with adverse consequences.
The price paid will be founded upon a detailed valuation analysis that is conducted by the buyer. As a baseline, this valuation uses a five-year discounted cash flow analysis, as well as an estimated termination value for the selling entity at the end of that period. However, it is best to supplement the analysis with a low-end breakup valuation, as well as a valuation that is based on prices recently paid for comparable companies. The later valuation works best for a high-growth target that has minimal cash flows. By creating and comparing a range of these valuations, a buyer can derive a reasonable price range within which it can negotiate with the target.
After the parties have discussed the acquisition and arrived at the general terms of a deal, the buyer issues a term sheet (also known as a letter of intent), which is a non-binding summary of the primary terms of what will eventually become a purchase agreement.
The next step in the acquisition process is due diligence. Thus far, the buyer has developed a valuation based on information supplied by the target, and which the target represents to be accurate. The buyer must now ascertain if this information is indeed accurate, and also investigate a variety of other financial and operational issues.
If flaws or weaknesses in the target’s finances or operations were found during due diligence, the buyer must decide if it should further negotiate the terms initially described in the term sheet. It is also quite possible that the problems discovered are of a sufficient level of severity to warrant abandoning the deal entirely. This is an excellent time for the buyer to stop and have the senior management team conduct a high-level review of the acquisition team’s work, with the intent of making a go/no go decision. The review should dig into the assumptions used for valuation modeling, the level and types of identified risks, competitor reactions, and so on. This is a valuable exercise, because too many buyers become caught up in the bureaucratic process of completing an acquisition, and do not stop to think about whether it still makes any sense to do so.
If the buyer elects to proceed, then the parties must negotiate a purchase agreement. This document describes the form of the acquisition, the price to be paid, and the representations of both parties regarding their condition and obligations prior to closing. Also, if the target is concerned about deferring income tax recognition, then the purchase agreement can be structured to achieve that goal.
If both parties prefer to conclude an acquisition with utmost dispatch, it is possible to simultaneously conduct due diligence and create the purchase agreement. However, both parties must be aware that problems found during due diligence will likely result in alterations to the purchase agreement of an iterative nature. Thus, what the parties save in time may be expensive in terms of additional legal fees. Under no circumstances should the purchase agreement be signed before the due diligence has been substantially completed, since major problems with the target company have a way of coming to attention at the last moment.
If the buyer is a larger company with a substantial ability to control market prices, then acquiring another company in the same industry may subject it to government anti-trust laws. If so, it must notify the federal government of the proposed acquisition, and wait for government approval before proceeding. The government may deny the transaction, or require some restructuring of the combined entity, such as the divestiture of some assets.
The final step in the acquisition process is the integration of the two companies. This process is facilitated by an integration team, but the actual integration work is conducted at the line manager level, where those directly responsible for certain operations must integrate operations. Integration is not necessarily a one-sided, traumatic integration of the acquiree into the buyer. If the acquiree is a vibrant, well-run company, it is entirely possible that the buyer will shift some of its operations into those of the acquiree, sometimes to such an extent that it is subsequently difficult to ascertain who acquired whom.
In summary, the acquisition process flow involves an initial expression of interest, a valuation analysis that is likely to be repeated as more information about the target becomes available, a term sheet, due diligence, a purchase agreement, and finally the integration of the two entities. The odds of successfully completing each step decline as the process proceeds, so that a buyer may initially communicate with several dozen companies, issue term sheets to a quarter of them, and eventually conclude a purchase agreement with just one.
The Acquisition Process