Resources and Tips / What should I look for when acquiring a company?

What should I look for when acquiring a company?

By Grant Thornton LLP

6 min read

The Canadian business market continues to be red-hot, with the M&A tally for this year already exceeding $255 billion, over double the annual average of the last half decade. Incorporating M&A into your growth strategy can help to consolidate your position in the market. Perhaps you see growth opportunities in a business with technology that could automate current operations or you want to buy out a competitor to grow market share. Whatever your reasons, you’ll want to define them clearly, find a good acquisition candidate, conduct due diligence, determine how you’ll finance the deal, and consider tax implications.

 

Define your goals: Why am I doing this?

Think about why you’re looking to do an acquisition. An acquisition may make sense if you want to grow an existing business and are hoping to accomplish one of the following:

  • acquire technology and/or talent
  • expand your geographic footprint
  • gain access to supply and distribution channels
  • grow your product or service offering

Start by defining goals that align with your motivation. What kind of company do you want to acquire? Why do you want it? Draw up a list of screening criteria to stay on target as you are assessing options. This might include:

  • the business’ stage of life
  • its industry
  • how much capital you’re willing to spend
  • the valuation multiple
  • customer concentration
  • geographic market

Find a good acquisition candidate

Once you’ve determined your goal and established your screening criteria, you’ll want to find a good acquisition candidate.

Start by getting the word out to people who might know which businesses are for sale and have access to unknown opportunities, like lawyers and accountants. You can also leverage relationships within your target industry to help uncover leads. And remember that the market isn’t limited to businesses that are explicitly looking to sell—working with an advisor could give you access to new networks and opportunities.

Confirm intent

Once you’ve found a business you’d like to buy, establish essential terms with the potential seller by writing a letter of intent. Make sure you’re on the same page early in the process to avoid frustrating expenses and missteps down the road. A letter of intent should detail the basic terms, but the more specific you can be the better. Terms can address:

  • Are you buying a whole business, or part of the business?
  • The deal structure—are you buying assets or shares?
  • Will the seller have responsibilities post-sale?
  • Will there be a vendor earnout provision, and what will it be based on?
  • What happens with current management?
  • How long do the parties have to close the deal?

Conduct due diligence

Next, conduct a due diligence to familiarize yourself with the business you’re planning to buy—acquiring a company means taking on the good with the bad. How will the target company’s competitive position and other attributes align and integrate with yours? What are the vendor’s reasons for selling? Focus on the things that will have the greatest impact—typically the company’s financial and legal positions.

Review the valuation multiple. Ideally, the value you pay for a business today matches its future value, especially during competitive auctions.

Consider its debt level, service contracts, and financial statements. This is also the time to identify any legal liabilities and risks and address them prior to the sale to avoid unpleasant surprises after.

Determine how to finance the deal

Once you’ve defined your goals and found a target company, you’ll need to decide how to pay for the purchase. Typically, this includes some sort of financing with various types of equity or debt options.

Equity options:

  • use cash on hand
  • leverage your business assets, like real estate
  • get equity partners involved, such as friends, family, or private equity firms

Debt options:

  • leverage assets within the target business
  • offer a vendor take-back, which is a percentage of the purchase price paid over time with interest that allows you to finance a deal without having to search the debt market and pay fees
  • pay an earnout, which is a portion of the purchase price that’s paid to the vendor if the company meets certain performance benchmarks after closing the deal

Consider each option’s pros and cons to determine what will work best for you. Generally, equity comes with a lower level of risk—but is often more expensive. Debt can involve a lower cost to your business, but also carries higher levels of risk.

Keep an eye on the future. There may be opportunities to refinance after you’ve acquired your target. Any additional value created by the business can be leveraged for your next acquisition.

Think about the tax implications

Consider the tax implications of the purchase during candidate identification, negotiations and due diligence to help you spot opportunities and mitigate risks. Give thought to how the target business operates and how this can fit with your own tax structure.

Work with your tax and legal advisors to outline the deal structure during negotiations. Consider whether you’re buying all or just part of a business, and whether you’re buying its assets or its shares. You can also establish the basic terms—and tax consequences—for any vendor earnouts.

Next comes the tax diligence phase. This review isn’t just about finding liabilities—if done properly, it can also find opportunities such as favourable tax attributes. This process should include more than just a review of past tax returns. Other things to consider include the tax implications of the company’s human capital, information technologies, and core accounting systems. You’ll also want to meet with tax people on the vendor side, as the best results will come from a cooperative effort between both parties.

Lastly, the use of representations and warranties insurance has increased significantly over the past few years, and you may wish to use it as part of your deal. Just remember that the insurance company will do a due diligence on your due diligence, so it’s not a short-cut to avoid taking this step yourself.

Have questions? Let us help.

Acquiring a company requires significant planning and expertise—but you aren’t alone. We understand the complexities associated with M&A and will work with you to find the best way forward. Whether you’re still deciding if an acquisition is right for your business or are actively searching, our advisors are in your corner – learn more here.

The information contained herein is intended for general informational purposes only and does not constitute as advice or opinions to be relied upon in relation to any particular circumstance. For more information about this topic, please contact your Grant Thornton advisor. If you do not have an advisor, please contact us. We are happy to help.

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