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WHAT TO INCLUDE
Your list of screening criteria can comprise a mere five items, or it can run on for 30 pages. Somewhere in between is sensible -- say, no more than several pages. Less than that is likely to be too sketchy and more than that too narrow and confusing. The following example doesn't include all the key criteria, but it covers the main ones (in abbreviated form).
You should also classify each element in terms of whether it's a "deal killer" versus a "non-deal killer." In the example below, the CEO clearly would consider the presence of a union to be a deal killer, whereas it would still be possible to buy a company that is involved with client litigation.
Example: You are the CEO of a Michigan-based advertising agency that focuses on consumer products. Company sales are currently $50 million per year, and the growth rate is 25%. This is a reasonable set of criteria for acquisition targets:
Industry focus. You want to purchase advertising agencies, especially those that focus on consumer products.
Price range. You will not pay more than two times estimated sales for the next 12 months.
Type of consideration. You have about $10 million in the bank and are willing to use some cash for the
acquisitions but want to use stock as most of the consideration. You are also willing to borrow about $10 million more.
Size. You want to focus on those companies with at least $5 million in sales.
Financial metrics. You want to buy companies that are growing sales and profits by at least 20% each year.
Litigation. You want to be careful if a company is involved with litigation with clients. This must be investigated thoroughly.
Unions. There must not be any unions.
Strong management team. Senior managers must have at least five years' experience in the industry.
The most common error in formulating buying criteria is being unrealistic. For example, if a buyer stipulates that it's looking for companies with revenue growth of 100% per year yet doesn't want to spend a premium valuation, that buyer's search is likely to be prolonged indeed. This is why it's critical to enlist a range of key constituents in the criteria-defining process.
Once again, each category will approach this step somewhat differently:
Entrepreneurial buyer. First, you need to decide what industry or industries to focus on. Again, it is probably a good idea to focus on the sector(s) in which you have the most experience. But even if you have a wealth of experience in an industry, don't assume you know all you need to. Rather, conduct extensive and intensive research, through the Internet at the library, and by talking to industry contacts.
I recommend you spend at least several months on this type of research.
Next, you might want to hire a broker or consultant with experience in the industry to gather advice and collaborate in formulating your buying criteria. You might want to spend 10 to 20 hours with this adviser.
Strategic buyer. While the CEO should lead the effort to develop the company's screening criteria, he or she should involve other senior managers, such as the chief financial officer, chief counsel, chief technology officer, and the vice presidents of sales, marketing, and distribution. It's also smart to hire an industry consultant or broker to help. As with an entrepreneurial buyer, a strategic buyer should hire these outside advisers for 10 to 20 hours.
If your company can afford an investment banker, it is the best way to go. In fact, it is quite common -- especially for public companies -- to have an investment bank on retainer at all times. In addition to helping you define screening criteria, the bank will be constantly looking for buyout opportunities. For such services, a retainer's payment is dependent on the amount of services required.
For small deals (companies with revenues below $10 million), the retainer can range from $5,000 to $10,000. For bigger deals, the retainer can be $10,000 to $50,000. And if an investment bank locates a buyout opportunity and a sale is eventually closed, the fees can be more than $1 million. (See the section "Investment Bankers" for a fuller explanation of investment bankers.)
If M&A is to play an ongoing, critical role at your company, you should seriously consider creating a position -- say, senior vice president of business development -- to be filled by someone with extensive M&A experience. This can be invaluable.
Finally, you need to involve your board of directors, soliciting their input on screening criteria. It's the CEO's role to keep the board informed -- throughout all stages of the M&A process. He or she should plan on having regular meetings -- perhaps monthly. Board members should have timely access to key financial reports to prepare for such meetings. Traditionally, boards of directors played a negligible role in most M&A deliberations. That has changed drastically over the years. By the 1980s, boards of directors were becoming more active. For example, in late 2000, the board of directors at Coca-Cola played the decisive role in preventing the acquisition of Quaker Oats.
If your company has a board of advisers, this group obviously should be consulted. Though they have no legal decision-making authority, these advisers can be a source of valuable guidance and information. In fact, when making new nominations for the directory and advisory boards, look for candidates with M&A experience.
Financial buyers. Typically, partners and associates spend several months researching various industries to target. They also will hire an investment bank, broker, or industry consultant. Moreover, several of the in-house analysts probably have the background to formulate screening criteria.
