'Cruise Like A Strategic' ??

"How robust will my M&A auction be?" This is a common question that often leaves sellers pondering. Seasoned advisors can sometimes predict lukewarm buyer interest, but occasionally even the most experienced investment bankers are perplexed by the lack of enthusiasm from buyers, particularly strategic acquirers (a group often referred to as "strategics"). Why does this happen, and how can it be avoided? Reflecting on my experience of participating in over 300 M&A auctions as a strategic buyer, I couldn’t help noticing some recurring themes that had turned my team from being “very hot” on a target to lukewarm at best. I firmly believe that many of these issues can be prevented if addressed early.

1. Target selection

Private equity firms are lauded (and rightfully so) for their meticulous industry research to identify key themes for their target selection process. However, what’s sometimes overlooked is the vision for how these targets will fit into their respective industry ecosystems after evolving under PE ownership. This is particularly important for strategic acquirers whose day-to-day business could be disrupted by a newly acquired company. Strategics often label such targets as “lacking a strategic fit.”

To address this, it's prudent for private equity investors to think ahead and compile a shortlist of prospective strategic buyers (let’s just call them “prospectives”) at the early stages of target evaluation rather than waiting till it’s time to sell. This prospective thinking will serve as an additional dimension for PE owners to determine whether a target has the potential to become a coveted asset for strategics down the road. Watch out, however, for targets with “good bones" (e.g., excellent technology, a strong position in a growing niche) that get overlooked or even labeled by strategics as “lacking a strategic fit".?

Keeping prospectives in mind from the get-go will, on the one hand, help navigate towards opening new avenues for growth, such as breaking through hard-to-crack new revenue channels or customers, securing access to key talent, and adding other key capabilities that prospectives are missing. On the other hand, it will help avoid value-destroying pitfalls, such as creating significant customer overlap with prospectives, being dependent on a single niche vendor, or getting entangled in a market vertical where prospectives will face conflicts of interest. These are just a handful of examples.

2.? Shaping the target into an attractive asset

The notion of prospective strategic buyers should gain further prominence during the target's buildup phase. Significant moves, whether organic or inorganic, should be carefully deliberated with the prospectives in mind. These include:

• Expanding or eliminating product or service offerings
• Entering or exiting a new geographic market
• Evaluating partnerships with customers, suppliers, or competitors
• Overhauling a large-scale IT system (e.g., Workday, Oracle, SAP)
• Changing a key supplier or a professional service provider (e.g., audit, tax, accounting, legal, IT security)
• Exploring new markets like government, academia, or non-profit

Beyond growing organically, most PE portfolio companies grow through a series of acquisitions (add-ons, bolt-ons, and tuck-ins). Integrating these acquisitions as soon as feasible, ideally within three to nine months of closing, should be of paramount importance. Failing to do so makes your portfolio company less attractive, not only to strategics but also to many PE buyers. Although integration progress can be challenging to measure, the absence of integration often leads to unrealized cost and revenue synergies, low employee morale (e.g., “us vs. them” polarization between unintegrated entities), and poor customer perception (e.g., multiple disparate touch points with customers).

3.? Plan early, and don’t lose bidders before your auction reaches a crescendo?

No two deals are alike when it comes to the preparation needed for a sales process. It’s important to set the right timeline for each situation. First, ensure that all in-progress add-on (or bolt-ons, or tuck-in) acquisitions are substantially concluded before approaching potential buyers. Few things are as disconcerting as when a strategic must seek internal approvals to put in a competitive bid, when 20% of the target value depends on a pending acquisition, for which a letter of intent (LOI) was signed a week prior. A longer timeline for an add-on to close adds to execution complexity and gains more doubters of the deal's integrity and value, making strategics reduce their bids or even lose interest altogether.

Second, align your portfolio company’s team and capabilities well in advance of the sales process. This means filling in key roles, particularly those specific to the company’s industry, such as quality assurance, regulatory affairs, data sciences, and domain experts. A lack of key talent may be perceived as a weakness in the corresponding area, and sourcing talent can be costly and time-consuming.

Lastly, balance your fast-moving PE offers with those yet to come from their strategic counterparts by slowing the process down. Strategics often require more time and information to commit to a deal, but their synergy potential often leads to higher bids. Particularly avoid accelerating the process at first sight of an aggressive PE offer. Doing so may backfire. It is a well-known buyer strategy of coming in very aggressively on the purchase price and then, once the seller loses the negotiation leverage of an auction, chipping away at the value by negotiating and contesting many economic levers (e.g., quality of earnings deficiencies, working capital definition, deferred revenue, treatment of trapped cash, debt and debt-like definitions, special indemnities, holdbacks, true-up disagreements, and many, many others). It is exactly these “break-away” deals that fall apart with higher frequency.

I have frequently witnessed PE bidders outbidding strategics, and there have been even instances where strategics are not even invited to auctions. While one can get away with this approach in good times (often spectacularly so), following this strategy can backfire in more challenging times. A better approach would be building something of value for strategics and then attracting and retaining them in auctions (along with PEs). Their involvement ignites competition among bidders, unlocks significant synergies (both favorable for higher purchase prices), and, increasingly, many private equity buyers in today's landscape are strategics themselves (via their portfolio companies). I believe that adopting a strategic buyer's perspective, especially when implemented early, can put a private equity firm on a strong and lucrative footing, setting it apart in this fiercely competitive and, at times, challenging market.

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Eric Hakimov is an acquisition and investment professional with over 17 years of experience on both the buy and sell sides of M&A ( 高盛 , 摩根大通 , Monument Capital, 艾昆纬 and Labcorp ). He had represented buyers and sellers as an investment banker earlier in his career and then became a private equity and strategic buyer/investor.