When we buy a business we not only want to know what we are getting, but we want to know what we can do with it – that is, what potential it has.
The greater certainty we have about being able to execute on improving the business, the more willing we will be to take on the acquisition. Sometimes it is simply a matter of acquiring a competency or capacity that will enhance our existing business, but for lots acquirers it is simply bringing a business up the curve on industry best practice.
What you really want in an acquisition is a high probability of achieving excess gains. That is, being able to generate a level of profitability over the level that the business had achieved before acquisition.
The newly achieved excess can generate additional cash to pay down acquisition loans or increase the value of the business well beyond the purchase price. While there is no silver bullet to such gains, there is the tried and true method of using benchmarking to select a target business that has almost certain upside.
Benchmarking is a technique used to compare like businesses within an industry over a wide range of performance measurements. This is particularly powerful where many businesses are very similar in their product/market interface and structure. The benchmarking data will indicate the range of performance of a large number of similar businesses. The ideal acquisition is where an acquirer has a knowledge of best practice within an industry and is able to implement the changes needed to bring a business up to best practice level.
Don’t imagine that you have to do all the heavy lifting by yourself. Within any industry there will be a source of advice and consultancy on industry best practice.
Providing there is enough margin in the acquired business to justify the additional investment, recruiting some proven executives and contracting in industry expertise should enable you to generate those additional profits.
Clearly there is an advantage if you have a background in the industry and have worked for one of the high performers. Knowing where to direct your energies and investments to get momentum in your productivity improvements will save you time and generate additional cash faster. However, watch out for those firms that are so far behind that they have lost the capacity to come out of the trenches. You want to look for businesses that are well managed but lack the knowledge of best practice rather than one which has run out of steam.
Your investments need to go into incremental improvements rather than a drastic overhaul. You want to find a business that has good foundations and will benefit from renewal rather than one where there are fundamental flaws.
Look for businesses that are poor performers across a range of metrics where you already know how to make the adjustments but that has the resilience to allow you to spend the time doing it. Watch out for the business where your money simply delays the ultimate sinking.
Benchmarking is an essential tool for screening target acquisitions and, if used well, will pay off in enhanced post-acquisition profitability