Now that much of the smoke has cleared and the economy is slowly righting itself, the mergers and acquisitions (M&A) arena is beginning to pick up.
However, before beginning the bidding process for potential targets, acquiring firms must be aware of several business valuation pitfalls that might doom an acquisition.
“With mergers and acquisitions rising again within the U.S., it appears that the economy is on the mend,” says Adam Wadecki, manager of operations at Cendrowski Corporate Advisors LLC. “However, acquirers must be careful not to overpay for target firms as they begin the bidding process. The use of sound business valuation assumptions can help acquirers achieve this goal.”
Comprehensive business valuations can afford acquiring firms a relevant and reliable picture of a target’s growth, strengths and weaknesses, while providing a foundation that will help develop realistic post-acquisition strategic objectives.
Smart Business spoke with Wadecki about issues acquiring firms should look for in performing valuations and how to mitigate these issues.
What issues should acquirers watch for when pursuing target firms?
It’s vital for acquirers to understand how a potential target company earns its profit and to know if that earnings stream will continue. Sometimes, a highly profitable division may have been sold, or a competitor may have gained the upper hand in the marketplace with new technology.
If margins or revenue will be impacted in the future, an analyst won’t perceive that information by looking at past or current financial statements — it requires rather active due diligence. Acquirers also need to know if the target has a consistent, stable customer base, or if there have been one-time, large orders, inventory purchases, or nonoperational gains that have distorted earnings.
It’s highly important for acquiring firms to understand the true status of the firm’s operations absent any accounting or non-operational distortions. While financial ratios can tell part of the story, executives of the acquiring firm should examine first-hand the target firm’s operations and analyze its modus operandi. They should estimate the amount of time it will take to standardize accounting, inventory and finance systems across firms, as well as whether or not the firms’ cultures are compatible.