Acclaro Growth Partners' M&A and Strategy Weblog

Gradual Improvement in Deal Flow Activity

As a business strategy due diligence consulting firm partnering with many of the leading middle market private equity firms, Acclaro Growth Partners has a front row seat on the state of private equity acquisition activity in the middle market.

In spite of a general slowdown in deal activity that began in the latter half of 2007 the middle market we support outperformed the overall market through the first three quarters of 2008. However, deal flow in all segments came to a screeching halt when the credit markets froze in September of 2008. New deals involving platform companies continued to languish through the first half of 2009 but an increase in portfolio company strategy development and “bolt on” company acquisition helped to offset the lack of platform acquisitions.

However, the good news is that the level of activity is slowly improving. A number of factors are contributing to the improving environment.

1.    An improving economy

2.    An improving stock market

3.    Improving credit markets and availability of debt financing

4.    Improved portfolio company performance

5.    Ability to place valuations on corporate assets

At the same time the structure of the deal continues to evolve in ways that differ significantly from the pre-2008 structure. Today the deal is likely to:

1.    Consist of a higher equity percentage, 50/60% versus 20/30%

2.    Debt financing remains difficult and expensive - but increasingly available

3.    Earn outs, seller financing and rollover equity are frequently components of the deal

While the environment is improving and is expected to continue to gradually improve, the days of acquisitions that are highly leveraged, cheaply financed with a high likelihood of assured returns is currently a thing of the past. With so many added risk factors and a reduced margin of error it is understandable that private equity groups are turning more frequently to third party business due diligence firms to assist them with their business due diligence and evaluation of the business thesis of the target firm.   

"Co-Invest" Options for Pre-LOI Business/Market Due Diligence

Assumptions, assumptions, assumptions...In the weeks leading up to the presentation of a Letter of Intent, potential acquirers make many assumptions about the market positioning and business strategy of the acquisition target.  Some are bigger guesses than others (how much share will the company take from competitors).  Some are more important than others (how fast will the company grow its ebitda margins).  It makes sense to prioritize your laundry list of educated guesses down to one or two that are both a.) highly critical to your valuation model and b.) heavy on the "guess" and light on the "educated."

With only one or two important market/strategy issues to resolve and a week or two to gather data, you can decide if it makes sense to outsource the research.  A research-based strategy consulting firm is likely to get the work done faster, more objectively, and with more analytical rigor than an internal diligence team can -- mainly because the outsourced option is focused on the singular task at hand.

Paying for the pre-LOI research is a risky proposition.  What if you decide not to even submit the LOI?  What if you do not win exclusivity? What if the deal never closes?   Fortunately, some research-based strategy consulting firms are conducting this highly targeted, short-time frame research on a "co-invest" basis.  In other words, they are doing the pre-LOI research at no charge to their client under the assumption that they will win a larger market/strategy due diligence assignment if their client wins exclusivity.

So, for acquirers that have already vetted a business strategy due diligence consulting firm, feel comfortable with that firm, and intend to hire that firm for the full-blown diligence work, the pre-LOI research "co-invest" option may be a good idea.

The consulting firm will certainly have a leg up on its competition, and may be just as interested as you are in this concept!

Visit www.acclaropartners.com to learn more about our capabilities.

Add-On Acquisition Trend is Growing

While many private equity groups are having a difficult time pulling the trigger on new platform acquisitions, they are making hay with add-on investments for their portfolio companies.  In some cases, the financing for add-ons is easier to line up because the original loan agreements documented the terms for add-on contingencies.  There is generally less risk associated with strategic acquisitions of competitors than investments into entirely new, unfamiliar niches.  LPs, especially in these uncertain financial times, expect PEGs to do something -- and portfolio add-ons qualifies as a worthwhile use of PEG resources.  And, at the same time, add-ons certainly place some of the burden of returns on the management teams.  So the trend is currently toward an inward focus on portfolio comapnies and their add-on investments.

These add-on acquisitions do not require full-blown market/business strategy due diligence, but they do benefit from some aspects of business strategy diligence.  Customer calls reveal the degree of satisfaction, the unmet needs of customers, the reasons for lost accounts, and the fit between customer purchase decision criteria and the company's key strengths.  Management assessments uncover a wide range of issues related to individuals, the team, and most importantly, the cultural fit between the acquirer and the company being acquired.  Operations assessments are important diagnostics of the efficiency of the processes being carried out in the business model of the acquisition target.  They can reveal the low-hanging fruit that can be picked to improve profit margins, and the costs of these changes.

In conclusion, as private equity groups carry out add-on acquisitions, they should consider elements of the business strategy diligence process.  For more information, visit our website Acclaro Growth Partners.

Drivers of Business/Market Due Diligence in 2008

Business is good for providers of business strategy, or market, due diligence.  This is surprising since overall M&A activity is down.  There are three simple reasons:

1.  Lenders, previously reluctant to interfere with the due diligence process of sponsors, are increasingly requiring lead equity sponsors to hire third party business/market due diligence professionals.  In some cases, they are even specifying particular firms.

2.  The quality of deals available at this time is down.  Acquirers recognize that there are more risks associated with today's deals.  They wisely want to know about all of the skeletons in the closet (and how to remove them) before they close the deal.  The poor quality of today's deals is increasing demand for diligence.

3.  Over the past decade, there has been a consistent trend occuring in buyout shops -- while the old mantra regarding market/business due diligence has been "that is our job," more private equity groups today are recognizing that attitude is short-sighted.  They do not have the time to thoroughly conduct all aspects of diligence, or even oversee the outsourcing of all aspects of diligence, effectively.  Moreover, they recognize increasingly that their expertise is simply not conducting the primary research calls that constitute good market/business due diligence.  Thirdly, they understand that customer calls (which are the extent of the business/market due diligence that most groups would conduct internally) are not nearly comprehensive enough.  Conversations with competitors of the target, suppliers, and market experts, can be much more revealing.  So the trend toward outsourcing is growing.

As the economy improves, the lending conditions improve, and the financial conditions of the private equity portfolio companies improve, we should see even greater use of third party market/business due diligence.

Wildcards and the Due Diligence Process

Some of the best business stories are about the company, or the competitor, who ignored the rules of the game, thought outside the box, and experienced tremendous success.   We encourage clients to develop a process for gaining and maintaining an awareness of the potential for disruptive, disintermediating, playing-field-altering opportunities.  And we encourage clients to be aware of surprising threats as well.  Otherwise unforeseen opportunities or threats are known as “wildcards.”  Acclaro developed a proprietary approach and process that assists executives in identifying, evaluating and capitalizing on them.  Acclaro’s WildCard ScoreCards™ alert senior management to these opportunities. Acclaro classifies wildcard opportunities as external awareness and internal capabilities which, once exploited, can become wildcards.  For more information, click here Wildcard Link.

Due Diligence of the Value Proposition and Brand Promise

As part of Strategy due diligence, we explore three tenets of a company’s promise of value – its value proposition or brand promise.

First, we determine if the company’s unique selling point is truly unique. Are competitors doing precisely the same thing that this company claims is well-differentiated?

Second, we assess the customers’ needs and interests to determine if the customers actually care about the Company’s presumed point of differentiation.  It may be unique and different, but if it does not motivate customers to purchase, then who cares about it?

Third, we analyze whether customers are getting the message about the unique selling point of the Company. It may have a truly differentiated offering, that customers want and need, but if the customers are not receiving the message about it, the whole offering is for naught. 

When a company passes these three tests, its value proposition and brand promise are effective.

Strategy Due Diligence

At Acclaro Growth Partners, we define our work as business strategy due diligence.  To us, that work breaks down into three "buckets:"  External, Internal, and Strategic.  Today's blog post concerns the Strategic bucket.

Strategy due diligence, typically conducted in concert with the Internal and External research, involves an assessment of the direction of the Company,  Wildcards that it may not be considering, and the Value Proposition and Brand Strategy of the Company.

By design or by default, every company has chosen a strategic direction, or its path to the future.  Our strategy due diligence work assesses the validity or efficacy of that path.  We also analyze the company's strategic planning process (if any), the fact-based inputs into that process, and the management team's perceptions of the value of planning.  The result is an analysis not only of the plan, but also the process, the inputs, and the people involved.

Human Capital and Management Due Diligence

Human capital assessments explore Recruitment, Selection, Training and Development; Leadership Development; Culture; Systems for Performance Management; and Feedback Loops.  As we conduct human capital due diligence, we examine the company’s talent acquisition and retention success; we check out training and development capabilities; we look for cultural and ethical consistency; we try to find compensation systems that reward behaviors that connect to the strategy and the corporate goal; and we test for performance feedback programs. The result is an understanding of the relative strengths and weaknesses of the acquisition target, from a human capital perspective.  This work aids in determining if there are reasons to walk away from the deal that involve management.  It also helps in the creation of a 100 day action plan for management, in the event that the buyer decides to go through with the deal.  Click here to learn more

Due Diligence of Internal Competencies and Efficiency

Core Competencies and Operational Efficiency Reviews offer insight into potential competitive advantages (of an operational, cost, or service nature, for example) that may bring incremental value to the customer.  Here, the due diligence focus is on identifying unique capabilities and operational efficiencies.  These core capabilities may involve any operation or function of the business that contributes to the efficacy of the business model.  Operational examples include procurement efficiency, internal communications between functional areas that contributes to operational efficiency, logistics and distribution efficiency, inventory efficiency, outsourcing utilization, and workflow process.  We are trying to assess how unique and differentiated the company’s operational processes are, relative to competitor capabilities.  For more background, visit Internal Operational Competencies and Efficiency

Competitor Due Diligence

Competitor Due Diligence can serve three distinct roles for buyers.  1.) Assessing the capabilities and competencies of competitors.  What are the competitors' strengths, relative to the acquisition target?  Are they more efficient in production, do they have access to more resources or people skills, or do their competencies and brand promises better match customer needs, for example?  2.)  Understanding the intentions and future directions of competitors.  Plotting the likely strategic paths of competitors against known customer needs and purchase decision criteria reveals that some competitors are heading in a very logical direction, while others are driving themselves off of a cliff.  The next step is to decide if we are comfortable with the strategic direction of the acquisition candidate, given the strategic direction of competitors.  Is it acceptable, for example, to try to compete head-to-head against a larger competitor with more resources and competencies?  3.)  Competitor due diligence can also be used to assess the broader competitive dynamics of the market.  Michael Porter suggests evaluating the attractiveness of a market based, in part, on an assessment of the risks of new entrants, substitutes, competition from competitors, competition from suppliers, and the internal rivalry of market participants.  For more insight, Click Here.