Fall 2022 End Term Finance Exam Answers on Acquisition Search from the University of Iowa
You can ace your finance exams by using our solved examples to prepare and revise for your paper. We have compiled some questions on the topic of acquisition search, mainly focusing on developing criteria, generating opportunities and preliminary screening. You can use these blogs to help you ace your test. We also have qualified finance exam takers that you can hire to complete your test on acquisition search.
What is the typical criteria include when an acquisition is considered principally for commercial reasons?
If an acquisition is being considered principally for commercial reasons, typical criteria are likely to include the following:
- Type of industry/activity
- Management and workforce
Acquisitions intended to increase market share must be in areas of activity closely related to the acquiror's existing business. If the objective is growth in a general sense, companies engaged in different areas would be considered. Frequently, a company is prepared to consider a potentially more difficult acquisition in a business with which it is thoroughly familiar. If an acquisition in a new area, it must be capable of 'standing on its own feet'. A loss-making company or a company with management problems might not be considered whatever its other attractions.
If the acquiror is seeking benefits related to synergy, it will concentrate on the attractions fit of business. A strong manufacturer may be looking for an organization with a widespread marketing and distribution network. A company seeking to secure supply of a key component or additional sales outlets will focus specifically c these areas.
The last type of commercial motive discussed. By definition, this will involve the acquiror actively seeking a business with significantly different characteristics from its own, perhaps in a totally unrelated industry. Criteria related to type of industry and activity may be defined in a positive or in a negative way. A company may take a positive decision to emphasize high technology or overseas markets. On the other hand, a company may decide it will in no circumstances consider an acquisition in say property or shipping. This type of rule should not be allowed to degenerate into dogma. A ruling which is soundly based when established should be reviewed periodically as business conditions change and the company itself evolves.
Acquisitions undertaken primarily for commercial reasons are vulnerable to the reactions of management and workforce. Unless a reasonable degree of co- operation can be established, many of the anticipated benefits may not be realized in practice.
Acquirors may decide that they will not consider an acquisition of this type unless management has been proved to be competent. They may also seek assurances that the majority of the senior executives are willing to stay.
The attitude of the workforce is perhaps less likely to be one of outright opposition but nevertheless problems can occur. If the acquiror has not previously had to deal with a unionized labour force, he may be unwilling to acquire a company whose workers are organized in this manner. Lack of experience in negotiating with unions may act as a deterrent. The acquiror may also be apprehensive about the spread of unions to his own organization.
Acquisitions can be made for either financial, customized or size reasons. Discuss these reasons in detail.
If an acquisition is intended principally to improve the financial position of the acquiror, strict financial criteria will be applied. Financial criteria are amongst the most difficult to establish in a way which does not prove to be counterproductive. If the returns required are set too high or applied too strictly, an ideal acquisition target may be defined which in reality is never encountered.
Few people can resist a bargain. However, a management which insists on buying companies at below market price may find that they make no acquisitions. When they do finally succeed in concluding a deal, the results may be disappointing. The emphasis on apparent cheapness can cause business weaknesses to be overlooked.
Asset strippers aim to acquire companies at a discount to net assets. Allowing room for negotiation, a target may not be of real interest unless the discount is substantial, say one-third. Although it may seem that only a forced seller would accept such terms, there is scope for a good deal of disagreement in buyers' and sellers' estimates of what assets are actually worth.
If increase in earnings per share is paramount, it is unlikely that a company currently making losses will even be considered. Many companies are prepared to give an acquisition say two years to recover to a position of reasonable profitability. Unless some latitude is allowed, an acquiror will rule out the possibility of making a potentially attractive acquisition at the low point in a company's fortunes.
Some acquisitions are used to improve the gearing of the enlarged group. In this case a company which is already highly geared or one which is facing substantial capital commitments is unlikely to be considered. If an acquiror's strategy is to issue highly-rated shares or other paper, the willingness of vendors to accept such paper may make an acquisition attractive which would not meet normal criteria. If a vendor has a pressing need for cash, this is likely to rule out the use of paper except in circumstances where a vendor placing can be arranged.
In addition to financial and commercial aspects, other more specialized factors are often involved in acquisitions. This will make setting criteria a simpler process. For example, if a company is being acquired for its management, stock exchange listing, its tax losses or a license it holds, then the criteria more or less set themselves. If an acquisition is being made as a defense against a takeover threat, it can be judged purely by its effectiveness in this respect. One extremely important factor will be sheer availability at short notice.
In circumstances where motives include subjective elements such as empire building, criteria are unlikely to be set in an organized way. The motive may not be fully realized by the decision makers themselves, far less openly acknowledged.
There are likely to be fairly obvious limits to the size of a possible acquisition. Even in the era of junk bonds and leveraged buy-outs, there is little sense in the average company drawing up a complex scheme to take over General Motors. It is also useful to set a cut-off point at the lower end of the scale. There is a large fixed element in the time and expense in evaluating an acquisition. The acquisition must be of a certain minimum size to justify the effort involved. A series of small acquisitions ties up management time without making a significant difference to the performance of the group.
Size may be defined in different ways. A trading company may have an impressive turnover figure without a large asset base. A company with a big balance sheet if it is in financial difficulties or is heavily geared may not be expensive to buy.
When an acquisition is being done due to size, what is the criteria that the acquirer may wish to consider?
An acquiror may wish to consider maximum and minimum size criteria under various headings:
- Purchase price
- Turnover or value added
- Assets, liabilities and capital requirements
- Market share
- Number of employees, diversity of markets served and spread of business
What is the most a company is prepared to pay or can afford to pay? This figure may depend on the possibility of using paper as part of the consideration.
These may be the most useful indicators of how substantial a business is being considered. Care is required as some companies may have a high turnover with little value added whereas others may have a smaller turnover but with value added representing a significant proportion.
The most immediate impact of an acquisition is frequently on the balance sheet. Key ratios may come under pressure. An acquisition must be judged not only in terms of its initial effect (including the price paid) but taking into account any additional capital which may be required. Weakness in capital structure or heavy capital commitments may have been part of the reason the company was vulnerable to a takeover in the first place.
There is a school of thought who believes that controlling a substantial proportion of a particular market is the best guide to whether a company can survive and prosper in the long term. A company with a toehold in its market may eliminated if a period of intense competition is encountered. An appropriate minimum criterion for percentage market share will depend on the industry structure.
Most companies making acquisitions establish a minimum rate of return which the target should be capable of generating. The minimum hurdle rate of return may be reduced if the acquisition is in a familiar business or increased if it operates in high risk areas of the world. Some discretion must be exercised as to the year in which this target return is intended to be achieved.
A further way of measuring size is by reference to the numbers of people employed and the numbers of markets served or products produced. This may be taken as a proxy for the complexity of the business as a whole. The more complex an acquisition, the more likely it is that something will go wrong.
Companies develop different procedures for getting suitable proposals when it comes to generating acquisition opportunities. Discuss the internal and external sources of acquisition opportunities
- From non-specialists
- Merger and acquisition unit
The senior staff of a competently run business know more about that area of business and the major participants in it than an external professional. Consequently, the best ideas for acquisitions within a company's existing sphere of business will often come from the staff themselves. Management should try to provide some forum or channel of communication so that ideas can be put forward and discussed, with some credit and involvement in analysis going to the originator. As executives may be more conscious of brand names and marketing networks than corporate organizations, assistance in providing information o the corporate structure of the industry may stimulate the flow of ideas.
In addition to opportunities identified through involvement in a particular business field, the company may also establish a specialist merger and acquisition unit. One of the functions of this unit will be to search publicly available information to find targets which fit the criteria which have been laid down. Except in a very major conglomerate, such units are unlikely to be entirely independent or engaged solely in merger and acquisition work. They may be located for example in the treasurer's or controller's departments or within a corporate planning function. Such arrangements promote economical use of manpower. However, the approach of the staff will be colored by the environment in which they find themselves. They will be more effective if they act in an independent entrepreneurial way to locate the widest range of opportunities.
Companies rely on external sources to supply or prompt many of their acquisition ideas. One obvious source of possibilities is simply to advertise for them. In practice, unless the type of acquisition is a standard one, sellers will be reluctant to reply to such an open approach. It seems that a modification of Groucho Marx's law applies, that you would not wish to buy a company whose owners answer your advertisement.
The role of the intermediary is well established in the merger and acquisition field. Intermediaries may be experienced and negotiators. Often they are senior accountants or lawyers with expert knowledge of certain industries. are pure merger brokers whose modus operandi is to match buyer and seller without necessarily knowing much about either. Investment and merchant banks have access to a continuous stream of proposals through their professional and client contacts. They can offer a package of services, including provision or introduction of suitable financing and the placing of securities in support of an Many significant business empires have been built up through a close acquisition. association with one or more merchant banks. The development of a personal relationship is fundamental. As a merchant bank becomes familiar with the philosophy of an acquiror, it can increasingly anticipate his reaction. If the group significant client, the merchant bank will take the initiative in presenting proposals in order to keep the client relationship active. A merchant becomes a bank is not as transaction orientated as a merger broker but will still seek to get a transaction moving as quickly as possible. A client who is known to react swiftly and is prepared to pursue opportunities in spite of the inevitable uncertainties will soon gain a favored position.
Receivers and liquidators are a productive source of potential acquisitions. Unlike many sellers, they do not have any emotional attachment to the businesses or assets it is their responsibility to realise. They are frequently under time pressure. Not only are they firm sellers but they may be willing to accept a discount on the open market value in return for speed, certainty and simplicity of the transaction.
Relationships with outside professionals are usually conducted at a senior level. A company may also promote contact between its analysts and the junior staff of merchant banks to create an additional channel of information. Merchant bank executives are usually allocated on a client basis and competition to present good proposals to clients is fierce. Which client sees which opportunity first may be a matter effectively settled at a fairly junior level, allowing the more senior executives to remain above the fray.
What are the factors that play a role in the preliminary screening process when seeking suitable acquisitions?
- Matters of judgment
There may be unanticipated commercial consequences arising from an acquisition, particularly in an industry where vertical integration is involved. An arm's length commercial relationship between supplier and customer frequently proves easier to handle than the relationship between parent and subsidiary.
Rival suppliers may feel that a competitor who becomes a member of the group will always receive favored treatment.
If an acquisition takes a group into an area in which its own customers are active, the business put at risk may cancel out the expected benefits of the acquisition. Existing participants in the industry may feel that their supplier is trespassing on their own preserve. The resultant loss of business may make the uncertain benefits of entering a new field too costly.
An acquisition may be intended to secure the expertise and business generating abilities of its management. However, loss of independence and changes in working environment may result in disenchantment with a large group. In a service business, for example advertising or insurance brokerage, the members of the firm acquired may be very capable of leaving to set up on their own. Although it may be possible to impose certain restrictions on them for a period of time by means of service contracts or other agreements, this can result in the almost equally unsatisfactory position of a senior management with no real commitment to their job.
The intangible aspects of taking a company into an area in which it has no previous experience should be examined at an early stage. Acquisitions of companies in sensitive areas such as broadcasting and gambling can lead to official scrutiny of a group which may not have had to deal with regulatory authorities in this manner. Companies engaged in material litigation can absorb significant amounts of senior management time. Entry into overseas markets by way of takeovers of domestic companies may spark off a xenophobic reaction. Management should assess whether an acquisition can be concluded on an agreed basis or whether it will be contested to the bitter end. A contested takeover can provoke a counter-attack on the acquiror's financial position, management performance and business ethics. Unless an acquiror has the stomach for this kind of infighting, contested takeovers are best avoided.