Author: Dr Christoph Thierolf, Head of Corporate Advisory, Commerzbank Corporate & Markets
There comes a time for almost every business when you’ve done as much as you can at the size you are. You’ve saturated your current markets and growth is slowing. You realise that if you are going to grow further then you need to take a major strategic leap, whether that’s a merger, an acquisition or a private equity financing.
With at least half of M&A transactions estimated to fail to yield their anticipated results, this can be a daunting step. So what are the questions you need to be asking to make sure your next move is the right one and managed on your terms? Below are some of the most important issues for European small and medium-sized enterprises (SMEs) to consider on the path to M&A activity.
1. What’s our medium to long term strategy?
First off, assuming that future growth is seen as desirable, what does management agree to be the most effective means to achieve it? Will growth be best achieved by expanding the same offering into new markets and territories, or by expanding the offering itself into new products and services?
Simply expanding what you already do into new territories is, generally, the easier proposition (unless your business is in a sector such as healthcare service provision which is hard to expand beyond its own highly regulated market). The question then is whether you can build your market presence on your own or need a strategic partner in other markets to provide your distribution platform.
Expanding your product offering is a bigger challenge. Many European SMEs — particularly in the engineering sectors — have developed a prominent regional or even global market position by being specialists in a highly niche market. They therefore need to consider how they can now find a partner or franchise to broaden their product or technology portfolio without diluting their core expertise.
2. Which new markets should we be considering?
Global expansion is easier than it’s ever been in terms of supportive cross-border legislation and interested overseas investors. But when you have the whole world to consider, identifying which markets to target still requires substantial analysis.
Developed markets where demand is already strong are often also saturated markets where your long term growth opportunities may not merit substantial investment. On the other hand, less developed markets can offer strong growth potential but you may have greater political, market and economic risks to contend with.
Before entering any new market, it’s crucial to take the time to assess the specifics of the country or region in terms of its regulation but also production, cultural and environmental aspects.
Bear in mind it’s very difficult to understand the structure of a market from outside. We ideally recommend that a firm free up resources to spend some time physically in a target market. If that’s not possible — as is often the case with small firms — make connections with similar businesses operating there and learn from their experience.
3. Which markets will support our value chain?
While a partnership in an emerging region such as Latin America, for example, can provide a vast new customer base — the issue is whether it can also deliver all the quality you expect. In many cases, broadening into new territories can be an opportunity to secure resources and manufacturing on even more competitive terms. But you need to be sure that any move is genuinely enhancing your value chain, not compromising it.
4. How can we ‘test out’ the waters?
Particularly for family-owned businesses, considering merger or acquisition can seem a huge step and one that firms will frequently defer. We often advise clients to start a very open discussion with a potential partner, invite them to their home market or travel to theirs. Once you’ve understood a business you can think about the potential structure of any partnership.
The key is to test out a very modest agenda initially — say, for a specific product or a small new customer market. Once that appears to be working well, the next step might be to form a joint venture, then ultimately progress to a structural consolidation.
A challenge is retaining the control over the areas you want in terms of product or marketing, but still giving your new partner sufficient freedom so you can fully capitalise on their platforms, ideas and market capabilities. This requires an agreement that makes clear each firm’s respective roles and responsibilities and what will be managed jointly.
5. Do we agree what ‘success’ looks like?
While it’s important to be open-minded about the form of an initial agreement, any test partnership should nonetheless involve clear targets and key performance indicators (KPIs) to measure whether the relationship is proving successful.
The lead times in new markets are such that sales-based or client acquisition-based KPIs can take a year or more to filter through so patience is required. Nonetheless, clearly defined and jointly agreed indicators that can be tracked and reviewed will put a partnership on the right footing. Moreover, any potential partner who resists the implementation of clear performance metrics should be treated with caution.
6. Do we recognise when a partnership isn’t working out?
Just as firms can be resistant to branching out, companies that do take the leap can be equally slow to acknowledge when a relationship has hit problems or requires a substantial revision of terms.
Assuming you have agreed on a sound plan and appropriate KPIs, it’s crucial to act if something goes wrong, management fails to agree or targets are persistently missed. Do not waste precious time trying to justify a failing partnership because of the effort and resources already spent on the venture.
7. Do we recognise when it’s time to merge formally?
For family-owned SMEs in particular, a merger or a takeover can be a contentious prospect with emotion often clouding commercial judgement. Questions that will determine whether an outright merger, acquisition or disposal is prudent include:
- What is your long term plan and will any other option other than a merger/takeover achieve it? Are you looking at a merger simply to solve temporary rather than permanent issues (e.g. a cyclical downturn)?
- Is there already a clear strategic fit between your plan and that of the potential partner/acquirer or will massive compromise be required to make both plans work together?
- Is the other party negotiating from a position of strength or are they seeking this transaction to solve their own issues?
- What genuine level of interest are you seeing from the other party — is the CEO or owner involved in initial approaches and follow-on discussions? Are you happy with the quality of leadership?
Don’t expect merger negotiations to be without their challenges. But discussions should be constructive and keep moving forward. Alarm bells should ring if issues repeatedly cannot be resolved.
8. Are we in the position to successfully conduct an M&A transaction?
Do you have enough management capacity, sector expertise, valuation and procedural know-how to conduct a complex transaction within a tight timeframe? It is always advisable to get professional, such as M&A and legal, support to structure and complete a transaction, as it is rarely the core competence of a company. The success of the post-merger integration depends heavily on the early identification of potential risks and conflicts in order to efficiently address them beforehand and/or in the contractual agreements.
9. What are the implications if we turn down an offer?
If you receive such an acquisition offer, consider not only what will happen if you accept it but what would be the impact if you don’t.
Bear in mind that if you reject an acquirer, it might still seek out an alternative investment opportunity with another party. If so, is it more sensible to accept an offer than face the prospect of a new, enlarged competitor? This is a particularly important question if you are operating in a sector that is already on a consolidation trend.
A seller’s market
Ultimately an M&A transaction should only take place when you are confident it presents a strong commercial and cultural fit. The good news for European SMEs is that demand for high quality acquisitions — particularly among US and Asian investors — is at a multi-year high with valuations peaking over Q4 2014 to Q3 2015. This reflects both the increased efficiency and improved financial position that companies have achieved post-credit crisis and the sustained high levels of market liquidity that provides them solid acquisition power.
Over early 2016, M&A activity is likely to continue to be strong. In short, European SMEs are still enjoying a seller’s market. This being the case, companies can afford to take the time to ask the right questions and demand good answers before they take that next big strategic leap.
Find out more about Commerzbank
Get in touch: email@example.com
This document has been created and published by the Corporates & Markets division of Commerzbank AG, Frankfurt/Main or the group companies mentioned in the document ("Commerzbank"). Commerzbank Corporates & Markets is the investment banking division of Commerzbank, integrating research, debt, equities, interest rates and foreign exchange.
This is a financial promotion/marketing communication (together “communication”). It is not “investment research” or “financial analysis” as these terms are defined in applicable regulations and has not been prepared by a research analyst. The views in this communication may differ from the published views of Commerzbank Corporates & Markets Research Department and the communication has been prepared separately of such department.
This communication may contain short term trading ideas. Any returns or future expectations referred to are not intended to forecast or predict future events. Any prices provided herein (other than those that are identified as being historical) are indicative only, and do not represent firm quotes as to either size or price.
This communication is for information purposes only. The information contained herein does not constitute the provision of investment advice. It is not intended to be nor should it be construed as an offer or solicitation to acquire, or dispose of, any of the financial instruments and/or securities mentioned in this communication and will not form the basis or a part of any contract. Potential counterparties/ distributors should review independently and/or obtain independent professional advice and draw their own conclusions regarding the suitability/appropriateness of any transaction including the economic benefit and risks and the legal, regulatory, credit, tax and accounting aspects in relation to their particular circumstances. Levels, bases and relief from taxation may change from time to time.
Any information in this communication is based on data obtained from sources believed by Commerzbank to be reliable, but no representations, guarantees or warranties are made by Commerzbank with regard to the accuracy, completeness or suitability of the data.
The past performance of financial instruments is not indicative of future results. No assurance can be given that any financial instrument or issuer described herein would yield favourable investment results.
This communication is intended solely for distribution to Professional Clients and/or Eligible Counterparties of Commerzbank. It is not intended to be distributed to Retail Clients or potential Retail Clients. Neither Commerzbank nor any of its respective directors, officers or employees accepts any responsibility or liability whatsoever for any expense, loss or damages arising out of or in any way connected with the use of all or any part of this communication.
Commerzbank and/or its principals or employees may have a long or short position or may transact in financial instrument(s) and/or securities referred to herein or may trade in such financial instruments with other customers on a principal basis. The information may have been discussed between various Commerzbank personnel and such personnel may have already acted on the basis of this information (including trading for Commerzbank’s own account or communication of the information to other customers of Commerzbank). Commerzbank may act as a market maker in the financial instruments or companies discussed herein and may also perform or seek to perform investment banking services for those companies.
No part of this communication may be reproduced, distributed or transmitted in any manner without prior written permission of Commerzbank. This communication or the manner of its distribution may be restricted by law or regulation in certain countries. Persons into whose possession this document may come are required to inform themselves about, and to observe any such restriction.
By accepting this communication, a recipient hereof agrees to be bound by the foregoing limitations.
This communication is issued by Commerzbank AG and approved in the UK by Commerzbank AG London Branch, authorised by the German Federal Financial Supervisory Authority and the European Central Bank. Commerzbank AG London Branch is authorised and subject to limited regulation by the Financial Conduct Authority and Prudential Regulation Authority. Details about the extent of our regulation by the Financial Conduct authority and Prudential Regulatory Authority are available on request.
Italy: You should contact Commerzbank AG, London Branch if you wish to use our services to effect a transaction in any of the financial or other instruments mentioned in this communication.Copyright © Commerzbank 2015. All rights reserved.
Commerzbank Corporates & Markets
DLZ Gebäude 2, Händlerhaus
Mainzer Landstraße 153
60327 Frankfurt am Main
Tel.: +49 69 136 44440
30 Gresham Street, London
Tel.: +44 20 7623 8000