Acquisitions- Cucaracha Style
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They lived among the dinosaurs. They live among us now. They’re the hardiest insects on the planet, able to survive up to 45 minutes without air and a month without food. Cockroaches. Cucarachas. Most people find them disgusting. Serious investors should find them enlightening.
After all, these hard-boiled insects didn’t endure hundreds of millions of years of volcanoes, shifting tectonics, meteoric explosions, Ice Ages and, for the past couple millennia, relentless attack from the human race without doing something right.
So here are the lessons they can teach even the savviest corporate acquirers and private equity investors:
1. Don’t die. As most anyone knows, killing a cockroach—if you can catch one before it scurries away—is difficult. Stomp on it, squish it however you can, and when you’re done, most of them will still be squirming. One source says they can live for up to 30 minutes without their heads. That’s one tough insect.
For investors, the lesson is to never acquire a business that will kill your chances of survival if the deal sours. While this may seem common sense, the record of successful mergers and acquisitions isn’t all that great, especially among mid-market companies with between $20 million and $100 million in revenue. Research shows the M&A success is about the same as a coin toss—about 50 percent.[1]
While large corporations have the resources to absorb the consequences of a bad deal, mid-market companies typically don’t. So mid-market transactions, where many corporate acquirers and private equity funds play, need to be wary and hedge against failure.
One way to do so is to never pay all cash. Structure acquisitions so they’re made in incremental steps over time via buyout rights, installments or “earn-outs” that use current cash flows to pay the sellers. This strategy provides room to maneuver (or scurry) should your due diligence not have uncovered some lethal rot in the company you’ve acquired.
2. Stay in the dark. Cockroaches hate light. Investors should, too. Unfortunately, many acquirers draw attention to their deals unnecessarily either through exercising their bragging rights, getting tied up in an auction or targeting companies that are already in the limelight, for better or worse.
The safest approach, like the cockroach, is to stay in the dark, “under the radar” as they say. This way, negotiations can continue unfettered before unmanageable political, regulatory, labor, tax or other issues arise that can slow or even stop a deal in its tracks. Part of any due diligence should be to measure a company’s relative “radioactivity” regarding any of these matters. Staying dark also minimizes the risk of competitive bidders coming forward, which can lead to an auction.
Auctions can be especially troublesome for two reasons. One is that the business press likes nothing better than reporting conflicts, and most auctions pit different suitors against each other. The other is that the purpose of auctions is to get sellers the highest prices possible, which means investors are encouraged to pay the most – sometimes more than the business is worth. Then, on top of that, the deal is already in the public eye and subject to increased scrutiny—a double whammy.
3. Eat whenever you can. Cockroaches, as noted, can go a month without food. Investors should be just as patient. But once the right deal is made, investors need to seek a return of their capital as soon as they can. The way to do this is to structure the deal as an installment acquisition or as a partnership or joint venture that means you, the buyer, participates in all future cash flows. In other words, the seller gets paid while you get paid.
Not only does this approach accelerate an investor’s return on capital, it also helps minimize risk. In part that’s because—if Lesson #1 was followed—the amount of up-front capital at risk was minimized. It’s also because paying sellers from their companies’ future cash flows aligns their interests in maximizing those cash flows with your interest in a return not just of your capital but a profit from it as well.
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As Charles Darwin reportedly said in describing the essence of evolution’s survival-of-the-fittest concept: “It’s not the smartest or strongest creature that survives; it’s the one that responds best to change.” If investors keep these three lessons from the lowly cockroach in mind, they’ll usually find that they, too, will be able to respond to change, to hide from danger, and even better, to thrive and prosper.
[1]Why Half of All M&A Deals Fail, and What You Can Do About It, by Robert Sher. Forbes, March 19, 2012
