We frequently work with business owners and management teams, whether family- or founder-owned, ESOP-owned, or even publicly held, that are either considering or have determined to make acquisitions part of their growth strategy. In terms of both experience and corporate capabilities, we see a wide spectrum among these companies, from those who have never completed an acquisition and often have very lean corporate resources, to serial acquirers that have deep organizational experience and resources that may include a person solely responsible for M&A-related growth.

Regardless of a company’s ownership profile or existing corporate resources and capabilities, there is a set of best practices that we recommend companies follow to enhance the probability that their acquisition efforts will successfully create long-term value.

If there is one overarching principle that should guide your company’s M&A-related growth journey, it is having a solid understanding of your core strategic vision, and how potential acquisitions might fit into that vision. Key questions that should be addressed include:

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  Where do I want the business to be three to five years from now? This should include a vision with respect to the revenues or cash flow of the business, the products or services you offer, the geographies you operate in, and the composition/headcount of personnel you will need to get you there.

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  What gaps exist between the current state of the business and my vision for the future state? Determine whether these gaps can be filled through ongoing, organic means, or whether they might be best accomplished via acquisition(s) for optimal impact and efficiency.

Ultimately, if you decide on a growth pathway that involves acquisitions, the opportunities you consider and pursue should fit within the framework of your strategic roadmap. As you will likely come across many such opportunities, it is important to have the discipline to pass on those that don’t, no matter how attractive they may otherwise seem. In short, your corporate strategy should drive the acquisitions you consider, and not the other way around.

An important part of creating a successful acquisition effort is the development of a formal M&A process that clearly defines the roles and responsibilities of people inside (and potentially outside) the company. This process should include a designated owner (often the CFO or CEO) and should be designed to be consistent and repeatable. The roles and responsibilities of the various resources involved (senior management, functional leaders, owners, board of directors, legal counsel, outside advisors, etc.) should be clearly delineated so that you can develop a “playbook” that can be efficiently employed each time you have an acquisition opportunity to evaluate.

Generating a strong pipeline of potential M&A opportunities requires a combination of self-directed efforts and the development of third-party relationships.

As a business owner or manager, you likely have a deep knowledge of your industry and may be aware of many of the potential acquisition targets in your space. To the extent possible, reach out to these companies and let them know that you’re interested in having a conversation if they are ever interested in selling.

In addition, develop relationships with third parties such as investment banking firms, law firms, and accounting firms as potential sources of opportunities. If you want to take a more systematic approach, there are buy-side advisors who will work on your behalf to scour the industry landscape for opportunities. The more acquisitions you complete, the more your company will be noticed and the more inbound opportunities you are likely to see.

Your due diligence investigation of a potential acquisition opportunity should be a deep, multifunctional process, ideally involving leaders of the various operational functions in the company. Depending on the profile of the potential target, these functions may include Finance/Accounting/Tax, Human Resources, Legal, Operations/Manufacturing/Supply Chain, Information Technology, Sales and Marketing, and Environmental Health and Safety. To the extent that you do not have resources inside the company to evaluate these functional aspects, strongly consider engaging third-party resources. This is your primary opportunity to identify risks and potential synergies, and the process should be informed by functional experts. A thorough, multifunctional diligence review will help ensure that your purchase price and deal structure are aligned with the risk profile of the acquisition.

One of the most critical aspects of the due diligence process is the assessment of the potential acquisition target’s human capital profile. Acquirers often give little more than lip service to this aspect of due diligence, even though cultural mismatch is one of the top reasons for failed acquisitions. Talk to the owners and management of the target company, understand why their culture makes them successful. If these values don’t align with yours, strongly consider moving on to the next opportunity.

For potential acquirers that are ESOP-owned, being able to offer ownership in the combined business to the employees of a potential target may help mitigate any perceived cultural challenges. Educating the target’s employees on the value (cultural and financial) of working for an employee-owned company is important to help them buy in and embrace the role of helping to drive the overall growth story.

The integration process is another area where we sometimes see acquirers not plan adequately. As you progress through due diligence, your team should start to develop a vision for how the target will operate post-close. Are certain functional areas redundant, and can they be consolidated? Do you have to move or close a facility, and what might that cost? For ESOP-owned acquirers, how will the target’s employees be brought into your plan? Integration is an important process and should begin as early as possible. Some companies will designate a dedicated Integration Manager who operates as part of the diligence team, but this is a process that companies often engage a third party to oversee.

In addition to the internal resources that are tasked with helping to evaluate a potential acquisition, you will likely also need to engage certain outside advisors to assist you. These may include a buy-side M&A advisor, an accounting firm to help with financial and tax due diligence, dedicated legal counsel, and a consulting firm to manage the integration process. It is critical to engage a quality external team and not simply seek the most cost-effective option to keep overall deal expenses low. You should view this team of advisors as an investment—they will help you consummate the optimal acquisition, from the standpoint of the initial purchase price and deal structure, but also with respect to avoiding longer-term risk in the purchase agreement.

For ESOP-owned companies looking to grow through acquisitions, the best practices outlined above will, for the most part, still apply to their efforts. However, there are additional considerations that ESOPs may need to take into account.

As acquirers, employee-owned companies can potentially offer several competitive advantages in an M&A process, including:

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  Employees of the acquired company can retain employment and become participants in the ESOP

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  The two company cultures are more likely to align if the treatment of their employees is important to the selling shareholders

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  The acquired company’s sellers can potentially defer their capital gains tax on the sale of their shares in an IRC 1042 transaction

ESOPs may encounter challenges relating to the financing of potential acquisitions, especially if the transaction requires outside financing. Newly formed ESOPs may not have the incremental debt capacity to facilitate an acquisition due to the leverage incurred in financing the ESOP transaction. Similarly, mature ESOPs may not have sufficient debt capacity or capital if a significant percentage of their cash flow is used to fund repurchase obligations.

To mitigate such financing issues, an ESOP may consider acquiring another ESOP-owned company. Such a transaction can be executed via a stock-for-stock exchange in which the buyer uses its company stock as currency instead of, or in addition to, cash. This allows the acquiring company to conserve its cash flow and dry powder for future strategic investments.

Corporate acquisitions can be an important component of a company’s growth strategy, whether the company is privately held, publicly held, or ESOP-owned. Acquisitions are not without risk, however, and must be considered and executed with diligence and care. Following the best practices outlined above will help ensure that your company’s acquisitions have the best chance of being successful and creating long-term value for your company.