Let’s talk about a critical early step in the acquisition process: defining your M&A acquisition criteria.
With 4.5 million companies expected to be on sale within the next decade (Forbes), where in the world do you start?
Defining your acquisition search criteria will help you decide where to focus your attention and filter out which deals are which pursuing.
In this article, I’m going to walk through how you can drill down to exactly what you want to acquire and figure out your ideal target business.
M&A Acquisition Criteria: Uncover a Perfect Acquisition Target
- Goals for Acquisition
- Industry
- Biggest Needs
- Geography
- Revenue
- EBITDA
- Potential Value Creation
- Growth Lifecyle
- Company Culture
- Competitive Advantage
- Market Cyclicality
- Intellectual Property / Soft Assets
- Existing Capacity Available
- Marketability of Assets
- Risks: Socio-Political and Supply/Demand Threats
1. Goals For Acquisition
Before you start your search for a target business, it’s important that you have a clear idea of what you’re looking to achieve with the acquisition.
- Are you looking to enter a foreign market?
- Grow your competitive advantage by expanding your internal capabilities?
- Get more leads by reaching more of your ideal customers with media?
Be as specific as possible. This will help you narrow your search and let you move forward with intention.
2. Industry
In what industry do you want to acquire a company?
Think about industries you understand well and have a good track record in. How much cross over exists between your current industry and that of the target company?
Staying within adjacent industries is often best – industries that are similar, logical extensions of your current business. Moving out into non-related areas can quickly become risky.
I’d also recommend taking ROI by industry into consideration so you can see which offer the best potential for long-term growth. If the industry is rapidly declining (e.g. newspapers), that could be a red flag.
3. Biggest Needs
it’s time to drill down further and define the specific needs and desires you have within your business.
I’d recommend you think about two questions:
- Where area of your business is weakest and needs improvement?
- What is the missing piece for your next stage of growth?
This could be anything from improving average order value, to strengthening your team, to increasing lifetime customer value.
I’ve written a detailed post to help guide you through this process.
4. Geography
Would this acquisition expand your market share in an existing geography or give you access to an entirely new area?
Do you want to be close to the business so you can keep tabs on it, or are you willing to rely on a management team?
Are you looking to stay local, or are you open to acquiring businesses in other countries? If you’re going international, how significant is the target company’s presence in the foreign market?
5. Revenue
What is the revenue range of your ideal target company?
Think about what revenue level would be large enough to be worthwhile for you to devote the time and resources involved with an acquisition.
The revenue of the target company will also give you an idea of its potential – a business that’s already generating significant revenue has likely already proven product-market fit and has room to grow.
6. EBITDA
EBITDA (earnings before interest, taxes, depreciation, and amortization) is a measure of a company’s profitability.
It’s often used as a proxy for cash flow because it strips out one-time expenses and capital expenditures. This will give you a good indication of the company’s profitability, financial health, and its ability to generate positive cash flow.
Think about the EBIDTA range you’d be looking for in a business (i.e. $1 – $3M). As you get deeper into the process, you’ll want to get a sense for how the company’s EBITDA compares to typical industry benchmarks (ideally we’d want it to be at least be on par, or better than average).
7. Potential Value Creation
Value creation is arguably the most important factor to examine.
You want to look for companies that have the potential to create significant value for your business. The best way to do this is to look at the company’s growth potential.
What are the drivers of growth? What are the areas of low-hanging fruit that the current management team has not capitalized on?
Can the company continue to grow at its current rate? Is there untapped potential in the market?
There are of course many ways to create value, such as:
- Reducing costs
- Improving operational efficiencies
- Generating new revenue streams
- Expanding into new acquisition channels
- Entering new markets
- Expanding into new product categories
8. Growth Lifecycle
The lifecycle of a business is the progression it takes over time from initial launch to its eventual decline.
This lifecycle is made up of four stages: startup, growth, maturity and decline.
Ideally, you want to acquire a business that’s in the growth or maturity stage. Businesses in these stages have gained traction in the market, are typically fairly predictable, and still have growth potential.
On the other hand, businesses in the startup and decline stages can be more risky. They may not have established themselves yet or may be on the decline due to poor management, changing markets, etc.
9. Company Culture
You want to make sure that the company culture is a good fit for your own company. Otherwise, the acquisition could be a recipe for disaster.
Think about how you’ll determine if the company culture is congruent with your own. Will the companies coexist well together? Do they share the same values?
The existing management team is another important factor to consider when assessing culture. Do they have the same vision for the company?
In addition to looking at the track record of the management team, do they seem like good people that you can work with? Do they have a good relationship with employees?
10. Competitive Advantage
You want to make sure that the company has a sustainable competitive advantage that can’t be easily replicated by your competitors.
This could be anything from a unique product or service, to a strong brand, to a loyal customer base.
Think about how the company’s competitive advantage will benefit your own business. How will it give you an edge over your competitors?
Is it something you can leverage to drive more sales or grow your customer base?
A sustainable competitive advantage is key to a company’s long-term success, so make sure you understand what it is and how it will benefit your business before investing.
11. Market Cyclicality
Assess how the company is impacted by trends or patterns that emerge during different business cycles.
Some businesses are more cyclical than others. For example, businesses that sell luxury goods tend to do well during periods of economic expansion and poorly during periods of recession.
Alternatively, if the company you’re considering acquiring is in the retail industry, you’ll want to consider how it’s impacted by changes in consumer spending.
Think about how the company’s business will be affected by different economic conditions. Will it be able to weather a recession?
12. Intellectual Property / Soft Assets
Is there some type of valuable intangible asset that an acquisition would give you ownership of?
This would include any asset that has value, but cannot be physically seen or touched.
It could be anything from a great brand (with strong reviews online), to superior customer experience, to defensible intellectual property (patents, copyrights, and trademarks).
If they do have valuable IP, you’ll want to make sure that your target company has strong intellectual property rights to protect them.
13. Existing Capacity Available
Does the company have the ability to grow, or has it already operating at full capacity? This applies to any company that produces physical products or goods.
If a company has the ability to increase production by adding more shifts, hiring more staff or using a larger facility, this is a great sign for growth potential.
If a company has maxed out capacity, it may be difficult for it to expand without making significant changes to its infrastructure (you’ll likely need to make a large capex investment).
14. Marketability of Assets
Get a sense for the type of assets your target company has on their balance sheet.
How do they complement your existing portfolio of assets? Do they fill any strategic gaps?
Are they easily marketable and liquid? Or are they illiquid and hard to sell?
You’ll want to make sure that the target company’s assets are compatible with your own. Otherwise, you could end up with a bunch of assets that you can’t use or sell.
This is important to consider because it will affect how easy it is for you to exit the business down the line.
15. Risks: Socio-Political and Supply/Demand Threats
There are always risks when acquiring a business. But there are some risks that are specific to certain industries and countries.
As an example, businesses that rely heavily on manufactured goods may be at risk if there is a political unrest in the country where the goods are produced. This could lead to a shortage of supplies and an increase in costs.
Let’s look at the airplane industry as another example:
- Socio-political: changes in a country’s government or society could affect the demand for air travel, and therefore the value of an airline. For example, if a country’s government becomes more authoritarian, it might restrict its citizens’ ability to travel, causing a decrease in demand for air travel. Or if there is an economic recession in a country, people might be less likely to take vacations or business trips, again decreasing demand.
- Supply/demand: changes in the number of airplanes or pilots available could affect the airline industry. For example, if there is a shortage of pilots, airlines might have to cancel flights or raise prices, leading to a decrease in demand. On the other hand, if there is an increase in the supply (number of planes available for purchase), airlines might compete by lowering prices, which would lead to declines in revenue.
These examples can be major risks in all sorts of industries. If the company is reliant on a single supplier, you’ll want to consider how that could impact the business if there were to be a change in the relationship.
M&A Target Screening Criteria – Example
As you define your criteria, you’ll build out a thorough list of what you’re looking for, which will help guide next steps in your process. Keep in mind that we don’t want to be overly restrictive, as we might inadvertently overlook qualified targets.
Below is just one example of acquisition criteria for a potential target company.
It might not be possible to check all these boxes (there is no such thing as a “perfect business”), but having clarity on what you’re looking for can help immensely.
• Annual revenue: $1 – $5M
• EBITDA margin > 15% (at least $300K – $500K)
• 10 – 20 employees
• Longevity: in business 10+ years
• Consistent track record of stable operations
• Minimal exposure to seasonality and business cycles
• Low capital intensity / inventory light (prefer service based businesses)
• Strong, sustained fundamentals: positive cash flow and healthy balance sheet
• Stable and diversified customer base: high customer retention, no single customer accounting for > 20% of revenue
• YoY Revenue Growth for 3+ Years
• Targeting B2B service industries (accounting, management services, payroll)
• Identifiable competitive advantages and barriers to entry (defensible moat)
• Geography: based in New England area
• Preference for recurring revenue model
• Future growth potential: identified upside opportunities for the business
Conclusion
Acquiring a company is a big undertaking. There are a lot of things to consider, which can make it difficult to know where to start to avoid mistakes.
Once you get clarity on what you’re looking for, you can confidently move to the next stage of the acquisition process.
If you do decide to proceed with an acquisition, remember to do your due diligence and consult with experienced advisers to ensure that you are making the best decision for your business.
I hope you found this helpful – feel free to leave a comment below with any questions.
