Portions of this post were originally published in 2019 and have been updated to include more in-depth and up-to-date information.
The most successful acquirers in M&A take a proactive, systematic, and repeatable approach to screening targets and originating deals. They actively manage an M&A pipeline of suitable acquisition targets rather than making knee-jerk reactions to deals. They source deals with in-house teams — without the need for intermediaries or third parties and screen potential acquisition targets in line with the organization’s overall strategy.
Most importantly, they start by defining their deal acquisition strategy before they build their acquisition pipeline.
In this guide, you’ll go through the front-end of the M&A process step by step — from defining an acquisition strategy to managing your pipeline. This three-part guide was written for firms venturing into M&A for the first time, and for deal teams looking to streamline their existing M&A process for better results.
Part 1: Defining an Acquisition Strategy
“M&A will never be 100% successful and we learn from every deal we do […] I’ve learned [to make] sure the strategy drives the M&A, as opposed to the M&A driving the strategy.”-Don Harrison, VP of Corporate Development, Google
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Defining the Strategy
20 Key Questions for Defining an Acquisition Strategy
Considering the Motives
Types of Acquisitions Available
Building an M&A Team
A systematic and repeatable approach to M&A can act as a safeguard to value loss and begins with the development of an acquisition strategy. To do this, an organization should consider (or seek to determine) its business plan drivers and question how realizing its strategic objectives can be fast-tracked via M&A (if at all).
Defining the M&A Strategy
An M&A strategy can help identify the most attractive market sectors, determine whether organic or acquisitive growth is best (and, therefore, whether M&A is suitable), and assist in tackling the typical hurdles associated with an M&A campaign.
To define an acquisition strategy and tailor best practices, an organization could start by contemplating several questions – enumerated in the section below. The idea of such an exercise is to trigger thoughts around the rationale for pursuing an M&A campaign; such introspection can uncover some potentially expensive truths.
Firms should not pursue an M&A campaign via a scattergun approach or by making knee-jerk reactions. Establishing a clear vision and linking each deal to the overall corporate strategy will enable an organization to be proactive and maximize the likelihood of identifying the most suitable targets when building its acquisition pipeline.
20 Key Questions for Defining an Acquisition Strategy
- Why are we doing this?
- What are our alternative options (outside of M&A)?
- What lessons have we learned from previous acquisitions?
- Does growth via acquisition provide a good strategic fit and align with our objectives?
- Which (if any) growth objectives can be achieved more effectively via acquisition than organically?
- What products/technology requirements does our road map require? (Note: balance the cost of acquiring such products/technology against the cost of build options – buying may not provide 100% of what you are looking for)
- What products and/or services could we conceivably acquire via acquisition?
- Do we understand the structure, size, growth, and trends of our existing markets?
- How much risk are we willing to take on – what is acceptable to shareholders and stakeholders?
- Are we prepared to invest in pre-revenue/early-stage companies?
- What geographies do we want to operate in? (Note: as part of this, consider the order of preference for international market entry)
- Are we prepared to enter significantly different markets?
- What synergies could typically be realized from an acquisition in the sector(s) we are considering?
- What is the maximum size of deal we are comfortable with and what is the minimum size of deal we are prepared to dedicate resources to?
- What level of funding is readily available and what level of additional funding could be obtained, if necessary?
- How many acquisitions can we execute and integrate in a year without over-committing?
- What types of people, skills, and experiences do we need that could be obtained via acquisition?
- What financial returns do we want to achieve over the next X years?
- What financial metrics are most important to us?
- Are we considering a particular acquisition merely to prevent a competitor from accessing an opportunity in the market? If so, what is the value of this competitor not accessing the opportunity?
Consider the Motives
As part of defining an acquisition strategy, an organization should be mindful of the motives behind their acquisition decisions. Is your organization being proactive, reactive, or opportunistic in its acquisition decisions?
Proactive acquisitions are most likely to be successful (in terms of actually being closed and providing a suitable strategic fit) as they directly address points raised in strategic analysis.
They are borne out of proactive target screening, with thought given about how the acquisition can support the organization’s strategic objectives. As part of the M&A pipeline management process, the acquirer will likely have given thought to desirability (what synergies are available), feasibility (can the deal be closed), and validity (compare purchase price to expected future performance and synergies – does this seem reasonable?).
Download now: Synergies in M&A: A Framework for Value Creation
Reactive acquisitions are characterized by acquirers responding to an approach from a seller. In such a situation, the seller will typically approach numerous potential buyers in the same or a related industry.
While a potential acquirer will usually have a reasonable amount of time to consider such an opportunity (and can therefore screen the target in context to strategic objectives without acting on a knee-jerk reaction), the acquisition process may become competitive and provide little scope for negotiating on price and deal structure (e.g., deferred consideration or earn-outs may not be accepted).
Furthermore, the opportunity is less likely to represent a compelling strategic fit. Nonetheless, an organization in the acquisition market may feel obligated to pursue the deal because it “needs to buy something.” Reactive acquisitions are an arduous strategy and are likely to result in the need for crisis management.
Opportunistic acquisitions, despite what the name might imply, are the least likely to be successful in enhancing an organization’s operations and have the lowest probability of closure. They occur when an organization is approached with a seemingly attractive deal – often from a seller in a non-related industry and perhaps attractive in terms of price or deal structure.
While such an opportunity may represent a means of diversification, such deals should generally not be pursued, as the target is extremely unlikely to fit in a well-defined acquisition strategy or provide the compelling strategic fit required for your company’s narrative.
Understanding the Types of Acquisition Available
Acquisitions may fall under several categories – it is helpful to understand these since their explanations can help contextualize an acquisition strategy:
A synergistic acquisition target may or may not compete directly in the same geographic market but is involved in the same line of business. A synergistic acquisition will naturally offer immediate synergies in terms of added customers and market share, streamlining administrative functions and other operational and purchasing efficiencies.
A strategic acquisition target will offer similar products or services to the acquirer but sell to other end markets or offer different products and sell to the same end markets. The cost synergies available from a strategic target are usually less profound – however, potential revenue synergies and growth opportunities may be vast.
A complementary acquisition target is typically dissimilar from the acquirer’s core competencies. A complementary acquisition could provide an element of overlap in products/services, markets, or capabilities but is unlikely to offer any significant synergy value (where available, synergies are likely indirect and involve sharing resources/know-how/operational best practices).
This is generally characterized by a target having no overlap with the acquirer. This type of acquisition is usually high-risk and has the lowest probability of success in enhancing an organization’s operations.
Transformative acquisitions (those associated with creating value by fundamentally transforming core operations, processes, or business units) can offer significant potential for innovation and breakthrough performance. However, transformative acquisitions involve complexity that can go beyond the capabilities of management, providing the potential to bring operations to a standstill if not correctly managed. Therefore, any organization considering an acquisition of this nature must ensure it has sufficient people resources to manage it.
Build An M&A Team (Or Make Sure Your Existing Team Is Up To The Job)
One of the final steps in building a strategy is to build a team that can best support it. An M&A team can best support an acquisition when a well-defined acquisition strategy underpins it. This sets the level of activity and expertise required for building and screening a pipeline of opportunities during pipeline management, conducting M&A due diligence, negotiating and closing deals, and running the post-merger integration.
Many organizations determine the size of their M&A teams based on due diligence requirements (arguably the process requiring the most people across the deal lifecycle). However, choosing the size of an M&A team on this basis can result in a team that is too focused on the details or lacks commercial and strategic awareness (essential capabilities to an acquisition strategy).
While vitally important, due diligence is only part of the deal lifecycle. If an M&A team lacks the skills and expertise to effectively screen targets in line with an acquisition strategy, it could quickly begin to conduct due diligence on an unsuitable target.
Suppose an organization carefully considers its acquisition strategy and available people resources. In that case, it may realize it requires a larger M&A team (and perhaps, dedicated expertise) to manage the number and complexity of planned deals.
Conversely, an organization may target fewer simple acquisitions and conclude that its current M&A team is fit-for-purpose. Ultimately, an organization should take an overarching view when considering the M&A skills and expertise it has available now and what its future requirements may be.
With a well-defined M&A strategy in place and a suitable M&A team on board, an organization can turn its attention to building a pipeline of potential acquisition targets and screening these for best fit against the acquisition strategy.
Part 2: Building an Acquisition Pipeline
Identifying the right acquisition target is arguably the most fundamental component of a successful M&A campaign. A quick search online for “failed M&A” will reveal a myriad of case studies outlining where things have gone wrong.
While failure factors are sometimes unforeseeable, it is often the case that M&A goes wrong due to poor preparation in the early stages. Turning poor preparation on its head, adopting a repeatable and systematic approach to M&A can significantly increase the efficacy of an M&A campaign and prove extremely valuable when it comes to identifying suitable acquisition targets.
When researching targets and building an M&A pipeline, it is important to keep several points in mind:
- Strategy (see part 1 of this guide)
- Market Attractiveness
- Broaden the Search
- Stage-Gate Approval
- People Buy-in
Once an organization has defined its overall (and supporting) M&A strategy, it can start identifying the right market sector(s) to focus on.
A market-driven approach helps select target markets that are stable, growing, attractive to consumers, and most likely to deliver the expected deal ROI or desired revenue growth. Future market potential and development should also be considered — otherwise, firms may risk acquiring a target in a declining or soon-to-be obsolete market.
In identifying the right markets, there is an element of crossover with the process of defining an M&A strategy. For instance, questions such as “what geographies do we want to operate in?” and “are we prepared to enter significantly different markets?” will help formulate many market-driven criteria.
Ultimately, defining several market criteria will help when it comes to appraising markets against the strategic rationale underpinning the M&A campaign – and, therefore, help in the identification of suitable acquisition targets.
Once these criteria have been established (with the understanding that criteria may change over time), organizations can commence a more profound research process – the idea being that market criteria will be refined as more about the market(s) is established.
Broaden the Search
While the end goal of an M&A campaign may be the acquisition of just one target, it is doubtful that pursuing one target at a time will be enough to result in a closed deal.
Taking such an approach is risky and could leave an organization stalled at the starting line if things do not go as planned. For instance, significant time and effort could be invested only for a single target to pull out of negotiations, for a competitor to come along and trump an offer, for the due diligence process to reveal adverse findings, or for deal terms that eventually end up disagreeable.
Some estimates suggest that up to 100 potential targets may need screening by M&A teams to lead to the closing of just one deal.
Working to this estimate, one way to approach the building of an acquisition pipeline is to view it as a funnel. There will be a lot of targets at the top of the funnel.
Still, as the screening process advances, firms will eliminate some due to a lack of fit against the M&A strategy (remember, this supports the overall corporate strategy). Target screening (elimination or advancement) is managed best by adopting a well-defined Stage-Gate Approval process.
Any organization pursuing an M&A campaign should adopt a well-defined stage-gate approval process to support effective decision-making. However, many organizations have poorly managed stage-gate processes (or none at all), leading to lost opportunities with potentially well-fitting targets or losing out on targets later in the process due to the inability to make timely decisions.
A well-functioning stage-gate approval process is a three-tiered approach:
- Strategy approval
- Negotiation approval
- Go/no go
The strategy approval process should involve an appraisal of targets from an “outside-in” perspective to help establish whether a target could contribute to the overall strategy. This process should reaffirm and align with the higher-level strategic considerations made at the outset of the M&A campaign. Firms should also oversee how teams approach the target’s due diligence and compatibility from an integration perspective.
Negotiation approval should focus on valuing a select number of targets. Suppose valuations are derived based on publicly available information. In that case, they are far more likely to be indicative (and subject to more refinement later in the process) than if preliminary due diligence and management discussions have commenced.
The outcome of a preliminary M&A due diligence exercise (if undertaken) should be to reaffirm the decisions made in the strategy approval stage (i.e., the target is a good fit and should be pursued), to assist with pricing decisions, and to further identify any challenging integration issues.
As part of an initial post-merger integration checklist, thought should be given to the operations of a target, how they align/complement the existing functions of the acquiring organization, what synergies are available (cost or revenue), and the magnitude of the integration project.
Whether a target is a “go/no go” will ultimately depend on the key decision-makers within an organization. Here, the stage-gate process should build upon the questions and answers covered in the two previous stages rather than introducing a myriad of new acquisition criteria and questions – which could muddy the waters.
Key decision makers will be viewing a target from a more objective standpoint because they will not have been subject to the finer details of the earlier-stage screening process. Fresh eyes offer an unbiased advantage — decisions based only on whether a target would support the overall corporate strategy, in addition to addressing high-level matters such as desirability (“what synergies are on offer?”), feasibility (“can the deal be closed?”), validity (comparing valuation to expected future performance), and anticipated synergies (“does this look reasonable?”).
Many deals underperform (or result in outright failure) because firms take a one-size-fits-all approach to M&A. Leaders driving the acquisition pipeline must understand the nature of the target considered and how those working on the deal may have to adapt to ensure success.
For example, some targets may offer cost synergies realizable in the short-term, while others may provide longer-term revenue synergies. In either scenario, the approach to integration is likely to differ.
Therefore, depending on the people resources an organization has at its disposal – and the degree of adaptability – some targets may have to be “killed” (eliminated from the pipeline) because they fall outside of an organization’s experience and ability to integrate successfully.
In some instances, an organization may be able to adapt from its traditional approach to facilitate the successful integration of a target.
One possible approach to establishing adaptability is via gap analysis – i.e. where an organization compares its actual ability to perform against the required ability to perform.
Where gaps are extreme or cannot be bridged, firms can eliminate targets during the M&A pipeline management process. Crucially, considerations of this nature (and gap analysis, if undertaken) should be a strong focus of the deal team as an acquisition pipeline is being built – not post-deal, when it is too late to realize there is a lack of experience or resources.
For a deal to be successful, people need to buy in across an organization. Acquirers must ensure there is universal support for a target. One way to approach people buy-in is to confirm that all stakeholders in the deal process are involved from the onset of the pipeline build.
Collaboration could be made possible by utilizing a shared Excel document or deal management software, where all stakeholders can access information and make judgments on the pipeline in real-time.
Once the pipeline has been reduced to just a small number of targets, analysts should prepare a business case presentation for each target.
A business case presentation should help clarify the end-to-end deal process and ensure that the deal’s strategic rationale informs both due diligence and integration processes. On the other hand, a business case presentation could eliminate a target from the pipeline.
If this happens, a business case presentation should not be viewed as a failed exercise since it has helped flag the poor deal before it is too late and prevented costs and resources from being dedicated to an unsuitable-fit target.
Part 3: Managing an Acquisition Pipeline
The nature of deal-making is changing. For many organizations, the days of closing just 1-2 deals every few years in a limp to the finish line are over.
Today, M&A news is awash with stories of organizations running double-figure deal counts. Together, Alphabet, Google’s parent company, and Microsoft have closed ten acquisitions so far in 2022, (last year, the deal count total was 5 and 15 for Alphabet and Microsoft, respectively).
If corporate venturing initiatives are added to the mix (rather than just outright acquisitions), the figures relating to closed deals are even more profound.
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How to Approach M&A Pipeline Management
The Pipeline Process
Consider A Digitalized Approach
Deal Capacity & Other Key Success Factors
Any organization looking to close a significant number of deals in a year will likely be running several deal processes in parallel. Working off the frequently cited estimate of it being necessary to screen 100 targets to close one deal, some organizations could be running upwards of 1000 targets through their M&A pipeline each year.
How to Approach M&A Pipeline Management
Managing an acquisition pipeline befitting today’s M&A characteristics is increasingly becoming a speed juggling act – also requiring management of confidential information and demonstrable strategic thinking.
A systematic and repeatable approach is key to maintaining consistent high-volume M&A deal flow and effective pipeline management.
Taking the time to structure this process will allow for more informed and timely decisions and, ultimately, provide a greater chance for firms to pursue the most valuable targets from the onset of the acquisition process.
The core workflow of an efficient pipeline management process should include the following stages:
- Stage One – Define acquisition strategy (see Part 1 – Defining an Acquisition Strategy)
- Stage Two – Identify targets (see Part 2 – Building an Acquisition Pipeline)
- Stage Three – Screen targets
- Stage Four – Initial due diligence
Each stage in the pipeline should require straightforward entry and output criteria to be met before firms can progress a target to the next pipeline stage or before a target is eliminated from the pipeline.
The Pipeline Process
It is worth noting once again that the pipeline process does not commence with identifying targets but rather with defining an acquisition strategy (or investment strategy if speaking of corporate venturing).
In advancing from stage one to stage two, it is vital to revisit a few questions asked in section 1:
- Would the target support the acquisition strategy?
- What risks would the target introduce to the current business model?
- What degree of adaptability (people, processes, etc.) would be required to integrate the target into existing operations?
Without answering these questions, there is a risk that the initial target screening criteria could be vague or disconnected from the acquisition strategy. The crux of the matter here is that those devising a list of targets should be able to easily explain the deal rationale and strategic fit a target offers. If this is impossible, a target should not advance to stage three.
If deal teams can answer the conceptual question of whether a target could provide a strategic fit with an affirmative “yes,” the target can advance to stage three.
Here the objective is to collate and analyze more detailed information to support the decision as to whether or not a target should progress to stage four – initial M&A due diligence.
The information analyzed in stage three will likely comprise documents available in the public domain: abbreviated financial statements, annual reports, press releases, product/service catalogs, etc.
At this stage, deal teams can conduct an indicative or “ballpark” valuation – this is likely to be based on abbreviated financial information benchmarked against comparable company data (and therefore subject to many iterations as more information on the target is obtained).
At the same time, deal teams should conduct a more detailed appraisal of the potential synergies on offer. A word of caution, however: if synergies are included in the valuation of a target, these should be treated with care to avoid overpricing (see Greater Than the Sum: Estimating Synergies in M&A).
If a target still appears to offer a good fit at the end of stage three, it can progress to stage four – the initial due diligence phase.
This stage aims to screen a target in more detail – typically using information not available in the public domain (therefore requiring an initial approach to a target and an NDA signed by the acquiring organization).
Likely, a target will not be open to entering discussions around a potential sale – in such a case, this outright eliminates a target from the pipeline.
When a target is open to discussions, deal teams can use an initial due diligence checklist, essentially a precursor to a detailed due diligence exercise and provides essential information to the acquiring organization.
An initial target questionnaire enables a deeper dive into the financials and operations of a target. It should help establish whether deal teams should progress a target to a more formal stage of the deal process (the issuance of a letter of intent/term sheet and detailed due diligence).
Consider A Digitalized Approach
In stage three and four of the M&A pipeline management process, a vast amount of information will circulate among the deal team. While perhaps obvious, it is imperative to consider how data is managed and stored.
The most basic solution would be to adopt a dedicated folder for each target and each stage. A slightly more advanced solution would enable sharing certain documents with individuals inside/outside of the organization (this is most likely to encompass a basic cloud solution such as Dropbox or Google Drive, etc.). An all-in-one deal management solution will also often include VDR capabilities.
It is essential to understand the security limitations of the selected solution (especially if targets have supplied confidential information) and the ease with which deal teams can collaborate on a deal. This requirement becomes increasingly relevant as sales volume increases.
For organizations that have encountered the chaos of using multiple tools to run the pipeline process (think multiple Excel, Word, and PowerPoint documents), a digitalized approach via the adoption of deal management software could be considered (see How Philips Utilizes a Digitalized Playbook for M&A).
Adopting an M&A software solution for pipeline management means that access rights can be assigned to individual users. The ability to grant specific access and control what can be accessed is a powerful feature that is impossible with basic home-grown spreadsheet-based solutions.
Furthermore, an M&A-specific solution provides unrivaled collaboration for those screening targets and real-time M&A analytics and reporting functionality.
Deal Capacity & Other Key Success Factors
Regardless of size, the target screening process can require significant time and effort. It is, therefore, essential to introduce additional structure to the end-to-end pipeline process.
As targets are screened and advanced through the pipeline, organizations frequently emphasize the minutiae detail of financials and valuation metrics. However, history shows us that acquisition failures are often attributed to sidestepping key success factors that no end of spreadsheet analysis can insure against; these factors include culture, leadership, management, and overall strategic fit.
Cultural alignment is fundamental — it should be considered at the outset of the screening process and continually re-evaluated as a target advances through the pipeline. An assessment of culture should be objective and comprehensive – merely “getting along” during initial discussions with a target cannot alone be considered a good cultural fit.
To safeguard against overlooking key success factors, it is sensible for various individuals within an organization to screen targets; different experiences and backgrounds can help to provide a comprehensive assessment of a target rather than a narrow-focused judgment.
Furthermore, as part of the screening process, the future operating model should be considered – i.e., what changes would be necessary post-deal and how easily would change be implemented during the post-merger integration steps? Accounting for such considerations as the screening process progresses should help validate any assumptions of a target made earlier in the pipeline process and promote a more holistic appraisal.
Finally, where target screening is conducted at high volume, firms should consider “deal capacity,” i.e. how many targets can the firm realistically screen and how many deals can be closed in parallel or over a year?
Deal teams should approach pipeline management in a systematic and repeatable manner. Following a minimum four-stage approach will enable an organization to screen targets consistently and advance a more substantial number through the acquisition pipeline while eliminating those that do not prove a good fit.
For more information on how M&A pipeline management software can help accelerate your organization’s acquisition efforts, we encourage you to get in touch with our team of experts. Or, if you’re ready to get started now, request a personalized demonstration or trial of Midaxo+.