Dan Lubeck: Addition problems Featured

8:01pm EDT August 31, 2011
Dan Lubeck, founder and managing director, Solis Capital Partners Dan Lubeck, founder and managing director, Solis Capital Partners

When we invest in a company, our return on investment always is premised on value creation from growth. While we look to other factors to enhance and accelerate value creation (like enterprise improvement and leadership development), growth is the key.   

The most coveted and valuable companies (that is typical companies — not social media, Internet or other uniquely valued enterprises) are those with significant, sustainable, profitable organic growth. Since not all companies can accomplish that type of growth, an alternative or supplement to organic growth is growth from add-on acquisitions. While acquisition growth likely won’t be rewarded as highly as sustainable organic growth, great value can be created. 

An ideal add-on acquisition will be in the same or complementary business and will add profitable, retainable revenue and will add employee talent. It will have costs eliminated upon integration and can be purchased at an attractive valuation. As companies typically are valued on the basis of a multiple of earnings (most commonly EBITDA), an attractive valuation multiple for an add-on acquisition is any multiple equal to or less than the multiple that would be used to value the acquiring company times the earnings of the acquired company pre-integration. 

In other words, if the acquiring company is valued at five times earnings, and it can pay four times earnings for an add-on acquisition, and then save another one times earnings in costs upon integration, you’ve created a value equal to two times earnings on day one. Plus, there’s the harder-to-calculate value of broader product lines, more talent and other potential benefits from the add-on acquisition.

If this piques your interest, the following summarizes the five steps for completing an add-on acquisition.

Noncompetition/nondisclosure agreements. Sign mutual confidentiality and noncompetition/nondisclosure agreements (NDA). As the buyer, you will want to learn everything about the potential add-on without disclosing much information about your company. The NDA must give the seller comfort that the disclosed information will not be used against his or her company if the transaction doesn’t close. Typically, customer names and similar highly sensitive information is not disclosed until just prior to closing.

Initial information delivery. Once NDAs are signed, the acquirer should deliver an information request list to the seller. This list should be everything that is needed to understand the company well enough to propose a structure and terms but not a full diligence request list.

Proposal and agreement. Once the initial information has been reviewed, if there is interest in moving forward, the acquirer delivers a structure and terms proposal. A good acquirer will have listened carefully to the seller and incorporated not only fair economic terms but also terms that meet the non-economic needs of the seller. For the transaction to proceed, a final agreement must then be negotiated. It is then documented with a letter of intent.

Full due diligence and document preparation. At this point, the acquirer delivers a comprehensive due diligence request list to the seller and its representatives. The acquirer also retains CPA and other experts to conduct financial and specialized due diligence initiatives. Assuming due diligence is proceeding well, the acquirer has counsel begin preparation of the documents. This step should take 90 to 120 days.

Close. If the due diligence is satisfactory, the documents have been negotiated and there are no funding issues, there should be a final delivery of sensitive information. The closing should take place shortly thereafter.

I wish you great success in creating value through add-on acquisition.

 Dan Lubeck is founder and managing director of Solis Capital Partners (www.soliscapital.com), a private equity firm headquartered in Newport Beach, Calif. Solis focuses on disciplined investment in lower-middle market companies. Lubeck was a transactional attorney, and has lectured at prominent universities and business schools around the world.