A good bolt-on acquisition will add value to your company. When consistently done well, it can build up the right scale that leads to the sort of private equity exit that makes the hard work of the past four or five years more than worth it.
Just look at Smoothwall, the education safeguarding technology company Tenzing invested in in 2017. We helped them make three acquisitions. Now they’ve recently been acquired themselves for £75.5 million, a return of 5.6 times the invested capital.
So as a CEO and management team, how do you know what is the right business to buy that will hopefully help generate a similar level of return?
Buying to scale
Ultimately, it’s about what business you want to create to get the best price on exit. This is in terms of both its scale and its offering. There are a few ways to go about this, each of which has different levels of risk.
The ‘easiest’ type of acquisition is buying a business that’s highly complementary to yours. This can help you sell related products and services to your customer base and vice versa. Next, in terms of risk, would be one that offers similar products and services, to different geographies. This effectively gets you into new markets but with products and services you already understand well. A riskier acquisition would be of a company that would bring you both new products and new territories.
To give you a flavour of what we at Tenzing look for on behalf of our portfolio businesses, for virtually every one of them, we are looking for ‘more of the same’. It’s the most sensible strategy. Then, in most of our businesses, we also know the products and services we don’t currently have, but know our customers would buy and which make sense to add through acquisition. This is rather than trying to build them ourselves. To date, fewer of our businesses have been looking for international purchases, but this is definitely increasing.
In reality, for your first acquisition, you would ideally start with a business similar to yours. You’re likely to know the product and the market, so you’re not having to learn new things. You can then focus on integrating well and delivering value. Get the first one right, and it builds confidence, setting you up for more, potentially ‘riskier’ acquisitions in the future.
Pairing an acquisition strategy with that of your business
Whatever path you go down has to link to your business strategy. We always spend time early with the management team, collating opinions from around the business on M&A criteria. These include “white space” in existing products and services, desired business metrics, and broader market dynamics/trends.
An M&A strategy that complements the broader business strategy and draws from the deep knowledge within the business is then documented by the Acquisitions Director, along with the CEO, and often the CFO. This is then presented to the Board and agreed, (re)confirming both the strategic direction and desired risk appetite for M&A.
By agreeing the M&A strategy in the first few months of any investment, there’s no ambiguity. As an Acquisitions Director, I’ve then got clear guidance as to what we’re looking for.
You need to review this regularly, too, however, because businesses and markets change all the time. Most businesses have a formal strategy day at least once a year in which M&A will be discussed. They will ask questions like, how is our core business performing? Where are we from a finance perspective? What impact does this have on M&A? Have the desired criteria changed for any reason?
But M&A shouldn’t just come up once a year. In all of the board updates I do, I always remind everyone of the current acquisition criteria. Everyone can think about whether that is still the right thing, and if not, we change tack.
Being open to changing tack is also really important once you understand which of your acquisition targets are actually for sale. The reality is, some businesses are just not. So when it comes down to it, availability is the biggest factor in your ability to do acquisitions. You might have the best strategy in the world, and there might be 5,000 businesses you could buy. But if none of them are for sale, it makes no difference.
In any case, you need to be flexible. It’s all about cadence and not getting bogged down in hunting for things that don’t exist or chasing the wrong things. If there are only a handful of companies that meet your very narrow criteria, you could spend the whole investment period trying to unlock one of those. But then, if it doesn’t come off, you’ve not bought anything else. So you’ve potentially wasted all that time when there may be other options that would work differently, but just as well.
To supercharge the returns, we aim for at least one acquisition a year for each of our portfolio companies. It’s not a hard and fast rule, of course. Sometimes you won’t do any in a year, and two the next.
Asking the right questions
Once you do land on a potential match and have built a great relationship with the vendors, it’s then about asking the right questions. In my experience, even when a business looks amazing, ultimately, the data never lies. You might start with:
- What does the product look like, and how good is it?
- Why are their customers buying their product over others?
- How many customers have they been winning?
- If any have been leaving, why is that, and where have they gone?
Then there’s the factual financial data, like a monthly P&L, and any KPIs they track.
We will often get third party diligence providers to help us with specialist areas. For example, the two businesses CTS bought recently had the same broad market focus as CTS – legal – but focused on slightly different sub-sectors within that market. We tasked a commercial diligence expert to ensure we all understood any differences.
There’s always an element of trust involved too, as it’s all about the people, on both sides. I will talk to some targets where you inherently just get a sense that you trust the person on the vendor’s side. You believe what they’re telling you. And others where you don’t. Does that mean you won’t buy the business? Maybe not, but you approach it differently. You might be more sceptical.
Tenzing’s guiding principle is to back entrepreneurs who have built great, high growth businesses in resilient sectors, with a solid product and good team. Whilst this is ideally all the same for any bolt-on acquisitions, the perfect acquisition match for you could look very different, meaning focus, creativity and flexibility are key. Together, though, we’re confident we’ll find them.