By Neil Feldman
In highly competitive industries like electrical distribution, organic growth can be a daunting proposition, particularly when it comes to new markets. Widespread recognition can take years to establish and relationships have long been cultivated between existing distributors and their customers and vendors. The most efficient path to growth in some instances is through mergers and acquisitions (M&A).
Though the press often refers to M&A activity in the same breath, they are in actuality very different. A merger occurs when two separate entities combine forces to create a new, joint organization, while an acquisition refers to the takeover of one entity by another. A new company does not emerge from an acquisition. The smaller company is typically consumed and ceases to exist, and its assets become part of the larger company. Acquisitions are also referred to as takeovers.
“Legally speaking, a merger requires two companies to consolidate into a new entity with a new ownership and management structure, normally with members of each firm,” said Evan D’Amico, an M&A attorney in the Washington, D.C. office of Gibson, Dunn & Crutcher. “An acquisition on the other hand takes place when one company takes over all of the operational management decisions of another.” The vast majority of business deals, D’Amico noted, fall under the banner of acquisitions.
A distributor seeking to acquire another organization first needs to determine what their specific objectives are with the transaction. “Far too many businesses make the decision to acquire a competitor simply because the valuation looks cheap,” said Gary Miller, founder and CEO of GEM Strategy Management, a business consulting firm based in Greenwood Village, Colo. “That can be a mistake with major financial and cultural implications,” said Miller. “A significant amount of homework and planning is essential when an acquisition is being contemplated. Even if a particular company wants to desperately sell and the valuation looks over-the-top appetizing, it’s better to walk away then to acquire that company if the fit isn’t right for the acquiring business.”
If a distributor is looking to break into an existing competitive market, it is essential to ensure that key manufacturer personnel and industry reps will embrace and support the new business structure. “It’s never too early to start relationship building with the vendor community,” said Miller. “You want to extend an olive branch, lay the foundation for a good rapport, and get an understanding how their ground rules work.” While it’s generally acceptable to advise local reps of the plan and have that individual convey positive comments to the rep in the new market, Miller noted that it’s a cardinal sin to try and over leverage a good relationship with a local rep in an effort to receive white glove treatment from the new market rep. “That’s a surefire way to ruffle some feathers,” said Miller.
If a distributor has sufficiently deep pockets and can avoid the lending process in an all-cash deal, then they are clearly in a solid, well-capitalized position. Many acquisitions, however, require a meeting with a bank loan officer. Securing capital and best possible financing terms for an acquisition can be challenging. The noose on lending was significantly tightened in the wake of the 2008-2009 sub-prime lending crisis, though many banks have since moderated their protocols, but none are as loose as the days before the financial meltdown. A key to the type and availability of funding is the structure of the company that is being acquired. “A company with little debt, significant assets, and strong cash flow is a good candidate for an acquisition with a significant portion of long-term debt financing,” said Anthony Hussain, managing partner and founder of Miami-based Capvesco, a capital advisory firm.
Acquisitions often involve different layers of capital which could include bank financing and private equity. “The type of business being acquired, the valuation of assets, cash flow, and perceived market risk are the characteristics that determine which capital sources and financing structure are the most appropriate,” said Hussain. “Each type of transaction will have its unique set of evaluation criteria, cost of capital, expectations, deal terms, and covenants,” he said.
If the target company has a lot of assets, positive cash flow and strong profit margin, the buyer should be able to find bank financing, noted Hussain “But say you want to buy a company that has a lot of receivables and short-term assets,” he added, “the level of difficulty in securing bank financing increases.”
Finding a bank that has a history of financing the type of business being purchased can be a significant help. “What most buyers or prospective borrowers don’t understand is that each bank’s requirements are different,” said Michael Fekkes, a senior broker at Enlign Business Brokers in Nashville, Tenn. “So, you may go to one bank and get turned down for a conventional loan. You are then left with the impression that you don’t qualify for a loan, but every bank has their own criteria and appetite for risk, so it’s important to speak with a handful of them.” He recommends as a resource Diamond Financial Services (diamondfs.com), which structures and packages loans, working with over 100 banks and non-banks that do SBA lending. “They know which banks are lending for which types of loans.”
When whispers of an acquisition swirl around the office, a cloud of uncertainty can hang over the heads of employees. Senior managers should convey information to employees as soon as it’s readily available and be as transparent as possible. “It’s inevitable that an acquisition will result in some redundancy,” said Miller “In these cases,” he continued “redundancy can lead to lay–offs, or may require shifting roles of employees. While lay–offs most often cannot be avoided, reducing uncertainty amongst employees is best. Those employees that are being laid off should be told immediately and be provided with severance packages, if possible, and most importantly treated in a respectful manner.”
Remaining employees should have clear guidelines on their role within the new structure, and a development plan that will help them adjust to subsequent changes. All employees should be made aware of new processes, policies and procedures that result from the acquisition. This will require a training plan, which may include making employees familiar with everything from processes for submitting purchase orders and new reporting procedures, all the way up to new technology platforms. “Your training plan can include one–on–one training seminars with an instructor, web–based training such as webinars, or newly developed or revised training guides, said Miller. He also noted that there should be HR training for items like benefit plans, retirement savings, becoming acquainted with and signing-off on the employee manual, and harassment training.
The culture of the organization is bound to be impacted, and this may adversely affect the morale of employees. “The uncertainty can lead good employees to seek employment with competitors, or other employees to take on an unmotivated attitude,” said Carla Katz, a professor at Rutgers University School of Management and Labor Relations. “Either scenario can lead to disruption in the workforce,” she noted. “Management should communicate as openly as possible, and provide employees with the vision and mission for the new organization as early as they can. Mapping out the changes that will occur in a clear manner keeps employees informed, reduces uncertainty, and minimizes the disruptions. It may even help them view the changes as positive.”
While a merger or acquisition is not the most optimal time for employees, there are ways to increase motivation and productivity, according to Katz. She suggests setting aside time for employees who wish to discuss concerns or issues with the acquisition. Open discussions, noted Katz, usually prevents confusion about roles and responsibilities. Lastly, Katz recommends setting aside time for all employees—in both the acquiring company and the company being purchased—so they have ample opportunity to connect with each other. “This can be in the form of company–wide meetings or smaller social gatherings,” she said. “It’s just important to clearly communicate and reduce the amount of uncertainty throughout the organization.”
Feldman is a senior manager in the distribution industry and a freelance writer whose byline has appeared in “The New York Times,” “The Boston Globe,” and numerous magazines. He can be reached at firstname.lastname@example.org.
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