How to Evaluate a Potential Acquisition Candidate

Mergers and acquisitions allow businesses to increase market share, expand their geographical reach, and become bigger players in the industry. However, when one company acquires another, they take on the good and the bad. If the target company is saddled with debt, embroiled in litigation, or has poorly organized financial statements, these problems become issues the new company must deal with. The benefits from the acquisition are often overshadowed when the acquiring company also has to take on a host of costly problems.

Before making an acquisition, it's important for a company to evaluate whether the target is a good potential candidate. A good potential candidate is reasonably priced, has a manageable debt load, minimal legal disputes, and clean financial statements.

Evaluating an Acquisition Deal

The first step in evaluating an acquisition candidate is determining whether the proposed price is reasonable. The metrics that investors use to place a value on an acquisition target vary by industry; one of the key reasons why acquisitions fall through is that the target company's asking price exceeds these metrics.

An investor should also consider the target company's debt load. A company with a reasonable amount of high-interest debt that a larger company can refinance at a lower rate is often an ideal acquisition candidate; however, unusually high debt loads should be considered a red flag for potential investors.

While most businesses deal with occasional litigation—large companies like Walmart are frequently sued—a good acquisition candidate is one that isn't facing a level of litigation that is beyond what is reasonable and normal for its industry and size.

A good acquisition target has clean and well-organized financial statements. This makes it easier for investors to perform thorough due diligence and to execute the acquisition with confidence. It also helps prevent unwanted surprises from appearing after the acquisition is completed.

Conclusion

Evaluating a potential acquisition candidate requires a thorough and holistic approach that goes beyond just looking at the company's market value. Key factors such as price reasonableness, debt load, litigation history, and the clarity of financial statements are critical in determining the true value and potential risks of the acquisition. A well-priced company with a manageable debt burden and a clear legal and financial record is a strong candidate, as it minimizes the likelihood of unexpected problems post-acquisition. By conducting careful due diligence on these fronts, the acquiring company can ensure that the benefits of the acquisition will outweigh the potential drawbacks, leading to a successful and value-adding transaction.