Of course, buying at a low price is rather obvious general advice. When involved in an acquisition, however, it is, without question, the single most important element of the deal. In fact, I'd go so far as to say the success or failure of more than 90% of all acquisitions is determined during price negotiations.

And I'm not talking about the sometimes quoted "there is no bad acquisitions, only bad prices" mentality. I'm referring to the normal modeling, negotiation, multiple-comparing, pricing that goes on in acquisitions every day.

Why can't we just say "no?"

Buying low seems so straightforward, so simple, so obvious, yet I've seen instances over and over during my career where doing so went by the wayside during negotiations. Buyers very frequently get sucked into the deal and convince themselves to overpay. Why? There are several reasons:

They fall in love with the deal. Adding this cool new business becomes the objective, rather than making a great investment for the shareholders.
The acquisition is "strategic." People invoke "strategic" when they want to take the argument away from pricing reasonableness. In my experience "strategic" means "over-priced."
The "platform" argument, where the buyer convinces themselves they can afford to overspend on this business because it will become part of a platform they can use to make further, cheaper deals in the future. Check. In most cases the future deals either never happen, or aren't cheap.
The synergies are overwhelming. Maybe they are, but why would you giving any part of their value to the seller? Talk about counting your chickens before they're hatched -- when buyers use the synergies argument, they're not just counting them, they're giving them away.
Sunk costs. Sometimes the buyers have so much time invested in negotiating the deal that they can't seem to back away from concluding the transaction, no matter how overpriced it becomes.
Lost face. Kind of the opposite of number 1. The buyer finishes an overpriced acquisition because he will be horribly embarrassed if the deal falls through.
Keeping the deal out of the hands of someone else -- usually a competitor. Why not let them waste their resources by overpaying?
Mistakes in analysis -- I've seen this happen a couple of times where the price fits the "normal" multiples, but the analysis still contains major errors.

Example #1

A number of years ago, I helped negotiate the purchase of a small engineering services company. This was a company where the primary assets got in their cars and drove home each day. Lose the employees and you lose your revenue stream. The characteristics of the company dictated a very modest price, but the sellers had other ideas. My boss, sucked into the belief that the deal represented a "platform" and seeing major cross-selling "synergies," advocated for a much higher price.

We did the deal, but as a result I ended up saddled with an acquisition forecast that was completely impossible to deliver. In hindsight, the deal didn't represent a "platform," because we needed it to pay off before the board was willing to venture any further in this direction. Many of the proposed "synergies" simply didn't work. What was a nice little business turned into a failed acquisition, primarily because we paid too much.

Example #2

More recently, I had the opportunity to purchase a smallish manufacturing business. In this case, the seller was motivated, and I stepped in at the last minute when a previous sales contract fell through. Because I was ambivalent about getting back into the swing of managing, I was able to be completely unemotional about the value of the business. I offered a fair price that was on the low end of the range, and concluded the transaction soon afterward.

In this case, because there was no impossible forecast, nor any foolish synergies, I was able to earn a good return on the investment. In fact, with some restructuring and relocation, the costs of the business have dropped, and I am making more money than I originally expected.

Example #3

I continue to regularly look at acquisitions, and recently had the opportunity to consider a small division of a large corporation, one where the sellers recognized the business wasn't core and wasn't something they were willing to invest in to grow.

Before discussions ever got started, however, the seller's CEO was demanding to know "how much I was willing to pay" for the business (before I'd even seen the financials, no less!) While I was definitely interested in making the deal happen, I couldn't imagine paying more than 5x earnings for a small manufacturing business with only two customers in a cyclically peaking industry.

That didn't hit the CEO's expectations. Needless to say the talks immediately ended. Based on my previous acquisition experiences, however, I wasn't about to get sucked into overpaying for the business just because I liked the look of it.

Conclusion

Buying low requires discipline, tenacity, and an ability to recognize when emotion is starting to overtake your better judgement. Yet it is critical to success in almost every deal I've ever seen. Buy a good business at an overly-inflated price and you'll regret it for years to come as the returns -- good by some objective standards -- will fail to meet the inflated expectations of the purchase price. 24.2

Buy Low

Tom Spears

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