How to Assess Acquisition Candidates

Mergers and acquisitions allow businesses to increase their market share, expand their geographic reach and become larger players in their industries. However, when one company acquires another, it takes the good and the bad. If the target company is saddled with debt, ensconced in lawsuits or marred by disorganized financial records, these issues become the new company's problems to deal with. The benefits from acquisitions are often outweighed when the acquiring company also acquires a list of costly problems.

Before making an acquisition, it is imperative for a company to evaluate whether its target is a good candidate. A good acquisition candidate is priced right, has a manageable debt load, minimal litigation and clean financial statements.

Evaluating an Acquisition

The first step in evaluating an acquisition candidate is determining whether the asking price is reasonable. The metrics investors use to place a value on an acquisition target vary from industry to industry; one of the primary reasons acquisitions fail to take place is that the asking price for the target company exceeds these metrics.

Investors should also examine the target company's debt load. A company with reasonable debt at a high-interest rate that a larger company could refinance for much less often is a prime acquisition candidate; unusually high liabilities, however, should send up a red flag to potential investors.

While most businesses face a lawsuit once in a while—huge companies such as Walmart get sued quite often—a good acquisition candidate is one that isn't dealing with a level of litigation that exceeds what is reasonable and normal for its industry and size.

A good acquisition target has clean, organized financial statements. This makes it easier for the investor to do its due diligence and execute the takeover with confidence. It also helps prevent unwanted surprises from being unveiled after the acquisition is complete.