Growth by Acquisition: What You Should Know About Buying a Business
By Marcy A. Venarge, CPA, ABV, CFF, CVA, Manager
When it comes to growing their companies, owners of closely held businesses can follow one of two main strategies: internal (or organic) growth or growth by acquisition.
During challenging economic times, organic growth may be hard to come by, as customers tighten their belts and spending in many market segments slows. In such an environment, buying another business may enable you to grow by adding complementary products and services to your offerings, expanding your geographic footprint and/or acquiring the customers of one of your competitors.
Buying a business is not a step to be taken lightly, however. It will represent a huge commitment of money, energy and time on your part. That’s why you should carefully think through all of the potential implications, both positive and negative, before heading down the acquisition path.
Why do you want to buy? The first step is to ask yourself seriously why you want to buy a business. Growth may be one valid reason, but sometimes owners think that growth will solve all of their problems. The reality, however, is that growth usually brings on a whole new set of problems.
In short, bigger isn’t always better, and buying a business just for the sake of “getting bigger” is not a sound strategy. Rather, an acquisition should be the result of a disciplined strategic planning process that keeps the long-term goals and vision of your company in sight at all times.
Vertical or horizontal? If you can answer the “why buy a business?” question with valid strategic reasons, the next step is to begin the process of searching for acquisition targets. What kind of companies you target will depend primarily on whether you are planning a vertical or a horizontal acquisition.
In a vertical acquisition, you would buy a company above or below you in the supply chain. For example, a manufacturer might buy a raw materials supplier in order to source materials itself and grow its margin. In a horizontal acquisition, you would buy another company similar to yours, such as a competitor, in order to expand your market share or territory.
Depending on your industry, acquisition targets might be fairly limited and obvious. If not, an acquisition specialist can help you identify companies that might be a good fit for your strategic goals.
Search for “synergies” When considering companies to acquire, one of the main things to look for is potential synergies between the prospects and your business. The term “synergies” simply means that the result of two organizations working together is greater than the sum of them working individually. For example, many banks have merged in recent years in order to reduce costs and increase profits by eliminating duplicate employees, back-office operations, branch offices and other overhead expenses.
Care must be taken, however, to make sure that synergies will actually exist where they are perceived to be. If synergistic cost-savings don’t materialize like you predict, it will be difficult to hit your return on investment (ROI) numbers for the acquisition.
There are also many synergistic factors beyond cost-savings and financials that go into buying a business. Company culture is usually the biggest — many mergers and acquisitions that made sense on the balance sheet have failed due to cultural mismatches between employees and/or senior management. These clashes can be especially disruptive at small companies.
These internal problems usually manifest themselves in the form of disgruntled employees, breakdowns in customer service and the loss of key clients — all of which jeopardize the overall success of the acquisition. If you’re not confident that company cultures will mesh well together, and you’re unsure whether you will be able to retain a large majority of the acquired company’s customers, you may want to reconsider moving forward with a candidate.
Do your due diligence Synergies aside, the main thing you’re buying when you purchase any business is a stream of revenue and earnings for years into the future. If the merger is going to be successful over the long term, your projected income and profits must be realized.
Therefore, it’s critical that you perform thorough due diligence on any potential acquisition candidate before moving into serious negotiations with a seller. This means delving into the company’s financial statements in detail to confirm any statements of financial fact the seller may have communicated to you.
It may be wise to solicit expert help from a CPA or other qualified financial professional. Finding out too late that what you thought was $1 million in receivables is really only $600,000 will extend your payback period for the acquisition exponentially and cut your ROI drastically. An outside expert can also look at a deal from a more objective standpoint and help you see if it truly makes sense from every angle.
Here are a few more things to consider:
When it comes to growing their companies, owners of closely held businesses can follow one of two main strategies: internal (or organic) growth or growth by acquisition.
During challenging economic times, organic growth may be hard to come by, as customers tighten their belts and spending in many market segments slows. In such an environment, buying another business may enable you to grow by adding complementary products and services to your offerings, expanding your geographic footprint and/or acquiring the customers of one of your competitors.
Buying a business is not a step to be taken lightly, however. It will represent a huge commitment of money, energy and time on your part. That’s why you should carefully think through all of the potential implications, both positive and negative, before heading down the acquisition path.
Why do you want to buy? The first step is to ask yourself seriously why you want to buy a business. Growth may be one valid reason, but sometimes owners think that growth will solve all of their problems. The reality, however, is that growth usually brings on a whole new set of problems.
In short, bigger isn’t always better, and buying a business just for the sake of “getting bigger” is not a sound strategy. Rather, an acquisition should be the result of a disciplined strategic planning process that keeps the long-term goals and vision of your company in sight at all times.
Vertical or horizontal? If you can answer the “why buy a business?” question with valid strategic reasons, the next step is to begin the process of searching for acquisition targets. What kind of companies you target will depend primarily on whether you are planning a vertical or a horizontal acquisition.
In a vertical acquisition, you would buy a company above or below you in the supply chain. For example, a manufacturer might buy a raw materials supplier in order to source materials itself and grow its margin. In a horizontal acquisition, you would buy another company similar to yours, such as a competitor, in order to expand your market share or territory.
Depending on your industry, acquisition targets might be fairly limited and obvious. If not, an acquisition specialist can help you identify companies that might be a good fit for your strategic goals.
Search for “synergies” When considering companies to acquire, one of the main things to look for is potential synergies between the prospects and your business. The term “synergies” simply means that the result of two organizations working together is greater than the sum of them working individually. For example, many banks have merged in recent years in order to reduce costs and increase profits by eliminating duplicate employees, back-office operations, branch offices and other overhead expenses.
Care must be taken, however, to make sure that synergies will actually exist where they are perceived to be. If synergistic cost-savings don’t materialize like you predict, it will be difficult to hit your return on investment (ROI) numbers for the acquisition.
There are also many synergistic factors beyond cost-savings and financials that go into buying a business. Company culture is usually the biggest — many mergers and acquisitions that made sense on the balance sheet have failed due to cultural mismatches between employees and/or senior management. These clashes can be especially disruptive at small companies.
These internal problems usually manifest themselves in the form of disgruntled employees, breakdowns in customer service and the loss of key clients — all of which jeopardize the overall success of the acquisition. If you’re not confident that company cultures will mesh well together, and you’re unsure whether you will be able to retain a large majority of the acquired company’s customers, you may want to reconsider moving forward with a candidate.
Do your due diligence Synergies aside, the main thing you’re buying when you purchase any business is a stream of revenue and earnings for years into the future. If the merger is going to be successful over the long term, your projected income and profits must be realized.
Therefore, it’s critical that you perform thorough due diligence on any potential acquisition candidate before moving into serious negotiations with a seller. This means delving into the company’s financial statements in detail to confirm any statements of financial fact the seller may have communicated to you.
It may be wise to solicit expert help from a CPA or other qualified financial professional. Finding out too late that what you thought was $1 million in receivables is really only $600,000 will extend your payback period for the acquisition exponentially and cut your ROI drastically. An outside expert can also look at a deal from a more objective standpoint and help you see if it truly makes sense from every angle.
Here are a few more things to consider:
- Ask lots of questions. No question is too small or insignificant when considering the purchase of another business. However, don’t ask questions that you should be able to answer yourself during due diligence; instead, ask for help in understanding what you’ve found.
- Look for skeletons. Almost every company will have some issues that need to be dealt with. If you don’t find any skeletons in the closet, look harder. When you do uncover them, ask the seller to explain the circumstances, and then decide to what degree they may be deal-breakers.
- Detach yourself emotionally. After possibly putting hundreds of hours into researching and performing due diligence on an acquisition candidate, it can be hard to walk away when you’re close to finalizing a deal. But even at this late stage, you don’t have to buy the business. If you have legitimate concerns or can’t negotiate a price and terms that you’re comfortable with, it’s better to walk away than move forward with a deal you might regret later.
- Remember that business acquisitions are a matter of caveat emptor (let the buyer beware). As a buyer, you and you alone are responsible for taking all of the prudent steps necessary to give an acquisition the greatest possible chance of long-term success — for you, your employees and the employees of your new business.
We can help provide significant advice and assistance in buying another business. For more information, contact Marcy Venarge, manager, at 330.762.9785 or by email to talk about a deal you may be contemplating.
Sidebar
Financing the Deal
There are three main options available for financing the purchase of a business:
Seller: The seller may be willing to finance the deal, though he or she might want a higher price in return for assuming this risk. Given the current economic uncertainty, however — especially with regard to capital gains tax rates — this option may be less attractive to some sellers.
Debt: A bank may loan money for an acquisition, but the credit crisis has resulted in tighter lending standards and higher down payment requirements.
Equity: Venture capitalists and “angel” investors provide the financing for many business acquisitions in exchange for a percentage of ownership in the company.
For more information:
Transaction Advisory Services