Acquiring competitors and complementary businesses can be a significant growth accelerator for many businesses, yet the majority of entrepreneurs fail to understand the real value of buying profit.
When executed well the best acquisitions are the ones that cost the purchaser none of their own money, but still leave them with a profitable asset that can be structured to run under management.
As discussed in the previous Young Gun post, small business in Australia is facing a succession issue with 22 per cent of Australian business owners aged 60 or over. With an active seller market, proactive entrepreneurs with an understanding of how to structure a favourable acquisition may find themselves in the right place at the right time.
Heading into any deal, it is important to list the criteria that are important to you in an acquisition target. These criteria will differ depending on your industry, risk appetite and cash position.
The foundations of a successful acquisition:
1. The target is profitable
Generally speaking you don’t want to be buying a business unless the profit and loss statement ends in the black.
It is not advisable to buy a business that is making a loss in the hope of turning it around, unless there are serious cross-pollination opportunities with one of your existing business units. There are enough profitable businesses out there to keep you busy, particularly in this market, without looking at purchasing a loss from day one.
2. Key staff are secured
When Richard Branson was asked to sum up what makes a successful business in three words, he said, “People, people, people.”
In any acquisition the most difficult component is ensuring all the key staff are comfortable in staying and have some incentive to do so. The existing staff and management team in the business will probably understand the intricacies of the company better than anyone, so it’s imperative they are secured with employment contracts, which may even extend to one or two core managers being presented with an equity earn-in plan.
3. Appropriate valuation
The number one factor that prevents acquisitions from being signed, sealed and delivered is the disparity between what the seller wants, and what the buyer is prepared to pay.
The valuation needs to take into account many factors, including but not limited to, historical financials, industry and market opportunity, management team, the overall risk profile of the business and it’s future growth potential.
Keep in mind that the average private business in Australia sells for 1.5 times its net profit. Therefore in order to justify a price tag of a three or four times multiple, the business would need to score exceptionally well on many of the above criteria.
4. Strategic value
How are you able to make more money from this business than the previous owner?
Is it through flushing their products through your distribution? Could you push your products through their distribution?
Is it a cost saver in that the two businesses are similar and through integration you could save on wages?
Identifying where the uplift is going to occur, either through increasing profits or reducing costs, is fundamental to a good acquisition.
5. Effective due diligence
In any deal I participate in, I want to be the dumbest person on the deal team at all times. This means surrounding myself with people who are smarter than I am in their particular fields.
An accountant with transaction experience, a lawyer who understands acquisitions and the legal issues that come with them, an advisor who has experience in the field. All of these advisors are of paramount importance in helping you determine whether this business is a good buy.
Through implementing a planned and structured due diligence across the financials of the business, the legals of the business, and the commercial synergies, you greatly reduce your chance of ending up another statistic.
6. Be patient
Warren Buffet once said that if you could only make 10 decisions in your life, you’d be a billionaire. While the lure of buying that shiny business may be appealing, do not finalise any deal until you are certain you are getting a bargain.
The best acquisition target is the business that is surviving despite itself. A business that is profitable but doesn’t do any marketing, the business that doesn’t manage costs yet still manages to come out in front, the business that does great figures even though the founder hasn’t been focused on it for years – these are the acquisition targets you should have in your sights.
These are the opportunities to buy low, and perhaps one day, sell high.
Readers should seek professional advice before making financial decisions.