Business Acquisition as a Growth Plan

April 26, 2017

Why is it that large business and corporates commonly expand by taking over competing businesses but small and medium businesses don't often use this as an expansion strategy? The most likely answer is that bigger businesses are more of a known quantity, as compared to a smaller business, where any one key person leaving could totally change its profitability or even viability. But of course this fragility in business is something business owners deal with every day and actually if you look to take over a business, it can work to your advantage.

 

The main reason smaller businesses don't take over competitors is that they never consider it as an option and if you don't have it in your mind as a possibility, you most likely won't recognise the potential when it stares you in the face. So let me ask you a question:

 

A key competitor gets into financial difficulty, do you sit back and think, great one less company to compete with, or, do you think, what would they be worth to our business if we took them over?

 

The thing is, if you just ask a business owner a price for how much they would sell their business to you for, most likely they will come back with a totally unrealistic figure. This is because, even in the worse case situation people tend to ignore the following typical situations:-

 

They believe there would be a queue of people wanting to buy it.

They don't even consider the implications on themselves if the business stopped trading

They don't have the first idea of how businesses are valued

 

For a business to be worth money it needs to be proven to run consistently well without the business owners input. Now this generates two issues; firstly, if the business isn't doing well, then most likely the owner is underpaying themselves, so it would not be possible to employ somebody else to do their job. Secondly, the owner probably has a ton of information in their heads that is required for the business to run even day-to-day

 

So the real question is, why would you want to purchase a competitor? There could be a number of reasons, but the best takeover situation is where the competitor is offering a product or service that is complimentary to your own. Consider the following:-

 

Do they service different geographical areas to yourselves?

If they sold your product and or you sold their product, would it generate more total sales?

Do they have expertise you would benefit from?

Do they have sales streams that would benefit your product sales?

Do they have specialist people that would benefit you?

Would combining sales of the two companies give a percentage reduction in operating costs?

 

Therefore the first question is what would be the financial benefits of taking over a business and how much extra profits will be created so a payback can be calculated from any negotiated deal? For the record, the payback period is seldom more than 24 months and quite often significantly less than this!

 

The next question is, if this deal is going to make you money, why would the current owner want to sell to you at a low price? This commonly comes down to three reasons

 

  • They are loosing money, impending bankruptcy approaches and a sale can give the owner freedom from paying redundancy, clear debts and possibly let them keep their home.

  • They are sick of the pressures of running the business and want a life back. Now clearly you are running a structured systemised business, so you can impart this on their operations as they are absorbed into your structure. (If you aren't you probably shouldn't be doing this!)

  • They have run the business for many years and want a retirement option. Often they will be concerned for the welfare of their team in any deal here, as they don't want to be seen as wronging the people who have worked for them for years.

 

The real requirement here is to be on the lookout for the opportunity and this starts with having a list of businesses that would be worth a closer look if the opportunity came along. Once you have a list of types of businesses, or better still, specific businesses that interest you, then monitor the businesses for sale through brokers and register with them. If you know the specific companies, monitor their finances, marketing, PR and social media streams. Are they doing well and shouting about it? Or have they gone quiet? This may indicate things are not so good. You need to keep an ear to the ground for information.

 

If you have found a business and they are interested in selling, the next thing is to establish a price. It really goes without question, the seller is going to try to get more money than its worth and in any case the last thing they will actually like is for you to buy at the asking price as it will indicate they sold too cheaply! A business is worth whatever somebody is prepared to pay for it and there are lots of ways to go about valuing a business. However a rule of thumb I use is, twice the yearly net profit plus assets and that serves pretty well as a bench mark, but this would reflect a profitable trading business, not one in trouble.

 

The real strategy in buying a business, is to understand what it would be worth to you and then prove to the owner why it is only worth a certain amount to purchase. It is quite common to tie the owner in for a period and to pay relative to the business performance during that period.

 

If you are interested in business acquisition as a strategy, I hope this helps as a starter and I am always happy to talk further when you want to develop your own strategy.

 

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