Growing your small business through making an acquisition can be an excellent way to turbo-charge your plans. Every business needs organic growth through the usual marketing. Buying another business though can, almost overnight, take your business to the next level. In my career, I have been involved on both sides of many transactions. Through this, I developed my 4 ultimate guiding principles for buying a business.
These apply whether you are buying a new business or making an acquisition.
There are obviously pros and cons to this strategy. As a business mentor, my role is to help my clients assess these. Assuming the decision is made to proceed, I then support and guide through the process.
Remember my 4 ultimate guiding principles for buying a business and you will greatly reduce your chances of taking a false step.
4 Ultimate Guiding Principles for Buying a Business
Julie was the CEO, founder and main shareholder in a professional services business. She had been running this for around ten years, with no small degree of success. She had built revenue to around $3m per annum and was making a reasonable profit margin.
Several years back, Julia had moved to new offices to accommodate organic growth. She took on additional space and staffed up in anticipation of organic growth. This came, but not at the rate she expected. This means that she had under-utilised resources in the business, and she wanted to change that quicker than she could through normal sales and marketing.
She decided to start looking for a similar, but smaller business to acquire – something with around $1 to $1.5m of revenue and three to four staffers.
Principal 1: Kill the Deal Quickly
There are many ways to locate potential acquisitions. In my experience, especially when it comes to services firms is to either
- Network and then approach through industry associations or
- Engage an agent to represent you.
There is a little bit of reverse psychology at play here. You probably don’t want to buy a business that someone is trying hard to sell! Rather, it’s ideal to locate a business that could benefit from a bigger partner and lacks the immediate resources to grow on their own.
From this activity, we put together a shortlist of five prospects. One in particular seemed very promising. It had all the qualities we were looking for. Good staff, great client list – but the business was in a poor location and the profit margin wasn’t all that great. The owner was an excellent professional, but not a fantastic business person.
Negotiations went very well. But then, suddenly, they didn’t. Items that we thought had been agreed for our Terms Sheet were brought up for re-negotiation. Issues like the outstanding lease on his premises were a bit different from how they had been represented. He tried to change the timing of purchase-price instalments.
We tried to accommodate the new demands and adjust to the new information that our Due Diligence process uncovered. But for every new demand that was met, another appeared.
Ultimately, we couldn’t reach an agreement. But we spent a lot of time – time that ended up being wasted – trying.
Truthfully, Julie got sucked into this rabbit hole, because the deal had such great potential.
We took too long to kill the deal. We fell for the myth that there is a perfect deal or a scarcity of opportunities.
My experience in business acquisitions tells me, if an agreement on the broad terms and purchase price can’t be reached within a couple of meetings, then it never will be. When this happens, just walk away.
Reduce your opportunity cost.
Kill the deal quickly.
Principle 2: Succession not Acquisition
Why is a business worth anything anyway? OK, you have the tangible assets that could fetch a few dollars in a fire sale. Mostly though, the value of a business comes through its goodwill (especially in service firms). This Goodwill is an intangible asset that reflects the customers of the business like these services enough to keep coming back for more.
For example, an accounting practice. If they do a good job, customers will keep coming back year after year, with a high degree of regularity. They have established a relationship with the people, and that is hard to replicate or to break.
And an important part of buying a business is to do it in a way that preserves the goodwill.
Think about it from the perspective of a loyal customer of the seller. They hear that the business is being sold. It’s moving to a new location. The name is changing.
Typically, the average customer is now thinking about maybe finding an alternative solution.
Then they read that, actually, the owner – and the other staff – are staying on. There aren’t any redundancies. The key people – the ones with customer relationships – are continuing. This is good news for the customers, and you. It means that most will keep bringing their business.
In designing a transaction, we kept in mind that we wanted most of not all staff to come across. Remember, the profit lay in making better use of Julie’s existing resources, than for necessarily reducing the target’s costs. That would happen anyway because we retained most of the revenue whilst losing the target’s rental costs.
The lesson is to stop thinking of an acquisition as a purchase and start understanding it as a succession plan for the existing owners. Tie that in with a smart transaction design, namely, an upfront payment, followed by an earn-out, all linked to an employment contract.
Instead of buying someone’s business from the owner, you are assisting them to have a plan to gracefully exit over (say) several years. Whilst this happens, they continue providing great service to their customers long after he or she has left the business.
But what about vendors that just want to get out? Well, you won’t be buying businesses like that, because you always keep in mind Principle 3….
Stop thinking of an acquisition as a purchase and start understanding it as a succession plan for the existing owners.
Principle 3: Culture and Client Value Proposition
Wait. Are you buying a business to add on to your existing operation, gaining synergies and increased profit margin through scale – or are you just buying a new silo in a conglomerate?
If it is the former, then you need to dig deep in the due diligence to make sure you have a culture and a Client Value Proposition that is a close match to yours. Or be prepared to invest a lot of time and money to mould the business to fit your model.
My friends at Business Health used to say, are you buying a hamburger stand or a fine-dining experience? Both of them cook you dinner, but they deal in very different markets with a very different culture. Try and combine the two as they are, and both will suffer.
Julie spent a lot of time getting to understand all about her target’s ideal client, their value proposition – even how they packaged and charged their fees. This also fed into the culture of the organisation. She realised that the new combined company would have to make its own new culture and it was critical to start with two great cultures.
This aspect is often overlooked, as much of the focus is on the financial models. However, if you are going to be working together for several years, you want to enjoy it, right? Equally, you want your new customers to feel at home, and your existing customers to not feel like you are ‘losing your way’.
These intangible or market aspects are very important. Combined with a killer financial model you can not only achieve fantastic growth, you can create an amazing business and have a lot of fun along the way.
Culture and client value proposition always make a HUGE difference in ensuring the final principle:
Principle 4: For the Right Deal, Money will always be Available
The financial engineering of any acquisition is important. For the purchaser, before you go shopping, you need to know what your limits are and how this can be financed. Will it be through borrowing, or having your shareholders contribute, using the company’s funds or a combination of all three?
In Julie’s case, it was a combination. She negotiated to pay 65% of the anticipated purchase price upfront, with the balance paid in two instalments, at the first and second anniversaries (the exact amount of these latter payments were based also on financial performance post-sale).
She had some retained earnings in her company, plus some additional borrowings, to cover the first instalment. We projected that the increased cash flow of the combined business would allow the second and third instalments to be paid from the company. In other words, it would become self-funding.
The lesson though was that this was such a compelling transaction, the bank would have happily funded it completely. Alternatively, Julie and her other two partners had the resources to put their funds in if it was required.
It’s tempting to hold off making acquisitions especially if money is tight. In my experience as a businessperson and as a business mentor, I can promise you that for the right deal, there is never any shortage of money.
The role of the Business Mentor
Through this whole process, the role of the business mentor is an important one. In any deal, everyone has an angle. The vendor wants more money. The bank wants you to borrow it. The lawyers want to make the negotiation complex and expensive.
Everyone is looking after themselves.
Except for your Business Mentor. Your business mentor looks after YOUR interests.
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