Nearly every company has growth in mind. In a public company, the idea is that growing earnings creates a growing stock price. While we cannot measure that in privately held companies the same way, growing earnings does increase the value of your business.
The way we spend our typical business days trying to grow the business is known as “organic” growth; this applies to any way we try and grow the company from the inside. New products, new services, new sales people, more business from existing customers, new distribution channels are all examples of organic growth. In this discussion we will consider how to grow your business externally, via acquisition of other businesses or product lines.
Reasons to acquire
Typically, if you are the owner of a privately held business, at some point you are going to need an exit strategy. The exception is if there are family members to continue the business. If there is no logical successor to the business, your thought plan should be to grow the business until it is large enough to be what’s called “of scale.” Once it reaches the critical mass of scale in revenues and earnings, there is a bigger universe of potential buyers willing to pay a higher multiple of earnings when you decide it’s time to get out.
There is another scale issue that comes into play with acquisitions: the fact that you are spreading fixed costs over a greater number of sales dollars. Following the acquisition, you still have the same number of vice-presidents, receptionists, accountants and, if you move the new business into the old one, the same real-estate costs. Yet those and other fixed expenses are now costing you less per sales dollar than they were before.
Additionally, if the acquisition contemplates adding more sales volume to your existing printing operations, there is the opportunity to expand gross margins both through better manufacturing overhead coverage and weeding out some of the lower margined products of the combined entities.
As a result of the increased sales, as well as coverage of overhead and other fixed costs, each additional sales dollar creates more money at the bottom line. The combination of increased profit margins and a greater earnings multiple produce a powerful multiplicative effect on the valuation of the business. For example:
The power of improved margins and overhead coverage is readily apparent here. Note that the combined company increased its sales by 50 percent and margins were conservatively increased from 20 to 24 percent. Even with an increase in fixed costs for new people and expanded sales, the EBITDA more than doubled. Finally, the value of the business has almost tripled.
Searching for acquisitions
There are various sources for finding quality companies to acquire. It is crucial to note that anybody you solicit agrees that your conversations will be held in the strictest confidence. A party considering selling its business has to be concerned that word will leak out to its customers, employees and suppliers, among others. If a potential seller’s interest in selling gets into the marketplace, it can cause damage to the value of the business. Confidentiality must, therefore, be maintained at all times.
Direct contact is the best way to do a search. You should have a preconceived idea of the characteristics of your acquisition targets; it is crucial that you get to the decision maker. When my company acquired the American Equipment product line from Advance Process Supply in 1993, it was the result of a cold call I had made nine months earlier after we had acquired the M&M Research line from Medalist Industries. Advance Process Supply had a New York Stock Exchange parent company and, in my first conversation with its CEO, I could tell he was quite skeptical that we could buy the line. Nine months later, he called me directly and asked if we were still interested. If you are not a direct competitor, the recipient might express no interest but refer you to another company that is a fit.
In addition to direct owner contact, your own employee base is an excellent source of acquisition intelligence. Your sales folks might get info from their customers, your purchasing people might hear something from a supplier, and your distribution channels hear everything going on in the market.
Bankers, lawyers and accountants are also excellent deal sources. Your own professionals should be aware that you are on the lookout for acquisitions. In fact, they should be anxious to help you since doing a deal means more business for them.
Lastly, but certainly as crucial, is your friendly neighborhood business broker or investment banker. Frequently, an intermediary will not have your firm on its distribution list and an ideal candidate will be available for sale that is unknown to you.
As with sales of your products, an acquisition search should be a proactive and perpetual activity. Your inside people should be aware that if they generate a lead that creates a deal, they will receive a referral fee.
Paying for the acquisition
The best way to pay for an acquisition is if your business has a business line of credit with excess borrowing capacity. In the optimal situation, between the funds you have available to borrow and the additional assets you are acquiring, such as accounts receivable, inventory and possibly equipment, your purchase will be covered with little to no extra cash invested. More than likely however, there will not be enough borrowing capacity and you will need additional financing. Typically, the best way to get additional financing is through the seller.
If you will be moving the acquired business into your existing facility, you may often find there are surplus assets such as equipment and inventory which can be sold to pay off part of the acquisition price.
We represented a buy that bought a comparable product line and moved it into its factory. The buyer ran an auction at the seller’s plant, liquidated significant unneeded inventory, and wound up realizing over $500,000 in the liquidation. It then used those funds to help make an early paydown on the business debt of the acquisition.
Pitfalls to avoid
Whenever you read of a major merger in the newspapers, you will hear talk about synergies and revenue enhancement opportunities. While the right deal may very well create more revenue for the combined companies, you should be very conservative in forecasting that growth. If a key employee, for example, does not want to join your organization, it could impede the revenue projections. The same could apply to the distribution channel or a customer who had a strong relationship with the old company but does not feel loyalty to the new one.
A final cautionary note. Acquisitions are not cheap. There are professional fees for lawyers and possibly consultants. If the target company is out of town, there is pre-acquisition travel cost for due diligence and post-transaction cost to place a team of people at the newly acquired business’s location. Acquiring companies has often been compared to drilling for oil. You can expect to dig some dry holes before you find a sound and reasonably price opportunity, but when you do, the payoff can be tremendous.