Growing Your Business through Acquisition
The quickest way to grow your business is to acquire another company. Whether your goal is to take out a competitor, gain access to a new set of clients, add a new product line, or secure a new piece of the value chain, there are many good reasons to consider buying a company. But purchasing a firm can be a risky undertaking, especially if you fail to undertake adequate due diligence before signing on the dotted line.
Finding the Right Business to Acquire
If you already own your own business, what are the advantages of buying another company, rather than investing your resources into growing your existing business? By acquiring a company that is already profitable, you are spared the effort of having to build operations from the ground up. An existing business offers instant cash flow, established relationships with customers and suppliers, and a hard-earned niche in the marketplace.
In some cases, you may be looking to acquire a direct competitor, thereby instantly garnering new customers and boosting sales. In other cases, an acquisition can serve as a complement to your current business activities, expanding your firm’s vertical integration within the marketplace. Buying a company that is either downstream or upstream from your own company’s activities on the marketing value chain can, for example, provide you with new channels for distributing your products or with an in-house source of supplies or services.
Occasionally, opportunities to buy a business present themselves. The owner of your main competitor may, for example, choose to retire and put the business on the block. If you know the business well, your decision about whether or not buying the company is a worthwhile investment is made considerably easier. You may, however, need to conduct some research before identifying the ideal acquisition target.
There are many potential sources of information about acquisition opportunities. Newspapers, trade journals, and online publications provide listings of companies for sale. The local chamber of commerce or business clubs may also know of business owners who are looking to sell their companies. For additional help, you may wish to contact business brokers, who typically represent sellers. Brokers can be useful in guiding both the seller and the buyer through the technical aspects of the acquisition process. Buying through a broker can, however, inflate the asking price and limit your ability to negotiate directly with the owner. You do not, of course, have to limit your search to businesses for sale. If there is a company you wish to buy, you can approach the owner with an offer.
Performing Due Diligence
As with any major investment, determining whether a particular firm is the right fit for your portfolio requires a thorough investigation of the organization. This process of due diligence will help you to assess whether the asking price is fair and whether there are any hidden problems at the company that could make the company less attractive than it initially appears.
Before releasing sensitive information, the seller will usually require the prospective buyer to sign a letter of intent, or a non-binding offer to acquire the business that includes a confidentiality clause stipulating that the potential purchaser may not use the information for purposes other than reaching a decision about whether to buy the business. There are a number of documents you and your advisors will wish to review when conducting due diligence, such as articles of incorporation, partnership agreements, insurance policies, contracts with suppliers and clients, customer lists, real estate and property ownership documents, leases, and business licenses or certificates.
It is, of course, essential to review with the help of an independent auditor key financial information contained in the sales records, financial statements, bank records, and tax returns of the firm, preferably for the past three to five years. Compile a complete list of the company’s assets, including real estate, equipment, inventory, trademarks, patents and other intellectual property -- as well as a list of all the company’s liabilities, including mortgages and loans. Check to see if the company was or is involved in any litigation, either as the plaintiff or the defendant.
If the business has more than a few employees, you will need to examine the company’s payroll and benefits, employment contracts, and the qualifications and performance reviews of the employees. Consider whether you would want to continue to employ these people after acquiring the company, and the legal and financial implications of cutting jobs.
To gain an understanding of how the company markets itself and positions its products in the marketplace, review the firm’s website, advertising and marketing materials, advertising budget, records of marketing campaigns, and any documents outlining the company’s marketing strategy.
Once you have conducted the necessary due diligence, a team of professional advisors -- likely to include your lawyer, banker, and accountant -- can assist you in making the final decision about whether to buy the business, and then in structuring and sealing the deal.
Funding the Purchase
Thorough due diligence is especially necessary if you are seeking financing to purchase the business. As with any type of business investment, there are a number of sources of financial assistance, including banks and other lending institutions, venture capitalists, and loan programs operated by the U.S. Small Business Administration. Banks and any outside investors will, of course, require a thorough accounting of the company’s assets and liabilities, as well as of your own company’s ability to manage and maintain the newly purchased business.
A lender may allow you to fund the acquisition by leveraging the assets and cash flow histories of both your own firm and those of the company being purchased. This type of loan is known as senior debt, and it is secured against the company’s current assets. In some cases, the seller may agree to support at least a portion of the acquisition in the form of seller financing, or earn-out arrangements based on future earnings. Investors in the company being acquired may also be willing to exchange their current equity for shares in the buyer’s company, particularly if the post-merger growth prospects appear favorable.
While it comes with greater risk and higher costs than senior debt, you may wish to consider entering into an arrangement based on expectations of future cash flow and equity growth known as subordinated debt, or mezzanine financing. In a mezzanine deal, the business owner receives some of the funding in the form of a loan and some by selling equity in the business to the lender. The business owner pays interest on the amount borrowed, and the subordinated debt holders, like other equity investors, recoup their initial investment, plus any increase in the value of the equity, in the next round of financing, or when the company goes public. Keep in mind, however, that both equity investors and subordinated debt holders will, at least initially, dilute your ownership position in the company, holding you to specific financial targets and becoming involved in the running of the company.
Before the deal is completed, it is essential to have in place a transition plan that involves meeting with, or at least contacting, employees, customers, and vendors who will be affected by the change in ownership. Whenever possible, try to avoid making any major changes until you have had the chance to thoroughly familiarize yourself with the operations of the company you have acquired. Allowing some time before making any large-scale adjustments not only avoids causing serious disruptions to the firm’s current operations, it also provides you with the opportunity to observe and learn about the company’s working practices and culture. While reform may prove necessary in some areas, you may find that there are certain approaches that are worth retaining, or even applying across your business operations.
