How to be in control when buying a business
When buying a business you need to be in control of events. There are several reason why you choose buying a business as an option.
Be they to grow, enhance the goods or services you provide or solve a management problem. It is not because it is for sale.
Buying a business effectively boils down into four types:
- diversification; or
I regularly come across successful buyers. if you cannot tick off a few of these matters set out below when you go on the buying trail, you can be fairly sure they will end up as a failure.
Some keys to buying a business
Avoid buying too large a business relative to yours. it has to be easily digested both from a financial and operational point of view.
It should be generating profits and cash otherwise it will become a drain on yours.
There ought to be scope to improve margins either through scale and or better buying.
the acquired business ought to have a defensible market position, ideally in a niche area you aspire to.
Cross-selling opportunities ought to exist to either bring in more customers to your and or their business, markets, products or services.
There is no substitute for experience. Ideally you would have “done it before” If not then you need to bring together a good team of people to help you . This is particularly relevant where you will need to borrow the funds to make the purchase. This experience can be gained by buying a business smaller than yours and literally bolting it onto yours.
For example one of my clients bought a small business, just the customer list and employees to build his presence in a certain location.
Many small businesses operate in fragmented markets that is where there are many small businesses where no one dominates. So, competition is intense and a larger player can scoop up the prizes and gain some control over the market..
Moreover, at present i am afraid to say there are several zombie companies. These are companies who are able to continue trading due to the low cost of borrowing. One of my clients is being undercut. It forces price pressure and makes it really difficult to avoid the sector buying on price and not on value. I have planted the seed of an idea of buying up these smaller competitors and am waiting to see what happens.
Consider the money when buying a business.
When you acquire a business two cheques are effectively written. One for the business itself and the other for the growth capital. Underestimating the amount of funding required to grow a business and the timescales are common reasons why deals do not add the value expected.
Where borrowings are required to fund the acquisition make sure there is enough cash being generated in the business to repay the debt. If this is not the case, the repayments will hold back future investments in people, process and systems. So growth will be slower.
What are the three big mistakes when buying a business?
1. Integration plan
The research carried out says it is no good the day after the acquisition has completed in sitting down and deciding how to integrate the two businesses.
Recently I was involved in a sale of a professional service business. I was drafting the Heads of Agreement while encouraging the two sides to sit down and discuss how they were going to put the two businesses together. They were selling the same kind of service. When they did sit down and thought about the integration they soon appreciated the two businesses were more different than they had expected.. So, after further discussion, the terms of the agreement were altered in order for the transaction to complete.
On of eh other three big mistakes was communication. In particular the benefits to all the stakeholders. The owners on both sides need to see how they are going to benefit. It is easy to say we can cross-sell or save costs. it is a different thing to articulate these numbers and the benefits in the due diligence phase of the transaction.
This is where the 100 day integration plan comes into play. See what we’ve got, decide on the changes and put them into effect. The plan showing where the value will be must be written and agreed at least among the buying team before the deal is signed.
In their book, the authors highlighted the third big mistake. This is one I have seen so many times. It is poor communication. It happens where there is a lack of understanding of the cultures of the target.
The deal will fail and not add value where there is a lack of appreciation, evaluation and consideration the value of the people. We can argue whether people, processes or customers are the most important asset in a business. Their importance will vary with each business. Moreover, if the people are a vital part of the success of the business in the past, they will be so after the business is bought.
Basic principles to buying a business.
So, let’s go back to basics. “Why am I doing this deal?”
When you have a list of what will add value, the planning can be done effectively. Even if the planning is not as good as it should be but the people and communication are, can you still resurrect the deal?
The authors say just about but if you have two of the three wrong, then the deal is very likely to be unsuccessful.
What about the price when buying a business?
Up to now, i have not mentioned price.
Price is relative. It depends upon your attitude to risk. How quickly do you want your money back and how much are you prepared to risk? Some business owners when they look at buying a business would consider risking a larger amount over a shorter period of time than a lesser amount over a longer period of time.
Moreover, the return is also important. if you wish to make a return of 8% compounded over five years, the the price you pay at the start will be dependent upon what you believe it will be worth in five years time.
Does overpaying count as a failure to add value?
Another conclusion in the book is that the pricing of the deal is not necessarily one of the big mistakes. obviously the price is relevant but it is not one of the big mistakes. it can be recouped maybe over a longer time scale.
When i have negotiated deals with synergies in mind, these are agreed and a price struck. So long as there is a clear rationale for the deal, then price is not the key issue. It’s the whole deal that’s relevant especially where there is deferred consideration which is only paid to the seller when certain goals are achieved.
It is likely to be the case that the seller says my business is worth £x because of such and such. Some of these outcomes are usually dependent upon future events. The buyer will say, yes we recognise that and where it is based on future events or sales then that is a fair price. We will pay it only when the outcomes are in line with those predictions. Then the buyer will want to remain in control to ensure he achieves these outcomes.
The issue for the buyer is that the development of the business may not be best achieved by setting a price including the deferred amount which is dependent upon those outcomes. Indeed it may hold back the longer term development of both businesses while the earn out is achieved. Moreover, if it is not achieved and the seller will not leave until the end of the agreed period, then serious damage could be done.
Need help with buying a business?
Contact Andrew to discuss your purchase and how he may be able to help.
Andrew is the director of Assynt Corporate Finance Limited and an Accredited Member of the Association of Crowdfunding experts.
Previously a partner and head of corporate finance at Baker Watkin LLP, Andrew has more than 36 years of experience in all forms of corporate finance across many business sectors.
Andrew is also the Chair of Governors at a local school and an Assessor of Expeditions for The Duke of Edinburgh’s Award.
You can find out more and connect with Andrew over on LinkedIn.