Why Acquisitions can be the smartest and fastest way to grow your business.
Updated: Apr 1, 2019
Many SMEs assume an acquisition must look like this: Buy a competitor. Pay with cash.
No wonder it’s an automatic turn off. Most of us spend our careers trying to do things better than the competition, after all. The idea of taking over the headache of running their business - and in the process watching them head off into the sunset with your life savings - is not a satisfying vision.
But look a bit more closely and you may see that acquisitive growth can unlock real opportunities for expanding your business.
For a small business, organic growth can take years.
When I was running my football league business it took me two years to grow from 1-3 locations, two more years to get to 10, then two more years to get to 30. Maybe your experience is similar?
This is fine when you are first starting out. Caught up in the romance of the start-up phase, you are happy to wing it a little.
But what if you are a more established business? You have budgets to achieve and taking years to grow customer by customer, contract by contract, is not an attractive option. It could even end up being fatal if there are nimble competitors around, or industry regulatory or technological developments on the horizon.
In my case, I reached a point where could see that others were growing at a similar rate elsewhere so I decided the only way to push ahead of the pack was through acquisition.
This change in strategy got me to 200+ locations, something that would have taken a decade by organic growth alone.
Not just for the big boys
Many assume that M&A activity only takes place amongst multi-nationals with huge budgets.
But the SME sector is one of the most exciting, dynamic segments for M&A activity and is where huge value creation can take place.
There are a couple of reasons for this:
1. The SME sector is fragmented. At any one time there are thousands of owner managed smaller businesses where people are retiring, or their circumstances have changed. Businesses come up for sale all the time.
2. Finance is readily available. If your current business, or that of the target, is profitable and/or has a good asset base, financing can be pretty straightforward. And so long as you keep the target separate from your current business – broadly, a separate legal entity – the finance risk is contained.
3. Buyer/Seller rapport. At SME level, self-made entrepreneurs tend to negotiate directly. They are pragmatic deal-makers who get things done, so deals complete more readily - certainly compared to those multi-nationals where there are rounds of sign-off and layers of middle management to contend with.
The obvious advantages of acquisition over organic growth
The first straightforward upside is cost synergies. Usually, two similar businesses don’t need both sets of overheads. Two marketing departments, two bookkeepers, two websites – can all become one. Obvious.
Secondly there are economies of scale. This is where you get better purchasing power by being a bigger player. You get preferential rates (and respect) from your key suppliers and further down the P&L maybe you pay less for paper clips and loo roll. Again, pretty straightforward.
Finally, you take out a competitor. Most would see this as a good thing as it reduces competitive pressure, right?
Yes, but be careful not to get lured by illusory benefits driven by ego. Attempting to acquire a competitor that is too similar and at the same stage of development can have unintended consequences. For example, if the deal falls down, perhaps because of differing valuations, the target owner will often come away and re-double their competitive efforts (“I’ll show them what I’m worth”). Or they may get a taste for acquisitions themselves and you now have someone bidding against you for other targets (“I can do acquisitions too!”). All this can lead to more competition not less if your acquisition programme stalls.
The less obvious advantages of acquisition
Acquiring another similar business can offset some of your weaknesses. You might find the target has a brilliant marketing function, or IT system. Or it may offer a great product to the residential market whereas you are best at the commercial market. Either way, a combined group gives you a more resilient business with more options. You are more than the sum of your parts.
Furthermore, size matters out there. By bolting on sales, you may step up into a different order of magnitude in your industry – allowing you to tender for contracts or speak to customers higher up the food chain, an option that would not have been open to you previously.
Similarly, by growing your group profits, you may climb up a rung in the valuation pecking order. This can create unbelievable value and it’s what most private equity funds try to achieve as a way of life.
Allow me to elaborate on this point. The key lies in the mathematics. Acquirers pay more for bigger, diversified and safer income streams. So businesses that might be valued at 2-3x profits might be valued at 5-6x when their profits enter a higher range (say £1m + EBITDA).
A simple worked example would be useful here.
Start with a business with £300k earnings (valuation 3x £300 = £900k).
Acquire another one making £300k (you'll pay £900k).
Now you have a total of £600k earnings.
Implement synergies and economies to achieve £1m.
Your group might now be valued under the right conditions at 5x£1m = £5m.
Valuation growth of £3.2m (£5m - £900k - £900k) has been created through one acquisition!
If, as is likely, you leverage the acquisition with debt, your equity value creation is even greater.
Warning: this is easy to say, not so easy to do, of course. A lot of sweat lies hidden between those bullet points!
What type of business can I acquire?
Look beyond the obvious targets. You don’t have to focus on your direct contemporaries.
Many savvy deal makers look for complementary businesses. This allows you to combine your offerings to your mutual customer base. An accountancy practice acquires an IFA, or a legal firm, so it can offer packages for example.
Vertical integration is another option. This is a micro-economists term for the acquisition of a business up or down your supply chain. I know a brilliant kids sports coaching business that bought a sports team-wear company and was able to cut their cost of providing thousands of team kits. That’s vertical integration in practice.
Finally, consider any weaknesses in your business cycle, such as seasonality. Can you find a business that offsets such vulnerabilities? (A BBQ retailer acquiring a Christmas tree company would be a simplistic example).
Feel the fear and do it anyway
So, what’s stopping you? There are a number of reasons why business owners hesitate when considering growth through acquisition. The three most common ones in my experience are financial, time (lack of), and confidence.
The first one (financial) doesn’t have to be as frightening as you might think. If the business case is sufficiently sensible, there is a healthy liquid market for acquisition finance in the UK right now. If the target has a decent asset base with stable cash flows, and if the seller’s motivations are right, many deals can be structured so the financial stress on you or your business can be negligible.
The second issue is lack of time. Running a small business is all-consuming and many owners find it hard to imagine having the space to research the market, make multiple approaches and attend all the numerous meetings involved in making an acquisition. Not to mention the idea of having two businesses to run at the end of it! Sounds painful. Again, it doesn’t have to be that way, as I found out, particularly if you have the right support.
Finally, confidence is a genuine factor. We all have our areas of expertise. As a business owner you are a specialist at running your organisation, but probably not an authority on mergers and acquisitions. Understandably, you have some big questions such as:
- Where do I start?
- How do I make an approach?
- Won’t it be risky?
- How do I negotiate?
- How does it all work legally?
- Will I be saddled with debt?
- What if my customers or staff find out?
- Won’t I pay a fortune in legal fees?
All of this can overwhelming and sadly, there has been very little practical support over the years to support SME business owners through the journey.
In fact, that’s one of the reasons why New Path Advisory was set up in the first place. We strive to help our clients move their businesses forward through acquisitions. We can help clarify your strategy, identify and approach targets, and support the whole process through to completion – leaving you with the head-space to focus on running your core business.
If any of the issues I’ve spoken about resonate with you, please do get in touch. I’d be delighted to hear from you.