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 but by buying another business can, almost overnight, take your business to the next level. At Kenwell, we have been involved on both sides of many transactions, as we help our clients execute their GAME Plans. So, if you are buying a business, these are our 4 guiding principles.
There are obviously pros and cons to this strategy. As financial life planners, our role is to help our clients assess the best approach and then assuming the decision is made to proceed, we then support and guide them through the process.
By considering these 4 guiding principles, you will greatly reduce your chances of taking a false step.
Buying a Business: 4 Guiding Principles
Julie was the CEO, founder and main shareholder in a professional services business. She had been running it for around ten years, with a high level 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 increased staff in anticipation of organic growth. This came, but not at the rate she expected. Julie 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 staff.
Principal 1: Kill the Deal Quickly
There are many ways to locate potential acquisitions. In our experience, especially when it comes to services businesses, 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 and a great client list, but the business was in a poor location and the profit margin wasn’t ideal. The owner was an excellent professional, but not a fantastic businessperson.
Negotiations started 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 such as the outstanding lease on his premises were a bit different from how they had been represented. The vendor tried to change the timing of purchase-price instalments.
Truthfully, Julie got sucked into this rabbit hole because the deal had such great potential. And we tried to accommodate the new demands and adjust to the new information that our Due Diligence process uncovered.
Ultimately, we couldn’t reach an agreement. For every new demand that was met, another appeared. But we spent a lot of time – time that ended up being wasted – trying.
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 can’t be reached within a couple of meetings on the board terms and purchase price, then it never will be. When this happens, just walk away.
Kill the deal quickly.
Reduce your opportunity cost.
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 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.
A great way to achieve this is to think of your acquisition plan as being the seller’s succession plan. 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.
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.
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…
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 cook your 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, but you can also 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 this source.
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 our experience as financial life planners, there is never any shortage of money for the right deal.
The role of the Financial Life Planner
Through this whole process, the role of the financial life planner 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 Financial Life Planner. Your Kenwell team looks after YOUR interests. We assess the deal within the context of your GAME Plan, and assess its success using our Financial Wellbeing Scorecard.
Contact us today to start building your GAME Plan. We can’t wait to hear your story!