Business growth through acquisition is the purchase of the shares of one company by another company and is often quicker than organic business growth. You buy a business that is already established and trading, sometimes for cash (most of which is paid upfront), deferred consideration, debt, equity, or a combination of all four, with the synergies between the acquiring business and acquired business adding value for shareholders.

Acquisitions may make sense when looking at adding to the product range, expanding the distribution of products/services, bringing in additional manufacturing capability, and accessing efficiencies through scale/volumes.

However, acquisitions are time-consuming – often even more once the deal is done – and expensive compared to organic business growth.

Therefore, don’t start looking at acquisitions unless everything is in hand in your main business:

  • Do you have a team in place who can run (ideally, are running) the business in your absence?
  • Are your systems and processes up to date and scalable (can they cope with another business)?
  • Is your existing business profitable and cash generative, with a good track record with your bank or other funding providers (it will be difficult to raise money to buy another business otherwise)?

How to identify a suitable business target for acquisition?

Assuming you haven’t been put off so far, an acquisition may be the right route for you if:

  • You have a clear business growth strategy that acquisitions can form part of delivering.
  • There is an opportunity to acquire a business that fits with your business strategy, and is a good cultural fit with your business; and
  • The price for acquiring a business through acquisition is right.

The cultural fit between the two businesses will be key to successful integration – if you share similar business values, the teams in both businesses are more likely to work well together.

How much should an acquisition cost?

Pricing is about finding an overlap between what the business is worth to the buyer and what the seller is willing to accept.

A business acquisition should add value on day one. There is a huge body of analysis of real-world deals that suggests most deals reduce value for the shareholders of the buying business. A recurring reason cited for this is people overpay. Another common issue is poor integration (employees and customers respond badly to the detriment of the business).

For a business that doesn’t have a large value of fixed assets, the purchase price will usually be a multiple of the current EBITDA (earnings before interest, tax, depreciation, and amortisation). EBITDA is used as an approximation of the cash generated by the business. The multiple will vary by sector, and it is usually higher for larger businesses.

It is usually assumed that the purchase price is on a cash-free and debt-free basis with a normal level of working capital. Therefore, the purchase price will be reduced for debt in the business and may be further adjusted if, for example, stock levels have been run right down compared to what the business usually needs to trade.

What are the key stages of mergers and acquisitions?

A deal process may be ‘off market’ – meaning it is a conversation between you and the owners of the company you are looking to acquire. More normal, particularly in bigger deals, is a formal process whereby an advisor is engaged by the sellers to run a competitive process whereby the best offers are taken through a set of stages until one bidder is left.

Under each scenario, you should expect to sign a non-disclosure agreement upfront. You will then receive and review management accounts and similar confidential information to reach an agreed price and deal structure. This is captured in a non-binding offer, along with the expected timetable and key due diligence requirements. Once you are the preferred bidder, you should agree in writing on a period of exclusivity (to stop the seller from speaking to other potential purchasers). Your external legal and financial advisors will then complete due diligence to look for any issues in the business that you need to be aware of. If there are significant issues, you may need to renegotiate the price or take protection in the share purchase agreement or – in extreme cases – walk away!

The legal documents (share purchase agreement and any ancillary documents such as settlement agreements for any exiting employee shareholders) are usually drafted by the buyer’s legal advisors and negotiated between the two sets of advisors. Once agreed upon, the documents are signed, the monies move, and the deal can be announced.

Deal structures and business fundraising for acquisitions

An acquisition can be funded out of cash, deferred consideration, debt, equity, or a combination of all four. When assessing how much money is needed, alongside the payment to the sellers on completion, you also need to factor in deal fees as well as any working capital funding that the business you’re buying will need in the first six months.

The most standard deal structure I have come across is an amount paid to the sellers on completion with a further amount payable at a point in the future based on the performance of the business in the twelve months post-acquisition. That second payment is known as deferred consideration, and you need to be able to fund that too – usually through cash generated by your business and the business you’ve bought (otherwise through further business fundraising).

If you are raising funds for your business, you will need a business finance plan showing the actual (last two-three years) and forecast (current year plus two-three years forward) performance of your business and the business you are buying, plus any benefits from bringing the businesses together, otherwise known as synergies.

Business fundraising options extend beyond a bank loan (although this is a good first place to start as it is usually cheaper than other forms of business funding). For example, assuming your business is profitable and cash generative with a turnover over £1m, you could look at the Business Growth Fund https://www.bgf.co.uk/. If you are a high-growth business, you may also be attractive to venture capital or private equity investors – but this is a whole other topic, you could also look to seek funding for business growth through high-net-worth individuals who also invest in SMEs. Inspire can provide further detail on all the above and other business fundraising options.

Common pitfalls

Assuming you have a suitable target (value-adding, good cultural fit, sensible price), and you have everything in hand to grow your business through acquisition, I have set out below the most common issues I have come across in the acquisition process itself.

  • The buyer
    • Failure to engage with banks or other funding providers early enough (if you can’t afford to do the deal from the cash in your own business).
    • Failure to understand the seller’s key drivers/motivation. Yes, price is always key. However, in a lot of cases, this is the one transaction the seller will do, and it is a business they have spent many years building. In that case, job security for loyal team members and maintaining their brand may be very important. Understanding this and being able to give assurances on it could differentiate you from other bidders. It also helps build trust – which is useful when reaching sensible mid-ground in the levels of legal protection you can live with vs. what the seller is comfortable giving.
  • The seller
    • Lack of preparation for the diligence processes. Don’t push to start a process before the selling side is ready. Your advisors should be able to provide key information checklists to guide the sellers. The requested information should be ready and, ideally, loaded in a data room, before your advisors start their due diligence work. Alongside this, it is important the sellers brief their accountants and senior internal finance resource (FD/ FC) early in the process so information can be gathered efficiently, and queries resolved quickly.
    • Failure to engage suitable advisors early enough (late tax advice on the sell-side has delayed many a deal).
    • Incorrect set-up of the seller’s company documents (specifically drag-along provisions for minority shareholders). It is worth an early legal review if there is a long tail of shareholders.

Successful Integration

In the same way, a bad integration destroys value by alienating customers and employees, a good integration protects and even adds value.

You should start as soon as you have a reasonable level of certainty that the deal will be complete (once financial and legal due diligence is well-progressed). Identify a project lead for the end-to-end integration – you want someone with good interpersonal and conflict resolution skills, and with good project management knowledge and expertise.

Before completion

Get your communication right: agree on key messages and write and agreed on internal and external communications.

During the deal processes identify any key tasks that need to happen quickly – e.g., changing of bank signatories (especially if current signatories are leaving at the point of the deal), and any actions arising from due diligence (e.g., missing documents/unsigned documents need to be rectified). Put this together on a single plan with a timescale and an owner, known as the one-hundred-day plan.

Day one

Brief teams and key customers (ideally face-to-face as far as possible). You need clear, succinct, positive messaging on the benefits to each group for the business acquisition. Provide communication to key suppliers (again, face to face if they are especially important/powerful).

The first one hundred days

Track through progress against the one-hundred-day plan. Weekly calls initially, moving to fortnightly and then monthly as time passes should be sufficient.

Twelve to eighteen months

Larger integration work like changing systems or aggregation of two offices into one will take time and you shouldn’t plan to execute them early on (when the message is very much “business as usual”).

You should have a lead for each main project who should put a project plan in place and agree on this with the board and key stakeholders. Monitor progress and check in with teams and key customers regularly to identify any potential issues early.

Continue to monitor the business performance against the business plan and identify any shortfalls and take corrective action early, identify unplanned upsides and take action to maximise the benefit and last but not least, delivering on your plan is key to successful further business fundraising in future if needed.

On the 7th of December, we have next our monthly webinar providing a round-up of economic news and our forecasts for the UK economy and how it impacts the business community, sign-up here: https://www.eventbrite.co.uk/e/rob-perks-monthly-economic-outlook-tickets-424114045527

This is the last call to book your place to join us on the 17th of November for our free “Inspire Introducing Goldman Sachs” event, where more advice on how to overcome SME challenges will be shared.

Not only will you discover the support available for small businesses, including the Goldman Sachs’ Small Business 10,000 programme, but there will also be opportunities to hear directly from business leaders on their most valuable tips and resources to overcome the breadth of challenges facing SMEs. Sign-up here or contact us via team@inspirebiz.co.uk to find out more.

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