January 2012

Considerations When Buying an Existing Business

There are two main ways to achieve business growth: by increasing your sales and revenue, which is sometimes referred to as organic growth, or by acquiring another business. During challenging economic times, when organic growth may be more difficult, business acquisition is often an attractive growth strategy. Buying another business may enable you to expand your geographic footprint, acquire a competitor’s customers, or add new products and services that complement your own.
 
According to Lisa Aldisert, a New York City-based management consultant who specializes in small-business issues, the decision to acquire another business should be the result of a disciplined strategic planning process and long-term vision for your business: “Buying another company should never be a strategy just to get big faster but rather should be part of a strategic growth strategy that has been carefully thought through and planned.”
 
Types of acquisitions
 
There are two main types of business acquisitions: vertical and horizontal. A vertical acquisition involves buying a business that’s above or below you in the supply chain. A common example is a manufacturer buying a raw materials supplier so it can source materials itself and boost its profits. A horizontal acquisition, meanwhile, involves buying a similar company (often a competitor) to expand territory or market share.
 
As you begin your search for another business to acquire, you may want to retain the services of a business broker, especially if potential acquisition targets are limited and less than obvious. Most business brokers focus on particular industries (such as manufacturing, distribution, publishing or retail), so look for a broker that specializes in your field.
 
As you start to narrow down your list of acquisition candidates, try to identify potential synergies between them and your business. Cost savings and financials are two obvious synergies, but Aldisert also stresses the importance of cultural synergies: “Is the new business going to be culturally compatible with your business? All kinds of problems can result if not. As bad as culture clashes are at big corporations, they can be even worse for small businesses.”
 
Once you’ve identified a serious acquisition candidate, you should obtain a professional business valuation to determine a starting point for negotiations with the seller. While the seller has probably had his or her own valuation performed, you should hire your own expert to perform an independent valuation on your behalf.
 
Keep in mind that when buying another business, what you’re really buying is a future stream of revenue and earnings. Therefore, your projected income and profits must be realized over the long term for the merger to be considered a financial success. This makes performing thorough due diligence on potential acquisition candidates critical – before you move into serious negotiations to buy the business.
 
In particular, you must thoroughly critique the company’s financials to confirm that statements of financial fact communicated by the seller are, indeed, true. If not, your payback period for the acquisition may be extended and your return on investment (ROI) reduced.
 
Your acquisition team
 
It’s also important to assemble a strong business acquisition team to help you through the process. In addition to a business broker, this should include an attorney and a CPA who are experienced in business acquisitions and valuations. Not only will they provide assistance with legal, financial and other details, but these outside experts will look at a deal objectively and help you determine whether or not it makes sense from every angle: strategic, financial, cultural and otherwise.
 
Finally, Aldisert stresses the need to clearly define what role (if any) the former owner of the acquired company will play after the acquisition. “If it’s a merger in the traditional sense, the previous owner may want to stay on in some capacity, so you need to clearly define everyone’s roles,” she says.
 
Buying an existing business is a major decision, so stop by or give us a call. We can help you evaluate your finances and plan for any type of business expansion you have in mind.