Success in successfully operating a business you are thinking of acquiring comes down to a number of factors. Such a purchase is risky and that is why the price of a small to medium business reflects that riskiness. There is industry risk, economic risk, liquidity risk and transactional risk to name a few.
Industry risk – caused by potential disruption or collapse of the industry
Economic risk – events in the economy outside the control of the business
Liquidity risk – inability to borrow money or fund the business due to a downturn in sales
Transactional risk – risk brought about by the fact that new relationships with suppliers, clients and staff can disrupt the normal pattern of the business.
The first two are outside of the control of the business owner/buyer. You can try and tell the future but often that vision is not always 20:20.
Let’s examine a Case Study where our buyer attempts to manage the last two risks:
Let’s call our buyer Mr Smart. Mr Smart understands business. He has a degree in management and has successfully run his printing business after acquiring it two years ago. Mr Smart has the traits necessary to both successfully operate and build a business.
- He understands the financials.
- He’s not building out of ego but rather out of desire to be more successful and strengthen his financial position.
- He has good contacts.
- He has a good network and recognises the traits of a good business person in those in his network
We take up the story at a time in Mr Smart business life where he has the energy, capacity and knowledge to advance his business enterprise. Mr Smart’s first step is to find a business that he understands and believes he can operate. It is a bonus if that business is one which has cross-selling opportunities with his current business. The next step is to find someone else (Keyperson) to help him to run that business to be acquired. Mr Smart is a good judge of business ability and this is key to the success of the plan.
The strategy will be for Mr Smart to hold equity in the business and for Keyperson to hold further shares. It doesn’t matter too much who holds the majority of shares, if anyone, as there is a strong relationship of trust already between the two parties. Mr Smart is generally the senior person in the relationship. Often he is the strength that the bank relies on in granting a loan and he has more experience in business. He already owns one business and it will be his experience that will guide Keyperson in the operation of the acquired business.
Mr Smart assists in the negotiation and due diligence involved in the process. Both Mr Smart and Keyperson work hard on investigating and determining what the effect will be of replacing the current owner/manager, in an effort to reduce the transactional risk of the purchase. Along with this, both undertake an analysis to ensure there is no cultural mismatch between buyer and current vendor staff roster.
The deal is done and now Keyperson and Mr Smart are partners. The business will be more successful for the following reasons
- The risk is shared, and a risk shared is a risk reduced.
- The liquidity issue is less threatening since with the combination of two asset holdings, the reliance on bank finance is reduced.
- The knowledge bank is larger. Two heads are better than one.
- The risk of the transaction is also lower, since they have worked as a team on due diligence and understanding (mitigating) transactional risk.
- The new owner has a ready-made mentor.
The above scenario is played out over and over, not just in the above partnership example but in many acquisitions. Keyman is often not introduced as such but is played by a senior manager who is currently employed by the vendor company. Continuity is key. Success comes through envisaging what the company will look like under new owners, rather than focusing solely on what is happening in the company now.