KEY ARTICLE TAKEAWAYS
Use ROI analysis to determine whether organic growth or acquisition growth is the right strategy for your company
Learn why acquisitions don’t always turn out the way you expect
Understand the challenges of acquiring a company and how to manage risk
Prior to starting our investment bank, I was the deal guy in a company that acquired 27 companies over 24 months, and then became the President and COO of the business responsible for integrating all 27 acquisitions. Through that experience I am pretty sure I took some years off my life, and I learned quite a bit, some of which I want to share here.
Organic growth or acquisition growth?
Companies can grow revenues in one of two basic ways: organically (with existing salespeople, existing products, existing channels, etc.), or through acquiring another company (and adding its revenues to yours). How do you decide which strategy is the right one for you?
Most business owners who have been in business awhile and have grown their company’s revenues over time have a good sense for what it takes to grow revenues.
They know the cost of a new salesperson and how long it takes for them to be productive, how much it costs to develop and market a new product, what it takes to open a new office in a different geography, or how to nurture a new sales channel. Business owners know how hard organic growth can be.
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Likewise, most business owners have never acquired another business before. They may not understand what it takes to evaluate a company, how to price an acquisition, how to structure the terms of the deal, or how to successfully integrate an acquisition once the deal closes. This makes it especially challenging for a business owner to decide whether organic growth or acquisition growth is better for them. Many business owners unfortunately believe the grass must be greener – acquisition growth must be easier than organic growth, right? Wrong.
It’s all about ROI
The decision of whether to focus efforts on organic growth or acquisition growth comes down to return on investment (“ROI”)
– which strategy provides the best risk-adjusted return on investment of your time and money?
To determine the ROI of organic growth options and acquisition options requires some financial acumen and an objective evaluation of each of the relevant inputs and expected outputs. Have your CFO help you build models for each of your growth strategies and stress test each of the assumptions. This will help you understand the different levels of return on investment and give you important data with which to make these important decisions. We have built a tool to help our clients make these evaluations and are happy to share it – just send us a note.
Which strategy is more risky?
For most business owners, the risk level of organic growth will be lower than acquisition growth
Why? Because most business owners already have experience growing organically, while many do not have any acquisition experience. This lack of experience, plus the inherent challenges of acquisition growth, make acquisitions much more risky than organic growth. Business owners have an inherent comparative advantage pursuing organic growth but are usually at a disadvantage when trying to acquire another company.
As a result, the expected ROI for an acquisition must be much higher to compensate for the higher risk when compared to organic growth options
We advise clients that their return on investment for an acquisition should be at least 25% to compensate for the risk they are taking.
While we are often approached by business owners who want to grow through acquisitions. Asking an investment banker if you should pursue an acquisition or a sale is like asking your barber if you need a haircut – of course! But when we run our clients through the ROI analysis for their options to grow organically compared to their options to grow through acquisitions, and then look at the two strategies’ different levels of risk, in the majority of cases we talk clients out of an acquisition strategy. Not very good for business given we are deal guys (!), but the right decision nonetheless.
9 steps successful buyers take
If you do decide to pursue an acquisition, know ahead of time it is a complex, challenging process. There are hundreds of potential risks to contemplate and plan for. Here are some high-level pieces of advice if you are thinking about doing an acquisition:
1. Determine who is going to be on your team.
Acquiring a company is a full-time job for several people if done correctly. Your current management team is probably already over-worked, so who are you going to bring on to help you manage this acquisition, both before and after closing? Consider hiring outside advisors to help you with accounting, legal, diligence, and integration work.
2. Be crystal clear on exactly what asset you are buying.
Define clearly why you are buying this business – is it new customers, new geographies, new products, new technology, or something else? If you had to name just one specific attribute that you find most valuable in the target company, what is it?
3. Brainstorm the 10 ways you could lose this key asset.
Once you have determined exactly why you are buying this company, brainstorm all the different ways you could lose this asset. If it is people-related, think of all the ways you could lose those people. If it is intellectual property, think of all the ways you could lose these rights.
4. Develop strategies before closing to address each potential way you could lose this key asset.
Plan ahead for all of the potential risks you might face with respect to the key asset you are buying, so when you do face these issues, you are prepared.
5. Make sure your target company has a strong Number 2.
In my experience buying 27 companies, the most important lesson I learned is that entrepreneurs make poor employees. The very best deals we did had strong second-in-commands who were used to taking direction and executing on a plan. If there is no strong Number 2 in place, unless you have someone you can put in place to manage the target company, the business will suffer as the former owner’s interests and incentives change (they just got a big check!).
6. Don’t count on any “synergies” or “integration savings.”
Most buyers are overly optimistic about the potential savings they can generate by eliminating redundant positions, duplicate systems, etc. In my experience, synergies are very hard to come by, and in many cases, the opposite occurs: you end up having additional costs you did not have before (costs of trying to put a new system in place, raising the compensation or benefits of whoever was paid less prior to the deal, etc.).
7. Get an objective assessment of your culture and the target company’s culture.
If personnel retention is important to the success of your deal, if there is too great a disparity between the culture of your business and the seller’s business, you will have a very difficult time retaining the right people and your combined business will suffer.
8. Plan your integration strategy with the target company before closing.
You and the owner or manager of the seller’s company are going to need to make several important decisions related to integrating your two businesses. Who is going to be in charge? What will the new compensation system be? What brand will you use? Debate these issues with the seller ahead of time and get aligned – this will alert you to any potential challenges that might make the deal less appealing.
9. Know what employees care about.
When you are nearing close, make sure to have a really clear communication strategy for the employees of the seller’s company. They will be anxious and will assume the worst. Be clear with them about any expected changes you expect to take place, and in particular, WIIFM (“What’s In It For Me?”) – how will the acquisition impact their job function, whom they report to, and their compensation and benefits? You must answer these questions early, honestly, and be prepared to over-communicate.
I have learned dozens of other lessons (or what not to do) in pursuing an acquisition strategy, so if you are considering an acquisition strategy, we’d be happy to talk with you about how to build one the right way and execute it so that it delivers the best returns for you and your business.
If you are considering either an acquisition or a merger and would like to discuss alternatives or how you can best position your company, please feel free to reach out to us at chris@classvipartners.com.
In addition, if you are considering acquiring another company, make sure to get an objective assessment of the seller’s business ahead of time so you are not surprised. Click the button in the red banner above to use our CoPilot Assessment on your target company. CoPilot will help identify what specific risks the seller’s business has that decrease company value. CoPilot identifies over 90 different types of potential risks a company could have that will make the business less valuable in the eyes of an investor. Get the test ahead of time and build value today with CoPilot.
AUTHORED BY:
Chris Younger | Managing Director | Class VI Securities, LLC | Class VI Family Office, LLC
Chris co-founded Class VI in 2005 with a mission to Enable the Entrepreneurial Spirit. Sharing a passion for what entrepreneurs mean to our community, Chris and his business partner David Tolson felt they could do a better job for business owners and have had a great time helping clients ever since.
Prior to Class VI, Chris spent more than 20 years gaining experience in executive management, marketing, sales, law, and mergers and acquisitions.