Where Angels Fear to Tread: Considerations When Buying a Business
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With interest rates remaining at an historic low with no imminent chance of a rise on the horizon, if you are fortunate enough to be sitting on excess cash there are undoubtedly some fabulous opportunities to acquire a business bargain.
Whilst the economy appears to be rallying we clearly have a very long way to go until we could even contemplate stability.
The fact remains, vendors still exist and business sales still need to happen, creating a buyers market in an economy very short on debt availability.
By implication therefore there will be some bargains to pick up for the astute, cash rich acquirer. That said perhaps it’s more important than ever to not ignore the old Latin tag of caveat emptor (let the buyer beware) and, just because something is cheap, by no means suggests it’s a good buy. Some rigorous due diligence, particularly on business potential in this economy, which sees more businesses declining than ever before, should be undertaken.
Having said that ROI (the return on investment an investor requires) levels do not need to be anywhere near where they were even two years ago, never mind five when expectations for an unsecured lend may have been around 40%, but they are not going to remain so modest indefinitely. Granted, your crystal ball may need an extra polish but nevertheless market data on market and product growth and decline probably needs to look a little further into the future than previous acquisition strategies have looked.
Deal fever exists in the best of times and more so in an economic decline when horizons can be false, based on over-optimistic views of potential on what appears to be a bargain basement price.
A cost effective price naturally gives you more leeway, but it’s still a cost and skeletons are coming out of cupboards in so many companies that in strong economic periods would have remained firmly buried.
An experienced buyer will have a detailed due diligence check list. If you are a first time acquirer, unless your acquisition is very, very modest, get professional help. As well as all the usual areas, the following need special review;
- Share: a huge share is not really great, where are you going to go if your target already has 90% of the market? On the other hand it could allow you to stich up the market if you secure the deal.
- Growth Potential: think National & Global
- Diversification; think product & market
Products & Services
- Price points: are you at top end, middle or low price? How price sensitive is the market?
- Substitutes: if this is a “me too” product, how will you protect your position?
- R&D: nothing lasts for ever; what investment has been done? What are the costs of entry to a new market?
- Cap X needed to maintain position: what’s needed in terms of investment post-deal? Has this been a neglected business; does it need a revamp?
- Potential: are the key people tied into the company? how motivated, driven and indeed cooperative are they?
- Loyalty: will your investment engage them or switch them off?
- Dead Wood: what’s the cost in moving and other parts of removing the “no hopers”?
- Technology: how up to date are they? What’s needed, where and how much?
- Physical buildings, equipment etc.: what capacity is there and how important is location if you have to move?
As the future is so uncertain a savvy acquirer, even one with excess cash, should seriously think about negotiating deferred consideration, a payment method where the balance due after the initial deposit depends on the performance of the business acquired. Vendors don't, of course, warm quickly to this option but that doesn’t mean they won’t accept it.
If you are buying a basket case or a fire sale business (a distressed business due to perhaps poor market or poor products), stick to buying assets rather than shares as this minimises risk and speeds up the process. Of course you may not have the choice and, if it’s a share deal or no deal, relying on the comfort of warranties and indemnities, legally binding promises the vendor makes about the business e.g. no outstanding litigation, needs to be done in the context that they are ultimately only as good as a funding available on the back of a successful litigation (i.e. more cost) !
So ‘cash rich acquirers’ are you ready to don your angel wings? I’d say yes but…Take off the rose coloured glasses and spread risk – in other words don't put it all on Red!
Jo Haigh is a partner in fds Corporate Finance Services, with bases in London, Birmingham and Yorkshire, and a partner in the fds Group, a specialist training and development business. An experienced dealmaker, Jo specialises in putting together the right deal at the right time and in the right format for growing businesses throughout the country. She has bought and sold over 300 companies in the last 20 years specialising in owner managed companies. She is a regular presenter for the Institute of Directors on corporate governance and mergers and acquisitions.
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