CHAPTER 26

To Grow Try This…With an Acquisition

Built on an effective aspiration it might be that you want to contemplate growing the business further by an acquisition. An acquisition, whether for a disrupter entrepreneur or for slower organic growth company, is potentially the sort of Trojan horse, step-change that might work very well for you. Conversely if you are selling your business and an acquisition is not something you are minded to consider, you might find some useful thoughts below—though probably as reversed thoughts. In fact even if you are maintaining the status quo, there are still nuggets to be discovered as we review things that increase or destroy value.

Don’t rush off at this moment to go and buy your nearest rival (or sell to your nearest competitor). They’ll probably have seen you coming and are ready to extract a fancy price. Neither should you (necessarily) go and acquire the business that you know appears to be bargain priced. In this latter case there has to be a reason for the price: If it really was that good a deal, why didn’t someone else in your industry, trade, or profession snap it up long before it came to your attention?

Cynics of business, cynics in your own line of business, and simply people that have done them will tell you that acquisitions rarely deliver fully on expectations. There are lots of reasons for this. But top of the list, and here’s why you don’t do it yet, is that the buyer is invariably wearing the famous rose-tinted spectacles at the time of the acquisition.

And here it’s you who is the buyer.

So to make sure you are wearing the right spectacles—it’s sunglasses by the way, and we’ll come back to those later—we are going to look at the whole DNA around an acquisition before we don the glasses.

We’re not convinced we’ve tempered your enthusiasm enough so far. So please remember that an acquisition is really just another make or buy decision where you are about to choose buy. With this being so, please, please remember that you also have the ignore option. And whatever you do, don’t get yourself suckered into an acquisition because you have to. As an example, one of the authors worked for a telephone handset wholesaler. The CEO saw the opportunity to acquire an underperforming rival. To the CEO’s credit, he involved many of his current team in investigating the proposed business or undertaking due diligence for those more legally minded. However, the sales director and credit controller took the view that if the acquisition was occurring, there was no reason why our company couldn’t sell products to this rival—who had otherwise been on credit stop. By the time this was picked up, our rival owed us a huge sum of money and they in turn made it clear that unless the acquisition occurred, they’d be forced into liquidation and our company would be that sum out of pocket.

We did reduce the purchase price to reflect this, but in reality we should have walked away. The message we learned was to tread carefully—so carefully our next piece of corporate activity was to sell another part of the business.

So why would you want to make an acquisition?

Synergy

Synergy is by far the number one reason for making an acquisition. Two plus two equals five. Yes, it’s true. Two businesses combined only need one CEO, one set of premises perhaps, one sales force, one widget making machine, but will have two lots of customers—so a doubling of customers combined with one set of shared costs really can perform a magical transformation to one’s bottom line.

However, and didn’t you just know we were going to say that, if you are the acquirer, you really, really have to make sure that the costs are set on the trajectory to oneness. Before you commit to acquiring, how exactly are you going to get out of the lease on the acquired premises you’re not going to want? What is the people plan in the face of your expanded management—expanded because you’ll want some of their best people in your top team, won’t you? And having got the best ones, what are their plans to cut the combined number of posts and so achieve the goal? We’ll labor this point. Managers don’t like surprises and know from real-world experience it is often easier to keep people JIC rather than fight later for the right to hire additional heads. JIC also covers over the fact that managers will have skimped their due diligence duties and probably don’t know in sufficient detail what many of the acquired staff’s day-to-day work is about. Or even that the hire in question is part of moving the business forward at all.

One of the authors holds his hands up on this one. During a software company acquisition, he fought really hard and ultimately successfully to retain an acquired employee on the grounds he knew all the complexities around most of the historic ongoing business. Days after, it became clear that one could upgrade these historic customers to the current product line and that the knowledge holder’s lock on the data was bypassed and that his special knowledge was not necessary going forward.

Moving along the Value Chain

Everyone talks about the supply chain. These are the steps between the raw material and the end customer. Even if, as we have assumed, you manufacture widgets, it is surely not the case that, at one end, you dig the iron ore and coking coal out of the ground to make the necessary steel, nor, at the consumer end, you sell the thing-a-me-jig your widget is in, to Mrs. Mayweather in the Mall? Along the way, and at each step, processes occur—even as simple as barcode scanning at the till. Remember that margin on the overall sale is taken out by each step’s processor. So it stands to reason there is margin upstream or downstream to your piece—either behind or in front of you in the supply chain—that can be acquired and its extra margin, at least in part, added to your bottom line.

Do be excited, they are sensible places to look. The cautionary tales are those of scale and relevance. You might use a lot of screws in the assembly of your widgets, but find that actually you are only taking one-thousandth of your screw manufacturer’s production. So acquiring the screw manufacturer would be disproportional to your requirements and 99.9 percent of your newly acquired production would need to find customers not connected to your own widgets. Should some of these others be rival widget manufacturers, you might lose their business just as you begin to relish the opportunity to turn the price screw (sorry) on them.

If you don’t find widgets to your liking, think about the consequences of buying an organic farm to support your organic restaurant. The chances are with your location, you’ll have a limited growing and cropping season—facing surpluses for a few short weeks and the trouble of disposing of the excess, and many months of the year still buying in supplies from elsewhere.

Going the other way, to retail, always looks an attractive option because in almost every chain this is where the highest proportion of the end user price is syphoned off for what seems like the easiest task. Retail can be a success, but remember, though, high margins in retail come from dealing with pernickety consumers (not logical B2B customers) who often make unwarranted returns to expensive-to-run retail outlets and who expect to be able to select from a variety of brands—not just yours. Sure, the web reduces some of these costs, but then remember that, on the web, people have to find you, and then you will typically have to incentivize them to select from you alone. So we don’t believe retailing is necessarily all it’s cracked up to be from a profits source perspective, unless you like being a shopkeeper.

Geography

Doing something in business you shouldn’t used to be said to be taking coals to Newcastle. Of the one hundred plus Newcastles around the planet, the Newcastle in question is in the United Kingdom. And of its two, it is Newcastle upon Tyne rather than Newcastle under Lyme. The expression is premised on the fact that behind Newcastle, in the county of Northumberland, there were once a huge number of efficient coal pits. Today, post Margaret Thatcher’s 1980s government, post the decline of coal as a fuel, there are no mines operating within striking distance of this once remarkable coal-exporting port. So today, for the more limited users of coal, taking coals to Newcastle is actually necessary. Coal itself is both bulky and, as fuel goes, relatively cheap, so trucking a ton of the stuff for a Tynesider’s household is not hugely economical for a business many miles away and therefore best distributed on a local basis.

At the other end of the value per transaction spectrum, realtors (United States)/estate agents (United Kingdom) also typically only work parochially, but for them location is not based on the cost of sending out property particulars but the more hands-on elements of their trade.

So there can be good reasons for having local depots, local representation, or whatever as part of an expansion plan. Acquiring a similar business to yours in different geography then makes sense. You will still only need one CEO and so on, but you will require duplicated equipment and people to deliver at the cutting edge. Plus, and be careful here, you might start breeding a new cost of someone(s) to be regional this or that, running up extensive mileages somehow coordinating these otherwise rudderless locations.

In math, we see this much more as two plus two equals four, but if the second two (and indeed third, fourth, etc., two) can be acquired economically, then you can still build a good bottom line.

Another win–win from geography can be that the cost of operations— mainly thinking here people and premises—might be significantly lower in another geography and you can move back office or production to this other location and become more competitive. A friend of the authors expanded his accounting practice by acquisition from simply being in the equivalent of San Francisco to then also active in Jackson, MS, where average wages are only about two-thirds of the former location but the bookkeeping staff are at least as good at their jobs. This obviously allows him to offer back office support to clients in the high price area at better prices.

Deal Structure

All acquisitions are different. However, it is a good bet that the business you acquire is sold to you by its owner who is probably also the most senior person (in status) in the acquired business and is selling because of whatever reason they prefer your offer of stuff (be it upfront cash or stock, shares, or whatever), to them continuing to run the business to extract cash as salary or dividends over time. After a handover, their likely preferred option is to disappear out of the business completely, which is immediately a positive step toward any synergy you desire.

We’ve said stuff above—because as illustrated it doesn’t have to be cash. We’ll deal with this stuff properly, later. However, sometimes it is cash that does all the talking. This is almost always the case when you are looking to acquire a business from an administrator/liquidator. These folks are appointed to extract cash for the benefit of creditors and often within that category, for specific secured creditors. Money to pay their own fees also has to be generated, so that to maximize the underlying cash recovered versus costs ratio, they are looking for quick, cash, deals.

In these instances, you are only buying those assets you want, typically some of the brand, stock, equipment, and customers, and from a holistic approach, abandoning staff not required and obligations of all sorts—for premises, to the tax authorities, to the other company’s bank or other creditors. The liquidator/administrator will push you for a quick decision and they’ll push you on price. We wouldn’t want to accuse them of providing misleading guidance, but please write and tell us if you ever find them telling you that you are the only bidder. Let them see early on that you do have access to the money and that you are prepared to deal. In return, use every waking moment on due diligence—if in doubt start with customers; at least then, heaven forbid, if you don’t proceed with the purchase, you might instead have an insight into some prospectively rosy future sales for yourself!

We once had the opportunity to pick over the corpse of an auto dealer. Their parts inventory contained a lot of readily saleable items for a franchise we held of the same marque nearby, so we encouraged our acquiring team to concentrate on valuing the collapsed business’ 100 best-selling lines. The 100 incidentally being our best sellers, not necessarily that of the corpse business. Our offer for those—based on 25 percent of what we’d have to pay elsewhere—was sufficiently above other bids that the liquidator invited us to offer an extra 1 percent for the remainder of the stock and clear it all for him. That extra yielded tens of thousands of later value.

And that’s all we took. Well nearly. We rather think the service manager at our place somehow found a customer list in the carnage and that list somehow got packed up with the parts. Later he somehow managed to use the list to make the demised dealer’s former customers a new offer for the servicing of their autos.

In these situations, be picky, but better, be selective based on what your due diligence of their information throws up. You can’t win it if you’re not in it and you don’t want the booby prize, however well it is dressed up.

Sunglasses

We’re majoring on acquisitions, because sooner or later you’re going to get suckered into one (or more). Sure they can be good for your business and the underlying math works, provided always they deliver on promises. If they do, you’re home free, scot free, or simply out of jail. Our concerns therefore naturally focus around the negatives, to alert you best we can, to the existence of bumps in the road, circling vultures, amassing sharks, and the odd snake in the grass.

So please forgive the emphasis—the rose-tinted spectacles must be thrown away. Sunglasses are de rigueur. The other side mustn’t see the whites of your eyes. There’s a high-stakes game of poker to be played. And it will almost certainly only be about the price to be paid. But just as in real poker one can go all in, that is to say, stake everything, so one can also fold. When negotiating an acquisition, one can similarly opt not to play the hand, or ignore in our earlier parlance—provided of course there is no legal commitment to go ahead.

Reasons Not to Sign

Stage one: Articulate clearly and succinctly what the business you are going to acquire does and who it does it to. Add on to this summation a statement of what you want to achieve from it post acquisition and create some success criteria by which you will measure how both businesses (yours and the target) come through the process. Can’t do it? Then don’t proceed. Can do it? Write it down—you might look back on it later—and laugh or cry.

Stage two: Break the target into bite-sized chunks. That’s probably best done by functional area, for example, sales, marketing, production, and distribution. In turn, this should be based on how the target is organized rather than your existing business, so that nothing is lost in translation and all the pieces you’re examining collectively add to the totality. Then look at the pieces. Do you like everything you see? If not, don’t do it.

Stage three. Get stuck in to understanding (where understanding is the summation of both learning and application) both the helicopter height view and the nitty, gritty, deep-down dirty detail of each of your chunks above. By all means, get yourself an acquisition checklist. No do, but don’t look at it simply as a shopping list, because in addition—and let us reinforce the word—you need understanding.

Are you understanding how this possible acquisition really, really works? And if so can you kindly tell us, now and honestly, why the vendor wants to sell? And if that reason doesn’t chime with you, don’t do it.

Why go to all this bother?

What’s it all about, really? Let’s kick some tires.

Sales Analysis

More than any other single thing, you will want to know where the sales come from. Here, 80/20 will almost certainly apply so for the 20 percent of customers who make up 80 percent of the target’s business, please give 80 percent of your attention. Sure, per the checklist, you will want to know how they order, when they order, what prices they pay, when they pay, who they are, how to contact them, and so on, but that’s all mechanical. Does the current boss have a special relationship? Do they enjoy some special treatment—not recorded in the company’s records? We’re thinking here of customers being taken to trade shows, given exclusives, supplied uninvoiced additional product, offered marketing support, loaned some of our target’s staff, and so on. Will they remain with the business under new management? Illustratively, we always find ourselves pondering if ladies-who-lunch would still go to Alfonso’s hair salon if Alfonso sold out to Jacqui? OK, you are not buying a hairdresser, but will some of the bigger customers leave under your new management?

And always suspect. Years ago, a pal of ours had a fire. It destroyed a large proportion of his business premises. To help recover, his major supplier extended his payment terms by several months. About a year later, with our pal still paying about two months behind the norm (the business was recovering slowly), his major supplier bribed him (with clever discounting) to bring himself as up-to-date as everyone else, just so they could tell the buyer of their business that no one was, or had been, behind with payments. It wasn’t strictly true, but it seemed to be what it said in the books. Needless to say, under the new management, our pal again had to extend payment terms as he’d basically robbed Peter to pay Paul, to achieve the required catch-up.

Everything we previously said about your customers in this book is also relevant. Which ones cause problems, which ones only pay for the last order when they want the next one, and so on? You need to know this. You might even use this information as part of your poker game, to get a better price.

Stock, Not Inventory

Nothing is more open to abuse than inventory. Or do we mean stock? Why such different words for the same thing? There is no difference— they’re interchangeable. Your vendor will doubtless show you some sort of stock-take record as part of due diligence—that will give you a value at the bottom, of that stock when it was counted. Doubtless there will need to be another count a lot closer to your take-over time. That will tick some boxes on the acquisition checklist, but it won’t stop you being fleeced. Consider some of these howlers:

And that’s just about doing the stock-take, to tick the box on the checklist. How about getting to understand the detail? First, go physically look, so that the top 20 (we suggest in most places—but this time it is 20 as a number, not a percentage) of stock items by value are known to you and that therefore you can tell if the stock evaluation is of the right magnitude for these items. Next, just because it is in stock doesn’t mean it has any value to the business. It might have been acquired from the Mayflower in the seventh century and lain idle ever since. So alongside any evaluation, you want to know the stock-turn for an item. Depending on your trade, anything representing more than say three months’ worth should be reduced in value or not counted at all.

Finally here, what about customer returns? They might have been repaired, repacked, or whatever, but if they form part of the stock valuation, first is there a non-rose-tinted explanation of how they are going to be turned back into money and second, does that methodology work on its own or will it cannibalize new sales or undermine the value of the new product in your customers’ eyes? If in doubt, seek a reduction in inventory value and ultimately a reduction in the price you are prepared for the business.

Creditors and Liabilities

If you are acquiring another company (as opposed to buying assets from a liquidator), you are buying it warts and all. As part of the acquisition there will be a sale and purchase agreement and in that your vendor will warrant to you that they have disclosed all the liabilities and further that they’ll make restitution if not true and brought to their subsequent attention, assuming, of course, you use a commercial lawyer and these things are agreed. That doesn’t mean you ignore liabilities; on the contrary, they deserve the same attention, but, defensively, as customers.

Here are a few thoughts arising from some of our battle scars:

Rights to Do

We’ve mentioned earlier change of ownership in terms of customers but in fact there is a far larger list of rights held by third parties you need to consider. The business you acquire may well be a franchise: Think burger joint, gas station, Century 21…the list is long. To protect the franchise, the franchisor, and not the guy trying to sell to you, will need to ensure that you will uphold the franchise reputation. This might involve vetting, formal approval, and, in almost every circumstance, a fee. Even if not a franchise, the business name or a brand name might be licensed from a previous owner and that license agreement needs to be assessed.

Thinking back to the widgets, are they the business’ own development or are the rights to make them owned by someone else? Make sure you ask the vendor “What licenses and approvals will I need to carry on your business?” and then at every stage of every piece of due diligence, keep your enquiring eyes wide open. The vendor might not be aware of some of them himself—we can’t expect him to remember everything. We the authors were seeking to inexpensively acquire a school teaching aids business, only to discover that the expensive monthly rental contract on the photocopier had seven years to run, before we could cancel it!

Please, please remember, your desire to know vastly outweighs the vendor’s ability to remember. So probe for answers, not distractions. Worse that the only reason the vendor is letting go is that you are paying more than he thinks he would get from anyone else. So look under every rock, challenge every assumption, make every piece of bad news lower the purchase price…and still be prepared to walk away.

Post-Acquisition Plan and Review

We’ve touched on this already. If you are really determined to make an acquisition, then find time before signature to create yourself a post-acquisition checklist. This will be your document with timelines indicating what needs to happen post-acquisition, by whom and when, to bring your about-to-be acquired business into your stable. Look at the dependencies—if for instance you want to be out of some premises in six months, when should you appoint someone to start marketing it, contacting the landlord for approval, hiring a removal team, and so on. Ask yourself what comes to form the critical path and—at the risk of overworking the word—who is critical to the process and what safeguards do you have in place to assure you they’re not about to leave or take an extended break for whatever reason.

The checklist needs to be finished off with some performance criteria—which should be measurable—to be your target for the new (or the combined) business. It could be headcount, percentage overhead, cash in the bank, sales—or indeed measures for all of them, and the all-important date when each of these things will be measured.

When you have made the acquisition, look at your document. Strongly resist the urge to bin it when you conclude it is not relevant. Because we bet you, you’ll be looking for more entries from the bumper book of excuses again to rationalize why you have abandoned the plan. However irrelevant, conduct the review as at the date you originally envisaged. Look at the nonsensical data produced. Really look. There are in amongst the promises made before, and the delivery and execution after, some really valid things to learn for when you do it again. And don’t say never again. Remember life’s a bitch and Sod’s law will ensure you really do end up doing it all over again in the future.

We’re human. We never learn.

Paying with “Stuff”

There is no doubt that Cash is King. If you buy something, and you’ve paid for it, then it’s yours to do as you wish with. That’s great apart from the fact that, in our experience, cash is invariably in very short supply. So what are the options?

There are basically two alternatives to paying in full, immediately with cash. The first option is to defer the payment and the second option is to spread the payment over the rest of all time.

At first glance, option one looks to be favorite. In many acquisitions, the buyer will not see the same value as the vendor in the anticipated future income stream. This is usually dealt with by the vendor and purchaser agreeing to there being some deferred or contingent consideration to be based both on a delay in time and upon the performance of the business being acquired under the new management. As we have also identified elsewhere it may be the case that some of the consideration is simply deferred to be held as a warranty reserve so that if any of the vendor’s representations turn out to be incorrect, the buyer has access to funds for redress.

Now it is true that a strong vendor will seek to have as much of the above deferred cash as possible in a safe pair of hands which usually equates to an escrow agreement with one of the lawyers in the transaction. However, a strong buyer will be able to convince the other side—that the buyer himself holds the cash. And for the purposes of this book we are talking to you as the buyer. So let’s assume that you convinced the seller that some of the money they expect to take away on sale date will come to them later. So why not in fact press the case that all the cash in this transaction should be later and suggest instead that the vendor take loan notes from you the buyer. In this case, the loan notes will probably be for a fixed term and you will have to give them an interest rate coupon. However, if you plan it properly, not only can the acquired business cover the interest payments but it would also allow you to amass enough cash to redeem the loan notes when they mature. Effectively acquiring the business for nothing!

The other choice we introduced earlier was to pay for the business for ever. Here, we are thinking that you the buyer could issue the vendor equity, that is, stock/shares in your business. If the seller is convinced that you are going to do great things with his business and your business combined, then by giving him a slice of the action he might be persuaded to take no cash at all. For him, on the plus side, he gets growth in the value of the stock/shares based on your performance and, if you’re minded to pay them, by the receipt of dividends. His downside of course is that you might not make any money at all in the future and his shares become worthless. For you, there is the emotional challenge of giving away part of your business to someone who is probably not going to contribute anything further into the future. For some, this is a complete no-no but for others it is recognition of the contribution of a valuable building block at the time when that block was helpful to your growth.

Of course all three elements—cash, loan notes, and equity—can be mixed and matched to suit the circumstances. It was only in the now defunct U.K. Woolworths’ loose confectionery department there was a sign that said: Quality Street is not pick’n’mix.

Pause: Did you make notes of things in the Action This Today section in the back of this book? If not, please take this opportunity to review the prior pages to identify again any thoughts and ideas you want to follow up on.