Ready to grow? Purchase may be your answer
When a small company wants to grow faster than organic means will allow, a merger or acquisition is often the answer. Before heading down this path, there are many issues that you, as a potential buyer, should know about. Understanding these challenges can help you decide whether this is the right next step for your business, and can prevent unpleasant surprises along the way.
While talk of mergers and acquisitions often conjures thoughts of bidding wars and culture clashes, here are five points to consider that can lead to a much more positive experience as you expand your business.
1. Strategic planning is critical.
Before you begin searching for a company to acquire – a “target” company – take a good look at your own business. Create a detailed strategic plan for your business that includes future growth targets.
Once you fully understand your own business, it will be easier to identify businesses within your price range that can help you attain your goals. Consider engaging an investment banker, who can help you determine which target companies are the best fit for your business.
2. Competition for a target company may be fierce.
If you’ve taken notice of a company as a possible acquisition target, it’s likely that other companies have, too. A bidding competition between motivated buyers can significantly increase the cost and work involved in acquiring the target, and will likely involve considerations beyond merely the price offered.
Many sellers are concerned with intangibles such as their employees’ welfare and the ongoing goodwill of their customers. To succeed, your company will need to instill confidence in the target’s owners, convince them that significant compatibilities exist between your company and theirs, and show them that their business is likely to succeed as part of your company.
3. Deal structure is important.
You can accomplish a merger or acquisition by three principal means.
Stock purchase:
Sellers usually prefer a stock purchase, which involves a sale of the entire company, because they receive favorable capital gains tax treatment on the sale proceeds. In cases with few shareholders, a stock purchase is often simpler than an asset purchase. It also permits the buyer to maintain the greatest continuity of operations, and may permit the buyer to assume otherwise unassignable contracts. Because a stock purchase results in acquiring all of the target’s liabilities, a buyer may require the seller to provide greater indemnification.
Asset purchase:
Buyers generally prefer an asset purchase, in which they specify the assets and liabilities they will assume, rather than purchasing the entire company. Typically, the buyer also receives a stepped-up tax basis in the acquired assets. An asset sale also permits the buyer to avoid concerns about state and federal securities laws or minority shareholders who refuse to sell. Because the transaction only concerns the target company’s assets, the buyer has maximum freedom to determine which target employees to retain, and can limit successor liability. The seller, however, may seek a higher price because the gain will be subject to less favorable tax treatment.
Merger:
A merger entails the legal combination of two companies into one. A merger may be preferable when the buyer wishes to retain members of the target’s ownership group. It’s often possible to structure a merger to avoid adverse tax consequences for the seller.
4. Understand your financing options.
If you’re not in the position to pay cash to acquire the target, consider your financing options carefully.
All-cash vs. earn-out:
Rather than paying the entire price up front, it’s possible to reduce the initial purchase price in favor of later payments (such as earn-outs) that are contingent on the target achieving certain post-acquisition milestones.
Debt-financed:
Banks may be willing to finance part of the purchase, but many more business-acquisition loan applications are rejected than are accepted. Seeking a guaranteed loan from the federal Small Business Administration, however, may increase your odds.
Seller-financed:
As an alternative or complement to bank financing, the seller may be willing to shoulder part of the purchase-price financing by accepting a promissory note from the buyer. Seller financing may also provide lower interest rates and longer amortization periods than bank loans, and the seller’s willingness to bank on the future prospects of the company can provide the buyer with greater confidence regarding the target’s future profitability.
5. Integration is key.
The buyer’s ability to successfully integrate the target company into its business can determine a transaction’s long-term success. Among the most critical integration issues to consider before pursuing an acquisition include:
Corporate culture:
Differences in culture may be as straightforward as ‘team-oriented vs. individual-oriented environment’, or the cultural divide may be over an issue at the core of your company’s mission that doesn’t provide room for compromise. Your best bet is to thoroughly screen each company and rule out those whose cultures are incompatible.
Employees:
Future success depends on all employees working under a unified vision. Different challenges can arise in achieving this unity, especially when the buyer’s and target’s employees are working in different locations or operating under different compensation systems.
Redundancies:
Carefully distinguish between aspects of the target’s business that are redundant and those that legitimately enhance your business. Miscalculating a merger’s efficiencies of scale can lead you to overestimate the target company’s true value.
Business methods:
Maximize a newly acquired business’s value by ensuring that the target’s key know-how and business methods have been captured and can be reproduced as part of your business.
Taking the time to understand these issues before pursuing a merger or acquisition can reduce the number of surprises and challenges in the process, thus allowing you to focus on building a successful, growing business.
