Do You Want to Make a Strategic Acquisition?
February 13, 2023 •Oak Street Funding
It could be that you want to expand into a new area of business or location. Maybe you are considering purchasing because the owners and staff have substantial expertise that will benefit your company. Perhaps a friendly competitor is thinking about retirement and wants to be sure their clients will be in good hands. Or, you may see an acquisition as a way to add talent to your business during a tight or disrupted job market.
No matter the motivation for your plans, how you approach and handle an acquisition will have a lasting impact on your business and your peace of mind. How you finance the purchase will play a significant role in determining whether it becomes a financial success or a move you will regret.
What’s important to owners who are selling?
Business owners thinking of making a strategic acquisition should consider the motivations of the people who own the companies they’re targeting. This perspective can help develop a satisfying transaction for both sides and is especially critical if the other owner will remain with the combined business.
One of the most significant issues centers on how equity will be divided after the acquisition is complete. One approach is to develop a fractional formula built upon the gross revenues of both businesses and what portion of the combined company each represents. Similarly, there must be agreement on how compensation will be handled in the combined company.
Valuation is the most crucial factor*
The most important determinant is the value of the business that’s being acquired. Beyond the fact both sides need to agree upon a valuation, how that valuation will fold into the combined company will play a key role in determining everyone’s satisfaction with the deal.
The best way to begin the valuation process is to look at the company being acquired as a stand-alone business without considering potential savings and advantages resulting from combining the two companies. That initial valuation serves as a baseline to which other benefits of the consolidation can be applied and valued.
Structuring the acquisition
How the transaction is structured is just as important as the valuation. The acquirer needs to be confident the deal will be profitable. The seller needs to be compensated fairly for both its tangible assets and the sweat equity the owners have invested.
Rarely are combinations of businesses mergers of equals. Most often, one company is essentially taking over another, with some or all of the owners of both sharing in the ownership of the combined entity for a period of time. What typically guides the structure is the amount of time the seller intends to continue working. A transaction in which the seller intends to keep working for 20 years will be structured very differently than one in which he or she plans to retire in the next two to three years.
If the seller anticipates retirement (or a significant work reduction) within the next few years, consider a “two-stage” acquisition, in which the seller moves into the buyer’s business, and the formal buyout occurs when the seller is ready to stop working.
As with valuations, a transaction involves a variety of elements, notably:
- the amount of cash used as a down payment
- any working capital needed to make the transaction viable
- the impact any new or acquired debt will have upon future cash flows
- assets that can be leveraged to facilitate funding
- negotiation of any differences in opinions about valuation, and
- the effects of potential business benefits created by the combination.
How to finance strategic acquisitions
Growing your business through a strategic acquisition can be exciting. Most acquisitions will require some degree of outside funding because buyers lack sufficient capital or are unwilling to tie up a large portion of working capital. As you’re developing the acquisition plan, you should also be working on a financing plan. Critical to this plan is considering the amount of risk you’re willing to assume and base your maximum investment on that risk tolerance.
If you are thinking about growing your business using an acquisition strategy and don't know exactly where to begin, please feel free to contact us. At Oak Street Funding, we have experts in lending who have helped hundreds of clients make their strategic acquisition goals a reality.
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.