Many entrepreneurs think of Mergers and Acquisitions (M&A) as a game played only by large businesses. There’s a good reason why large businesses use acquisitions as a key strategy to grow and stay ahead of their competition…it works!
But while deep pockets, sizable assets and team’s of MBAs can help in buying other entities, they’re not required. Small and medium-size enterprises and even solo-entrepreneurs can also take advantage of M&A strategies to grow and protect their businesses.
What is a M&A
Mergers and Acquisition are simply transactions in which the ownership of a business entity or part of a business entity is transferred to or consolidated with another company. This is done for a number of reasons like increasing buying power, removing competition, controlling supply chain, acquiring talent or intellectual property, buying income, increasing diversification and more.
M&A have been around since the dawn of business. In 1708, the East India company merged with a competitor in order to establish it’s monopoly (Monopolies were legal back then). The strategy of merging a businesses with another (or multiple businesses) or one company acquiring another is just a natural part of the way businesses morph over time.
Over the last century or so, there has actually been “merger trends”. Beginning with horizontal mergers in the late 1800s, vertical mergers at the turn of the 20th century, conglomerations in the 60s, followed by hostile takeovers in the 80s, globalisation and private equity over the past 20 years and finally emerging market acquisitions in the past few years.
Large M&As often make headlines when it involves well known brands, but there’s been a quiet consolidation in the small to medium private business space that rarely makes the papers but has helped many entrepreneurs make small fortunes.
While merging or acquiring a business is not an easy process, it can create significant benefits for both parties.
Types of Acquisitions
It is unlikely that a small to medium size business will be conducting a hostile takeover, a large scale leveraged buyout or a blogabalized acquisition. So let’s focus on 3 common acquisitions strategies that can help SMBs: horizontal, vertical and conglomeration strategies.
This is purchasing of similar businesses in the same vertical or niche. For example, an accountant may purchase a few additional accounting firms and rebrand them under the same name.
This often creates benefits such as increase in market share, reduction of costs, reduced competition, leveraging talent across both businesses, reduction of headcount through removal of duplicate roles, simplified branding and messaging, sharing business data, and getting better buying power. If done well, there are often cost savings through a horizontal acquisition which improve margins for both businesses.
When a business purchases a company that can be part of their supply chain. For example, let’s say a grocery store were to acquire a bakery and a fish wholesaler. This allows the new entity to improve margins from its sales of baked goods and fish by getting better than wholesale pricing.
It also allows the grocery store to make profits from the wholesale of products to competing grocery stores.
Conglomeration is the merging of 2 businesses that may have little in common. For example a grocery store and an ecommerce business. This allows both businesses to diversify their revenue streams and mitigate against risk. This is especially important for businesses with limited revenue streams who are reliant on sales to survive.
There are typically some shared resources (like legal, accounting, and other business related expenses) that do allow for some minor benefits in cost savings. But typically this is not the focus on conglomerations.
Often during conglomerations, there will be interesting opportunities to leverage new views and approaches that may be common in one industry but not in others. This can create new avenues of growth and innovation
What can Small Businesses Gain from an Acquisition
Acquisition can be a great way to plug in some holes or vulnerabilities in your business. They can also be great ways to improve a businesses’ margins and make it more valuable. Here are some general benefits you can expect:
One of the best reasons to complete an acquisition is for the size premium. A larger business tends to sell at a higher valuation than small businesses (in business, bigger is better). For example, a small business with less than $1M in revenue may sell on the market for about 3 times it’s profit. But a larger business with revenues over $10M may sell for closer to a 4 or 5 times profit.
Merging a couple of small businesses into a larger one through a rollup strategy, can create value out of thin air. This multiple arbitrations through a roll-up strategy is often used by larger private equity firms and businesses looking to increase their value quickly. It works perfectly well at a small business scale.
The trick is to understand your market and see what other businesses in your niche are selling for. Find businesses that recently sold that were larger than yours and start getting an understanding of what the next revenue tier that you would need to reach in order to get the multiple premium. Then focus on finding the right acquisitions to get to that size.
Another important reason to look at a merger/acquisition is to diversify your revenue streams. This is often not a priority for successful business until something happens to disrupt that comfortable revenue stream.
Take Covid-19 for example, where many brick and mortar retailers suffered greatly by not having diversified income streams. Many scrambled to create ecommerce offerings to try to stay afloat and bring in some revenue to offset losses on the physical retail side.
Multiple streams of income is a critical aspect for long-term business growth and even business value. Businesses with diversified revenue streams, client bases, and product lines tend to sell for more.
So acquiring a business with a strong complementary income stream that helps you diversify your business can be a great protection play while building value for both businesses.
Innovation and Talent Acquisition
Many businesses feel that they need to continuously innovate and develop their own new products to be successful. While that can be an amazing opportunity, it is also very risky. There are typically significant costs in product development with no guarantee of success.
What if the marketplace doesn’t accept the product, what if a competitor is first to market, what if the dilution of focus hurts the rest of your business, what if you miscalculated demand or cost and it hurts your overall business margins.
A better and less risky approach is to acquire innovation. Find a business that has spent the blood, sweat and tears of developing the product, creating the processes, proving the market, figuring out the messaging, testing the price points, putting a customer service process in place, creating training documents, etc can be a huge advantage in both time and financial savings. This allows you to ensure you know the product will be successful.
Along those lines, through acquisitions, you can often get top talent that will help innovate in your legacy business as well. Buying a business with an innovative product line, strong intellectual property and brilliant people can help propel your existing business.
New Income Streams
Acquisitions allow you to buy predictable income and offer an opportunity to sell more to existing customers.
Successful businesses that have been around for a number of years have clear financial reporting that can help you feel confident in its past success and future potential. Obviously proper due diligence is critical but once that’s done, you can feel comfortable that business will provide an ongoing income stream.
Large businesses acquire income streams versus creating them from scratch; it’s faster, less risky, comes with a strong talent pool and a defined process. It’s the simplest way to grow your business and this acquisition approach works for any size company.
Once you’ve acquired a company, both entities now get access to each other’s customer base. Upsell and cross-sell products to both client lists can be a huge revenue generator.
Improved Buying Power
Volume discounts and buying power is the way Walmart, Costco, Amazon and all large retails dominate. By getting their products at a discount to everyone else, they can make more profit or lower their prices to put their competitors out of business.
Many small businesses get very little discount due to lack of purchasing power and in some cases almost pay retail. Making larger orders can provide significant ability to get products at a discount. And if you happen to be your manufacturer’s largest client, you may even have the opportunity to demand specific features, delivery methods, payment terms or other advantages that no one else in the marketplace can get
When merging companies together there are typically duplications that can be taken out of the businesses. While cost savings tend to be a bit smaller than many expect, over time they still make a significant difference to the bottom line.
All businesses have standard operational costs like accounting, legal fees, software and systems, employees and equipment maintenance. When merging companies together there is often duplication.
Putting both businesses on the same software platforms can reduce the number of required licenses and create volume discount opportunities. Using the same accountant and lawyer can help reduce those professional fees. Only having 1 marketing brand to support can reduce marketing costs significantly. And underutilized employees can be leveraged across both businesses to help maximize productivity.
There many more benefits for making an acquisition and they’re not only one sided. The company getting acquired can also benefit greatly:
- the seller gets a payout or can retain some equity in the new entity with hopes of future upside,
- the employees of the new entity could gain equity shares themselves or at least be part of a larger more resilient business with more job security
- the best processes between both companies can be leveraged across both entities making employee’s jobs easier,
- cross selling and upselling of products between both companies can create more revenue overall, therefore more bonuses and commissions
Financing an Acquisition
Financing a business purchase will very much depend on the business acquiring, the business being acquired, the owners, types of assets available, debt existing, and type of access to capital. There are a myriad of different options that exist. For example:
- Vendor Take Back – negotiating seller terms to make the acquisition work. A seller can offer a loan, earn-outs, balloon payment, or other forms of financing
- Traditional Financing – business loans from traditional financial institutions can be used to finance these transactions
- Leveraging assets – the assets of the business being acquired can actually be the source of capital. Account receivables, cash, equipment, real estate, etc can all be leveraged to create capital to make an acquisition
- Ownership – In some cases, a simple equity swap or shares in the larger overall business to the seller can do the trick to allow you take ownership of the business with little cash upfront.
- Raising Capital – whether through friends and family, employees, crowdfunding, angel investors, SPACs, venture capital or just other investment groups, raise money as debt or equity or a combination of the two can help fund the purchase.
- Government Programs – SBA and other government programs offer loans that can help small businesses or individuals with acquisitions. Exploring these government programs can provide you with relatively inexpensive capital for a strong M&A.
Financing businesses are often are a combination of multiple approaches and using leverage. Creativity is important here but so is understanding the options available. Research what exists and increase your network well before an acquisition to maximize options available to you.
Suggestion On Where To Begin
Many small businesses aren’t sure where to even begin when it comes to an acquisition.
The first step is to determine what your goals are. Are you looking to grow your business? Are you looking to protect it and create a moat around your company? Do you want market dominance? Are you looking to just create value and then sell the merged entity or is this a longer term play?
Once you have your priorities and goals figured out, then determine the ideal acquisition. What would they look like? What skills, resources, products, systems and structure do they need to have to make it valuable for you? How many can I spend on my acquisition?
Come up with a few companies that fit that profile and reach out to them with the idea of an acquisition. The chances of finding a business that fits perfectly with your business, where the seller is ready to sell and the price is on point with your expectation will never happen. So you’ll most likely need to settle on a few of your “wants” to make an acquisition take place. The goal is to find a prospective acquisition where the upside significantly outweighs the downside.
Also expect that you’ll need to cast a wide net to find the ideal company. While you may have a few businesses in mind (maybe existing competitors, partners, suppliers, etc), many skeletons get uncovered during due diligence that removes those businesses from the prospects list. So take the profile you have in mind and start contact businesses that look and feel similar to them. Use tools like LinkedIn, Dun and Bradstreet or other providers to find businesses similar to your ideal target.
And remember, just like sales, this is a numbers game. You will need to contact many companies to get down to 3 ideal acquisition candidates, to successfully close one.
Think Internet Businesses
Finally, consider an online business such as an ecommerce business, a content website, digital products or online services companies for your first acquisition.
There are many benefits of internet businesses that brick and mortar business don’t get to benefit from:
- Location independence
- Global workforce
- Global customer base
- Open for business 24X7X365
- Easier to integrate
- No complicated or costly leases or real estate transfers
- Easy to flip and resell
- And for internet businesses, seller financing is an expected part of the deal
If you are a brick and mortar business today, internet businesses are a great way to diversify and allow you upsell and cross sell to your existing customers. They are also great ways to test products to your market cheaply without the overhead of physical stores.
If you’re interested in learning more about making an acquisition of an internet business go to madxcapital.com and start taking some of our courses.
The game of mergers and acquisition is no longer for large institutions or deep pocket funds. It plays out in your backyard everyday and many business owners are increasing their wealth and improving their businesses through acquisitions.
Every business manager and entrepreneur should at least explore if M&A is right for their business.