When it comes to growing a business, acquiring another business may not be the first idea that occurs. After all, the classic image of entrepreneurship is someone building a company from the ground up, either bootstrapped or with funding assistance.
There is also a perception that business acquisitions are risky and difficult to complete. While there is an element of truth to this, there are many examples to demonstrate that a properly structured, well-thought-out acquisition strategy can be the most efficient route to growth available to an expanding company.
In more than 30 years as the UK’s leading marketplace for small business and medium-sized businesses, we’ve found these ten elements to be crucial to a successful acquisition – an acquisition that delivers profitability and growth.
The Inside Track on Buying a Business
1. Choosing M&A as your growth strategy
Organic growth may be seen as the idealistic embodiment of entrepreneurship, yet mergers and acquisitions offer a pathway to swift and dependable expansion. This is not to undermine the importance of organic growth, which remains a vital strategy for many businesses and the economy in general; acquisitive growth can be far more successful for businesses looking to expand at scale and quickly improve profitability.
There are numerous reasons why M&A is so effective at driving growth. Speed is perhaps the key attribute, with acquisitions enabling buyers to rapidly enter new markets, diversify their product or service offering and acquire talent and intellectual property. These are all things that can take years to develop organically, whereas M&A can enable them to be achieved in the space of just a few months.
If a business is looking to diversify, then it can be vital to quickly acquire expertise and credibility. Similarly, if a business is moving into a new geographical area, then acquiring a firm that is established in the area can enable the buyer to tap into an existing customer base as well as local trust.
2. Use aggregator sites and go off-market
Many prospective business buyers will limit their searches to businesses that are actively looking for a buyer – whether that is a strategic sale or due to insolvency. While this is a perfectly legitimate way to conduct an M&A strategy, the best acquisitions are often found by buyers who search off-market and proactively approach owners who have not formally put up the “for sale” sign.
Searching businesses for sale on aggregator sites like Business-Sale.com has the obvious advantage of showing active acquisition opportunities that can easily and conveniently be searched through according to your criteria. Even with all this at your fingertips, however, you are severely limited your search by only focusing on opportunities that have already been brought to market – with around 98 per cent of UK business not for sale.
Clearly, this offers a far wider pool of potential quality acquisition targets and, while it may seem like most owners would not welcome being approached by someone looking to buy a business that is not for sale, research actually shows that approximately two-thirds of owners say they would consider a serious offer for their business.
3. Know your target profile
One fundamental facet of a good acquisition strategy is to know exactly what kind of businesses you are looking to acquire. If your search is taking in off-market businesses, in particular, then having clear, specific criteria for target businesses will be crucial to conducting an accurate, successful search.
Having a detailed, granular target profile will save valuable time that might otherwise have been spent trawling through a massive list of unsuitable businesses, ensuring that buyers can find the right targets and make a move for them more quickly.
A target profile will depend upon each individual buyer’s needs, but will typically include information on the sector or sub-sector they are looking in, region, the type of customer or client base that the business serves and the size of the business they are seeking to acquire (usually defined by a metric such as headcount or turnover).
One important exception to having a fixed target profile is if an M&A strategy is focused on opportunistic acquisition. At that point, it becomes more a case of identifying appropriate opportunities as they appear, with the focus being on securing a good deal and meaning the target profile may have to be more flexible.
4. Be wary, but don’t avoid distressed opportunities
UK businesses are currently facing a raft of adverse conditions, from rising energy, labour and raw material costs, to falling consumer sentiment and the need to repay loans and other liabilities accrued during the COVID-19 pandemic.
This has resulted in surging financial distress among businesses, with figures from the UK Insolvency Service showing that company insolvencies reached their highest level in 2022 since the aftermath of the financial crisis in 2009.
From an M&A perspective, this means that there are currently a wealth of distressed acquisition opportunities available to opportunistic buyers. Some of these struggling businesses are inherently viable operations that, in better circumstances, and without a debt burden, would have strong profitability and growth potential.
For that reason, buyers shouldn’t shy away from targeting distressed acquisitions, with the potential upside being considerable. Note that it is especially important here to ensure a thorough due diligence process examining the reasons behind the company’s struggles.
A due diligence process will help to establish whether the business has run into difficulty due to external factors – potentially indicating that it is otherwise viable – or as a result of mismanagement, a poor business model or a lack of demand for its products or services – issues that may be deeper seated and significantly harder to remedy.
Due diligence can also help you to establish the business’ capacity to turn around. Does it have strong cashflow? Were its struggles related to debt servicing? Is its customer base and supply chain solid? Is its product or service offering resilient? How well is it likely to fare in an economic recovery? These are all key questions to ask when considering a distressed acquisition.
5. Don’t let the economy put you off
As with distressed businesses, buyers shouldn’t be put off M&A due to the current economic uncertainty being seen across the UK and around the world more broadly. M&A activity often declines during downturns, as financing conditions become tighter and businesses focus on cutting costs and improving their resilience. However, history is replete with evidence that the best value deals are often those carried out during recessions or downturns.
Acquisitions made during downturns can enable buyers to strengthen their position against more cautious competitors and provide strategic options and potential new sources of value that can help them to attain growth both during and in the aftermath of the downturn.
6. Develop a solid acquisition process
For buyers looking to buy businesses at scale and grow acquisitively through a series of acquisitions, it will be vital to develop an acquisition process that supports this, that is repeatable and ensures a buyer has numerous options whenever a deal falls through.
A well-developed target profile will be important in this regard, but buyers will also need to be adept at due diligence, knowing exactly what they are looking for and how to assess the state and growth prospects of the business.
How potential acquisitions are contacted should also be established: by phone or by email? Directly or through a third-party such as a broker? While it is important to be flexible, a scattergun approach that varies from one deal to the next will only create confusion, delays and spread a lack of clarity.
7. Ensure you have the right funding
Unless the buyer has considerable existing cash reserves (for instance, if it is a medium or large business), the majority of acquisition strategies will be reliant on some form of third-party funding.
It is paramount that this is in place before you embark on any transactions, as vendors or their representatives will need to know that a buyer has the means to finance the acquisition before they will proceed.
There are a range of financing options available to those seeking to buy businesses, but securing funding can be tricky and you will need to have developed a solid acquisition strategy offering a clear growth plan before investors will agree to offering their capital.
M&A financing, however, is one of the areas of dealmaking most impacted by the current economic climate, with inflation, soaring interest rates and geopolitical turmoil prompting traditional lenders, such as banks and investors, to tighten their financing conditions, making it harder for would-be buyers to secure the funding they need. In an outlook on M&A for 2023, a poll of dealmakers by CMS found that 87 percent believed financing conditions would be more difficult this year.
In this environment, one source of M&A financing has emerged as the go-to option: private equity. Since the COVID-19 pandemic, private equity firms have been steadily ramping up their M&A activity across a range of sectors and continue to sit on enormous piles of unspent capital.
In CMS’s poll at the end of 2022, 40 percent of respondents said that private equity would be the most readily available source of M&A financing and this prediction has seemingly been borne out, with a recent RSM UK report finding that 47 percent of mid-sized UK firms would seek private equity funding this year, up from 36 percent in October 2022.
Competition for private equity financing will be intense, but for buyers with solid acquisition strategies in place, the funding to complete their deals is out there to be secured.
Of course, private equity funders are not going to be interested in small company funding, and by that, we mean deals of less than around £8m – £10m in transaction size.
Financing smaller deals are often completed with a mix of options. These include but are not limited to a cash component, bank lending, third-party equity involvement, using the target’s cash, asset and invoice financing, vendor financing, leaving shares on the table for the vendor, and other creative arrangements with the vendor including earn-outs (see below).
8. Get the right advice
Advice will be crucial for those who do not have an acquisitions track record and even many seasoned business buyers will still rely heavily on expert insight. Often, the party behind a buyer’s M&A financing will offer advice and play a significant strategic role in the direction that an acquisition or overarching M&A-led growth strategy will take.
Buyers can also engage professional M&A / corporate finance advisors, who will offer expertise on the intricacies of the process, with some offering specific, in-depth knowledge on a particular sector or being able to provide contacts to experts in another industry. Engaging outside expert help such as this, of course, will come at a price.
It could also be beneficial to engage an Acquisition CFO, who can often offer insights on due diligence, tax implications, valuation and other operational and financial issues at a lower cost. For buyers who are considering multiple acquisitions as part of an acquisitive growth strategy, then it might be worthwhile permanently engaging an M&A expert to offer in-house advice on deals.
To oil the wheels of a slick acquisition process, it is crucial to have a deal team in place. This often comprises lawyers, accountants, business advisors, financial/tax advisors, and industry experts, who can work together at short notice to guide and advise at appropriate points.
9. How to structure the deal
Deal structure is a vital element of M&A, especially in the current climate, with valuation gaps seen as one of the major barriers to dealmaking amid the ongoing economic uncertainty.
While, in an ideal world, someone selling a business would of course prefer to receive 100 per cent of the consideration up-front in cash, that is often not a workable solution – particularly during economic downturns or recessions.
Even if a buyer is serious and able or willing to offer an amount that matches or comes close to the seller’s valuation, it may not be possible for them to pay this up-front, meaning that – unless the seller chooses to slash their valuation to facilitate a sale – a structure will need to be agreed in which the consideration is paid out over time.
Typically, this will involve an up-front consideration representing a significant proportion of the overall value, followed by further payments later on. Sometimes, these later payments will be guaranteed for a later date (e.g. one-year post-completion), and other times (occasionally running in parallel with guaranteed payments), they will be structured as an earnout and contingent upon the business achieving certain post-sale goals.
Structuring an earnout can be challenging to negotiate – with the terms needing to satisfy both buyer and seller – but they can offer an attractive option where there is a willingness to strike a deal. For sellers, an earnout can enable them to command a price closer to their valuation, while, for buyers, having a portion of the consideration dependent upon the business performing well post-completion, earnouts offer protection if the business underperforms, meaning they won’t have paid an overly-high valuation. This can be particularly attractive to buyers during downturns or recessions, when a business’ performance may be adversely affected.
10. Integration is the most crucial stage
Finally, the most vital stage of any acquisition, post-deal integration. While it may not be an obvious choice for the most crucial element of a deal, the integration stage is where the success of an acquisition hinges.
Without a strong post-deal integration process, all the hard work that has gone into every previous step of the deal will have been for nothing. Strong post-deal integration can make a success even of deals that were structured poorly or had little strategic rationale, while poor integration can lead to a strategically sound, well-structured deal failing.
Buyers should plan for integration in advance, setting out goals, timelines and metrics of success that will need to be met in the post-deal phase. Once a deal is completed, this plan will need to be shared with all relevant stakeholders, such as employees and management, to ensure communication and a sense of common purpose.
Integration should also take into account how the cultural differences between two companies can be aligned (not necessarily merged, but adjusted in such a way to create an overriding ethos that reflects the best of both approaches), how IT systems and other tech might need to be integrated, along with financial systems, sales and marketing.
One of the most important elements of post-deal integration is change management. Things can move fast in the wake of an acquisition and buyers need to constantly monitor and adapt to how the situation develops in order to keep the integration on track.
When it comes down to it, this last point – that integration is the most important phase of M&A – is the most salient when it comes to becoming a successful acquirer. A focus on integration is something that differentiates the best and most efficient acquirers from your average buyer.
Take, for example, Fairstone Financial Management, one of the most successful consolidators in the wealth management industry (one of the UK’s busiest M&A markets). Fairstone values integration so highly that its entire acquisition model is based around integrating businesses before they are fully acquired through its Downstream Buyout (DBO) model.
Under the DBO model, a minority stake in a target business is acquired and the firm is gradually integrated into Fairstone’s operations so that, by the time the buyer moves to fully acquire the firm, it is already effectively integrated into its business.
You might not need to go to these lengths to integrate acquisitions, but it’s illustrative of the importance of the process and a reminder that, while you might successfully complete an acquisition, the hard work doesn’t end there. It’s what you do after the deal has been sealed that determines whether it is a success or not.
