Growth by Acquisition

(Image from Free Digital Photos)

Today I want to talk about preparing a small business for sale to a new owner, because if you have a business that may be something you want to do. The past couple of years pushed many business owners to bring their retirement plans forward. When the owner of a small business retires, either the business closes down or it is passed along to someone else who will take it into the future, maybe the next generation but often a buyer.

From the new owner’s perspective, they’re going to acquire the business. I'm going to use the term 'acquisition' broadly, covering both purchases (of a business or of its assets) and mergers.

A buyer will pay a ho-hum price for a business with an ordinary financial growth curve. Getting a higher price for the sale requires an upward growth curve that is so much better than ordinary, it’s exciting.

Organic growth doesn't make a growth curve exciting enough to make a great exit. As the current owner planning for an exit, you can accelerate the growth curve by acquiring compatible businesses. If you’re ambitious about getting a premium price at your exit, you may be thinking about doing this.

For the moment let’s assume you have a good eye for ripe acquisition targets and can negotiate good deals to build up your business by acquiring others into it. You find access to funding on highly advantageous terms to do so. You’ve got your act together.

The potential stumbling point is often the timing. To get the combined financials squared away, you need to make the acquisitions and then have a few years to pay down any debt from buying them. If you want to sell before you've done that, the debt load from acquisition funding prevents finances from looking good enough.

But by the time you've done that, the merged business could settle into normal operating mode. It will be back to organic growth and the growth curve will be less dramatic.

When you sell to a big buyer – and by the time you exit, that's likely to be where you want to sell – they want to see a recent growth curve that's impressive and not slowing down... a hockey stick shape. They don't want to see a hockey stick followed by a less dramatic organic growth pattern.

There are solutions to this quandary. You could do some acquisitions shortly before exit where you acquire businesses and pay off the deals with deferred consideration out of the acquired cash flow. An earn-out arrangement looks better than a loan, even though in practical terms it has about the same effect. With enough reserves to cover the initial payment, you could entirely avoid having a new balance sheet liability drag down the appeal of your financials.

If none of that is feasible, your acquisitions may need to happen in two ways and two stages. For the short to medium term, you could use advantageous borrowing terms to acquire some businesses. If your horizon is 5 to 10 years to exit, that’s plenty of time to pay down debt, square away the consolidated business and build some reserves. It will give you a bigger base to stand on when you do a final round of acquisitions in the last two years before exit, for which you would not want to borrow or pay cash for the deals – you would want to find ways to make the acquisitions fund themselves so you will be positioned for the best possible exit. When done well, the final round injects verve into the financial picture at just the right time to attract a premium offer from a buyer.

One last word to the wise brought on by some recent interactions with business owners looking for an exit:

Selling a business usually takes more time than it seems like it should. A lot more.

There are exceptions to that general rule, but they aren’t exceptions you should want. A troubled business can be sold fast to a buyer who has the resources and know-how to fix its problems or suck it dry and shut down the empty husk. But for your exit, you want a premium price. The buyer will want to be sure it’s worth that much money. They won’t rush. The lawyers won’t rush.

Be patient about both your preparation and the eventual exit deal, and pay attention to how you time a boost in the financial picture. That’s the essence of how to get the reward you want.