Even in the middle of a worldwide pandemic, there is still opportunity to grow enterprise value by acquiring competitors. This growth strategy has long been a favorite of well-financed strategic buyers. For the past decade or so, the pace at which these buyers make acquisitions has accelerated substantially for reasons that include:
- Financing available is at a historically low cost.
- Huge amounts of capital available for acquisitions.
- The slow and uncertain path of organic growth.
- The large number of baby boomer owners eager to sell and pursue other activities.
Today, we add another more pressing (and perhaps depressing) factor: Many businesses are struggling because of the COVID-driven economic slump. As a result, many of these owners will want or need to exit soon. As revenue plummets, most owners simply cannot correspondingly reduce overhead. They may be forced to sell or shut their doors.
This perfect storm makes a discussion of growth by acquisition strategy appropriate with your clients whose companies are well-funded and continue to be so in today’s economic crisis. It is worth asking your clients the question: Should they consider acquiring smaller, less adaptable, less capitalized or less well-managed competitors? Should they use funds they receive via the Paycheck Protection Program (PPP) that is part of the Coronavirus Aid, Relief, and Economic Security Act to finance acquisitions?
As you consider these questions, keep in mind that acquisitions can benefit not only your client but the owners of the companies being acquired. By being acquired, at least owners would receive some compensation as opposed to having to shut their doors and loose everything.
Building company value via acquisition during a recession may seem counter-intuitive, but it can be done. If you know how, you can help your clients increase cash flow with minimal risk.
A Win-Win for Buyer and Seller
You will likely be the first to suggest this possibility to your clients who own well-funded companies because few advisors or owners appreciate growth opportunities in economic downturns. You might also be the first to suggest that in today’s buyer's market, your clients can find not only lower purchase prices, but also much more attractive seller-based financing and earn-outs. Consider the case of “Bob Eustace” and his company, “All-City Printing.”
For many years All-City successfully serviced many of its area’s top companies. At the outset of an economic downturn, Bob prudently pruned expenses and actually increased his company’s gross margins. But he didn’t stop there. Bob began acquiring smaller, undercapitalized and less profitable competitors who were unable to weather the downturn. The owners of these target companies had two options, either liquidate and receive very little (if any money at all), or sell to All-City.
Within 12 months Bob acquired three businesses, or, more accurately, parts of three businesses. Here’s how he structured the purchases:
- All-City acquired only assets it could use immediately, such as printing equipment. Usually this meant assuming existing equipment leases. When Bob purchased other equipment, he paid cash.
- All-City bought sellers’ customer lists and for two years paid the sellers 10 percent of each paid invoice as his company received payment. Ten percent (a form of earn-out) might sound stingy until compared with the amount customers would have paid had the sellers simply closed their doors. Due to greater efficiencies and economies of scale, All-City was easily able to generate enough cash flow from these new customers to make payments to the sellers.
Bob made very low-risk acquisitions that he financed by future cash flows of those acquisitions with the promise of increased future revenues. The sellers benefited as well through relief from equipment lease payments and income from ongoing revenue of former customers.
The lessons from All-City’s acquisition methods during an economic downturn apply today. In many situations, your clients may be able to acquire businesses—or the parts of businesses they want—with little up-front cash and no bank financing. While your clients would not sell their companies on these terms, their less well-positioned competitors may accept them because it could be their only option. Making targeted acquisitions is just one of many value-building techniques that you can suggest to your owner clients.
- Many companies are well-funded and continue to do well in today’s economic crisis. Suggest to their owners that now may be a good time to consider growing via acquisition.
- Owners may use funds received through the PPP (not needed to sustain the business) to finance acquisitions.
- Acquiring struggling companies may provide significant cash benefits to both buyer and seller
If you have questions about how to evaluate potential acquisition candidates or other value-building techniques, please contact us.