Strategic acquisition: A good choice for growth

Strategic Acquisition: A Good Choice for Growth

At Live Oak Bank, our SBA mergers and acquisitions (M&A) financing team has seen an increasing number of strategic acquisition requests. We are very pleased by this because we believe that there has never been a more advantageous time to use SBA debt to finance growth by acquisition. In this article, we will outline several factors that make strategic acquisition a good choice for a small business looking for dynamic growth opportunities. These same factors also make the debt used to fund strategic acquisitions more flexible and easier to obtain.

 

If you already own a successful company, you’ve already tested your entrepreneurial metal. You’ve established your business acumen and the foundation is already in place for leveraging your assets. “When first making the move from the corporate world, there are many surprises and challenges that go hand-in-hand with the satisfaction of business ownership. After proving that you know how to maintain and grow an existing business, you see where your skills can immediately improve an acquired business and how the combined entity can supercharge your bottom line more quickly than through organic growth alone,” says Jim Creagan, president of Randob Labs.

 

Based on a study by Barlow Research, 68 percent of small business owners in the lower middle market (LMM) and 67 percent in the middle market (MM) are expected to retire in the near future. The average age of retirement for both categories is 67 years of age. What makes these statistics so interesting? Based on additional research from Barlow done for 2017, 36 percent of LLM and 45 percent of MM companies are owned by individuals 65 years or older. These statistics show that the current environment is excellent for both buyers as well as baby boomers looking to sell their companies. Strategic buyers stand to benefit the most as a result of their buying power.

“When first making the move from the corporate world, there are many surprises and challenges that go hand-in-hand with the satisfaction of business ownership. After proving that you know how to maintain and grow an existing business, you see where your skills can immediately improve an acquired business..”

-Jim Creagan, Randob Labs

Strategic acquirers can afford to–and sometimes will–pay a higher multiple for a company that adds to company synergies. In many cases, the strategic buyer can increase earnings before interest, taxes, depreciation and amortization (EBITDA) of the company they are buying through the elimination of redundant expenses. A strategic buyer has a distinct advantage when compared to individual buyers because of their ability to pay more for the same company given the value of the increased outputs of the global, merged operations.

 

John Martinka of Partner On-Call recaps 19 reasons why growth by acquisition makes sound strategic sense in his book titled Company Growth By Acquisition Makes Dollars & Sense. The top five reasons include:

  1. The risks of geographic expansion can be dramatically reduced by buying a company in another city or state. This can eliminate a multi-year ramp up, which is often similar to a true start-up.
  2. In our current tight labor market, a strategic acquisition can be a great way to find qualified employees.
  3. To add more customers, the key to any successful business is diversification. A strategic acquisition of a direct competitor would allow you to sell your product or service to more customers, and vice versa. As an added bonus, you remove a competitor from the marketplace, as well.
  4. Yes, we can! By showing that you can successfully integrate another business, its people and its culture into yours, you are more attractive when it comes time to sell. This is especially true if your future buyer is another firm or a private equity group, as both types value management teams.
  5. Acquisition makes you a larger company and, all other things being equal, a larger firm is more valuable than a smaller firm. The multiple on earnings for a $5M company is less than it is for a $15M company, which is less than it is for a $35M company and so on.

 

When seeking strategic acquisition debt, the cash flow and equity of the existing company could potentially help garner more creative bank loan terms/conditions. For example, with SBA loans, strategic buyers can acquire a company with potentially no cash equity if the acquired company will be integrated into the existing operating company, if the debt coverage ratio is adequate and if the pro forma enterprise value supports it.

 

Strong strategic acquirers can potentially purchase struggling or stagnant companies at deeply discounted prices by virtue of being able to rely on the underlying cash flow or working capital of the existing company or any number of other areas of strength that the target company may be lacking and the strategic buyer has in spades. These areas include capacity of existing cash flow, working capital, excess debt coverage margin, equipment and workforce.

 

Existing business owners will already have experience with investment bankers, lenders, attorneys, CPAs and perhaps even with the due diligence process. Having a trusted advisory team already assembled puts you one step ahead in the acquisition process because they are familiar with your company, style and successes. It’s important to assemble a team of professional advisors with transactional expertise for the acquisition process to compliment your current advisors that may have a primary skillset in more operational aspects of your business. M&A experience within the deal team is a must-have to esure an efficient process.

 

The letter of intent (LOI), a valuation and due diligence process for an existing business owner, can be an easier process for an experienced business owner than for the first-time buyer or first-time business owner. The existing business owner has a much better understanding of the “worth” of this additional company to the combined operations, whereas first-time/individual buyers oftentimes tend to over-deliberate, try to make sure the offer price is perfect and tend to have much less room for error overall. David Ryan, principle with Upton Financial Group, Inc. comments, “While there are never guarantees on completing a transaction, selling to a strategic buyer is about more than just price. It is about getting a transaction completed and getting reasonable terms and conditions. Strategic buyers have experience making the conversations potentially less emotional than when dealing with an individual buyer who likely has never bought a business before.”

 

The negotiation process is typically more successful when it takes place between two business owners with trusted deal team advisors to help guide them on both sides. They tend to speak more of the same vocabulary and the discussion tends to be more productive and successful than when a non-strategic buyer is at the table with the seller. Transition risk is also significantly reduced, as the experienced entrepreneur has a much better feel for key issues to highlight during the initial LOI stages all the way through the due diligence, final PSA and closing processes. A strong and detailed integration plan is needed, however, to ensure existing operations are not disrupted.

 

Once a company has reached acceptable levels of EBITDA and operational stability through organic growth, owners can effectively employ a strategic acquisition approach, which can prove to be a much more efficient and less expensive way to further grow revenues and bottom line. From an exit planning perspective, growth by acquisition can catapult a company into the next level of EBITDA, making your company attractive to more diverse suitors who can potentially afford greater multiples and who might have access to a greater number of debt and equity acquisition structures.

The negotiation process is typically more successful when it takes place between two business owners with trusted deal team advisors to help guide them on both sides.

Ed Kirk and John O’Dore with Chinook Capital Advisors further expand upon the benefits of EBITDA growth by strategic acquisition. “Value can be compounded through what is known as multiple expansion. Simply put, this means that a company will get a higher EBITDA multiple as the EBITDA increases. As an example, statistics from GF Data show that in the manufacturing sector in 2017, the average enterprise value to EBITDA multiple was 6.3 for deals in the $10-25M range and 8.6 for deals in the $100-250M range. These EBITDA multiples will be even lower for deals under $10M and generally range from 3-6,” said Ed Kirk.

 

John O’Dore goes on to explain, “The reason that multiples expand as EBITDA increases is twofold. First, there will likely be more buyers interested in your business as the size increases. Many strategic and private equity buyers simply don’t want to pursue small companies that will cost them hundreds of thousands of dollars in transaction fees unless they add a significant amount in profits. Second, larger businesses are generally perceived as less risky since they likely have more diverse products/services, customers and management teams.”