14 July 2011 Growing your business through acquisition

By Phillip Briffa, Solicitor

In brief – Acquisition can accelerate the growth of your business

One way to accelerate the growth of your business dramatically is to buy another business. This can help you gain a competitive advantage in your industry, expand the scale of your operations and lead to a number of potential benefits. These include the growth of your client base, expansion into new markets, reduced competition and decreased expenses through economies of scale.

What makes a good acquisition?

To buy a business successfully, your existing business needs to have a solid foundation. This means having the people, systems and resources to be able to integrate your operations effectively and smoothly with another company. Be methodical - create an integration strategy with realistic expectations and deadlines. 

Funding the acquisition

How you fund buying another company is an important decision to be made at the outset. There are four main methods:
Debt funding – borrowing money from a bank to fund the acquisition
Equity funding – existing or new shareholders of your business contribute money to fund the acquisition
Cash-flow funding – this is possible if your business has cash reserves and is considerably larger than the business to be acquired
Merger – in effect, this means buying a business by selling part of your existing business to the seller of the acquired business
The acquisition process can be broken down into six steps.

Step 1. Identify the target

If you are looking to buy a business in your own industry, doubtless you already know who your competitors are and which of them are attractive acquisition targets. Alternatively, you may consider buying a business which is a supplier to your industry, allowing you to cut costs and/or increase profit margins. Another possibility is to look at distressed businesses selling assets – IP, equipment, plant – which create synergies with your existing business.

Step 2. Enter into a terms sheet/heads of agreement

This is a summary of the main commercial terms agreed between the buyer and the seller and should include a timetable for completion. The terms sheet usually remains subject to contract and is non-binding (except for any confidentiality provisions).

Step 3. Enter into a confidentiality agreement

If you are the seller of a business, it is prudent to ensure that any prospective buyer signs a confidentiality agreement before you disclose any confidential or commercially sensitive information about your business.  

Step 4. Conduct due diligence

It is vital to research the target thoroughly to analyse its commercial, financial and legal position.

Step 5. Determine the value of the target

Don't rely solely on EBIT and revenue streams in performing a valuation and don’t rely on your own skills to do the valuation unless you are an accountant. Consider these elements:       

  • Profit projections with reference to key business contracts
  • Profit margin
  • Debt/equity gearing
  • Cash flow
  • Balance sheet
  • Industry comparisons and competitive advantages
  • Non-financial factors such as the management team and public perception
Step 6. Negotiate the sale agreement

You need to determine whether you are acquiring the assets or the shares of the target. If you use a share sale agreement, you are acquiring all the assets and liabilities of the target company. If you use an asset sale agreement, you are not obliged to acquire all the assets or any of the liabilities.

Keep a cool head

The biggest disasters in business acquisition stem from failure to do due diligence properly. Sometimes people can be so swept up in the romance of the deal, so keen to clinch it, that it clouds their reason. Just because you can read the contract yourself doesn’t necessarily mean that you truly understand its nuances and implications.

We’ve seen people who have ended up saddled with the vendor’s tax liabilities and customer/supplier liabilities because they didn’t understand what they were committing to and failed to get professional advice. Your lawyer, accountant and business advisor are the people who can save you from making a decision with dire consequences.

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This article is not legal advice and the views and comments are of a general nature only. This article is not to be relied upon in substitution for detailed legal advice.

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