My companies have been acquired twice and I have attempted numerous acquisitions. While I don’t have the experience of an investment banker like GE or SilverLake, I have been down many roads that few have the opportunity to travel, and it’s nothing like you think. Yes, there is almost always human impact because maximizing profits is valued over people as a rule still, and not the exception.
Why do companies sell themselves or buy others?
- Rather than opening a new geographical region of sales, it is often easier to acquire a company already entrenched in that region.
- A product manufacturer may acquire it’s distribution partners in order to create an exclusive sales opportunity.
- A partner retires and needs to convert his stock in the company to cash.
- A technology company may purchase integrators to directly serve their customer base.
Failures – Investors universally agree that to actually complete an acquisition is almost a miracle, and this is because there are so many things that can put a stop to the deal — many acquisition attempts fail. In all my efforts only once was price the failure point, and in that one case I had promised to keep all the employees after the purchase, but the owner chose to take the higher bid. In one acquisition at the 11th hour the owner decided he wasn’t ready for retirement. In one very large attempt, I was declined as a bidder because I could not write one check, but had to shop for multiple investors and that would have put too much information about the company on the street. Because of the diligence required to properly evaluate a company, price negotiation and transition plan, it will often take four to six months from start to closing of a purchase — it’s not a lot of fun when a deal falls apart, and a lot of time has been lost.
There are many methods for acquiring a company (or being acquired), and here are some of the more common ways AV companies get bought or sold (more on evaluation below);
- AV Company East Coast needs to expand to the west and so they search out and find AV Company West Coast that is for sale. While small companies do purchase bigger companies, it is more typical to acquire a same size or smaller company to keep the financing simple. The loan has to be paid out of the profits of the company, so if the acquired company is not profitable then reductions (people) have to be made to pay the loan.
- An investor looks for a profitable company (or one with value) that fits the model he is looking for and inquires if they are interested in discussing an acquisition, then working with an investment bank puts together a “deal” for acquiring the company using cash loans from other investors. The originating investor (“the guy that created the deal”) will typically get 2-4 percent ownership, while the cash investors will take the rest. Many times the investment bank is the originator and has its own pool of investment capital to work from. Business investors always purchase a majority holding from the owners so that they control the board.
- An existing partner in the firm sells out to the other partner at an agreed upon price. If the remaining partner doesn’t have cash in the pocket, she will obtain a small business load or the exiting partner will finance the loan for some number of years and receive a monthly payment as a capital gain.
- Mergers are potentially the most difficult to make happen, because there is no buyer to take the lead, so a lot of turf battles take place. Mergers, however, are better for reducing the human impact because everyone stays around after the closing and has to face the employees.
Evaluation — Before you can purchase (or sell) a company, everyone has to agree to what it is worth. While this can be excruciatingly complicated, there are some rules of thumb that that give a good initial value of the company. The most common for an equipment sales and installation company is “3x to 5x times the company’s EBITDA.” EBITDA is a more constrained approximation of net profits commonly used as a starting point for determining the value of a company. For example: if West Coast AV company has sales of $100M in the last year, and its EBITDA is $5M then the company could reasonably be sold for $15-$25 million dollars. Recent AV company sales have sold at 4.5x to 5x and is typical of most similar type companies in other markets. If the company is in distress or its business model is inefficient then the multiplier may be more like 3x or even less. Technology companies that make software or own Intellectual Property (IP) of some type could sell at 40x or more (e.g., the virtual reality company Oculus had no sales and sold for billions to Facebook — go figure). Evaluating the true best price for a company is more art than science, and a small mistake can set you back years in recovery or lose millions.
The Up Side of an Acquisition:
- Customers typically feel more confident in larger companies than smaller ones and so sales have potential to grow.
- Larger companies are more likely to create new technology.
- Employee Benefit packages from larger companies tend to be bigger.
- Employees are more stable long term.
The Down Side of an Acquisition:
- When East Coast Company buys West Coast Company, it already has people staffing all the necessary administrative, sales and installation roles, and so many of those duplicate roles may be eliminated.
- East Coast Company very likely now has a loan to service and so looks for ways to cut costs — again this means lost jobs.
- Highly experienced shop manager in West Coast Company is not known to the executives in East Coast Company, so will have to work extremely hard to hold the position over a similar manager transferred in from the East.
- Stress is high among all West Coast Company employees waiting for the first round of layoffs.
Buying a business is not so mysterious as one would think: It’s determining a fair value and then paying for it that is the difficult part. Every business should bring in a consultant to show them the ropes and help with decisions from an unbiased perspective.