Rather than build their own businesses from the ground up, many entrepreneurs choose instead to purchase existing businesses.
If you have the resources or leverage to acquire an existing company, this strategy presents a number of advantages: extant product and service lines, established processes, loyal customers and more. But it also presents unique challenges—the effects of which can be mitigated by choosing your target wisely.
“To raise the likelihood that your newly acquired business will survive and thrive for years to come, look for targets with these attributes.” —George Otte
Positive Cash Flow
Cash flow is one of the most important financial indicators of an attractive acquisition target. Business coach Jean Murray defines cash flow as “the money that is moving (flowing) in and out of your business in a month.”
Basically, cash flow describes the movement of short-term, liquid financial reserves within a business. For ease, cash flow statements are usually segmented by month. Companies with a positive cash flow take in more cash than they send out on a monthly basis. Companies with a negative cash flow send out more cash than they take in.
As a buyer, it is in your best interest to seek companies with a positive cash flow. Such businesses are more financially stable. If you decide to implement large-scale changes, such as discontinuing product lines, ramping up research and development, or shuttering facilities, a positive cash flow protects your investment until you have fully implemented your strategy.
Motivated Sellers
Motivated sellers are often willing to accept below-market consideration. In family-owned businesses, common signs of seller motivation include:
- Owners are nearing retirement
- Next generation is not interested or trained to take over
- Owners are not willing or able to invest in new processes or equipment necessary to remain competitive
Deep Reserves of Talent or Expertise
According to the Society for Human Resource Management, U.S. employers are facing the worst talent shortage in at least a decade. In this environment, it is vastly preferable to retain key employees than to embark upon a long, potentially costly search for replacements. Look for acquisition targets with experienced executives or process-critical knowledge workers.
Sustained Growth
All companies experience temporary setbacks. It is more important that your target demonstrate consistent, sustained sales and revenue growth over the medium-to-long term than that their most recent quarter exceed expectations. Sustained growth indicates competent management, sound practices and strong fundamentals.
Lean Inventories
Be cautious about purchasing companies with bloated inventories. A well-stocked warehouse can be a boon, but only if its contents are marketable. Examine inventories carefully to determine whether they contain obsolete or hard-to-sell items before agreeing to take them off the seller’s hands.
Well-Defined Niche With Limited Competition
Attractive acquisition targets tend to operate in well-defined niches with reasonable levels of competition. It is not realistic to expect your target company to have a monopoly in its field. At the same time, an effective turnaround can be hard to execute in a crowded marketplace.
Access to New Markets
Look for acquisition targets that operate in new, potentially lucrative markets. This is especially important if you already own a complementary business that you plan to expand. It is much easier to mount a geographical expansion by acquisition than to start from scratch in a new location.
Straightforward Capital Structure
Attractive acquisition targets generally have straightforward capital structures: a single class of stock, easy-to-understand debt, simple ownership arrangements. Unless you have a background in corporate finance or access to experts with the same, there is little upside to investing in a company with an opaque capital structure.
Established Customer Base
An established pool of loyal customers is invaluable. Look for companies that have successfully cultivated customers and clients over many years, and then do what you can to build on their efforts.
Do Your Due Diligence
Acquisition targets are not always what they appear. Companies that seem attractive on paper can harbor hidden liabilities that pose financial and legal risks for their acquirers. No matter how sure you are that the company you intend to acquire is a low-risk, potentially profitable proposition, it is in your best interest to conduct thorough due diligence. And, no matter how small or seemingly trivial the transaction, this requires the assistance of experienced professionals. A targeted investment in due diligence now may well prevent unforeseen problems in the future.
Bio: George Otte is a Miami-based entrepreneur and executive with more than 15 years of multifaceted business operations experience.
