Frequently Asked Questions About Acquiring a Company
What's the best way to find a company?
50% of buyers find a suitable business to buy from a referral or through an intermediary. 25% find a business through a web search or newspaper ad.
Most of the companies that you should be calling on are not “for sale” – but could be. Identifying an appropriate acquisition can be very time consuming: 50% of buyers spend between 10 to 20 hours a week searching for 6 months to a year to find a suitable business. About 30% are able to locate one in less than 6 months usually by spending more than 20 hours a week on the acquisition process.
Many individuals seeking to buy a company do so through accessing their personal networks and then move on to “cold calls”. Cold calling on SMEs is particularly difficult for an individual because entrepreneurs are reluctant to discuss confidential information with someone they know nothing about. We recommend that serious buyers take the time to create a personal website that the entrepreneur can refer to during initial discussions.
Often serious individuals will engage the help of a third party professional to assist with these initial calls. Professional firms add credibility through their websites, testimonials and professional reputations and give the entrepreneurs the comfort they need to disclose confidential information.
What can I expect from initial discussions with targets companies?
Discussions with potential sellers can, and should, be a time intensive process - a level of trust and credibility must be established before the entrepreneur is prepared to open up to you.
Once this trust has been created, a legal document know as a Non-Disclosure Agreement will be signed by you and the target company – this agreement gives the target company the comfort that their financial information will be kept confidential. At this stage the amount of financial information provided varies widely. We find that many SMEs are surprisingly open to providing full historical financial information, while others only provide high level numbers and wait to see what a potential deal could look like before providing more detailed disclosure.
Until you sign a Letter of Intent with a target acquisition, which outlines the key points of the deal, don't expect to get specific information such as individual customers' names, suppliers' names, product mix or SKU profitability. You should be able to get enough information to allow you to decide that you're interested in proceeding to the next level while providing very broad and non-committal parameters of a deal.
How do I figure out what I should pay for the company?
This is where you may need some outside professional help.
It's not just a question of what is the target company's worth – it's also a question of how the deal is to be structured, that is to say, how much cash is given to the owner at the closing and what is the amount, and the nature, of payments made to the owner afterwards.
Typically, companies are valued based on the expected cash flows that the company will generate in the future. To do this, the company's historical performance is used as an indicator of future performance. So that's why you'll hear that a company was valued at, say, a 4 or 5 times multiple – meaning it was valued at 4 to 5 times the company's current annual cash flows or EBITDA (earnings before Interest, Taxes, Depreciation and Amortization).
Your advisor will help you come up with this number, and a deal structure, based on (1) what the current market is for such companies, (2) what the owner's expectations are, and (3) what are the various financing options that are available to you.
Will I have to pay 100% cash on the closing?
Not necessarily, particularly when buying smaller private companies. Acquiring companies in the SME market has its unique challenges, including large “valuation gaps” (the difference between what you are prepared to pay at closing and what the seller thinks their company is worth), and the risk that the owner is possibly the key ingredient to the success of their company.
A significant “valuation gap” can be dealt with by agreeing to future additional payments to the seller should certain milestones be attained such as meeting certain sales or EBITDA levels. Vendor financing can be structured in a manner that's appealing to the seller which can often bridge the “valuation” gap. Other forms of capital also exist, as discussed in How do I finance the deal?, that could provide the necessary cash at closing.
How do I finance the deal?
The “value” of the deal is different than the amount of cash that is paid to the owner when the deal closes. Deals are financed by a combination of the following sources:
- Traditional banks
- Subordinated debt
- Payments to the Seller post-closing
- Private Equity
- Your equity investment
It's important to remember that you want to create a financing structure that both allows you to complete the acquisition and also allows you to grow your company while at the same time ensuring that you can ride out the inevitable bumps along the road. In other words, don't overextend yourself just to get a deal done.
Traditional banks: Traditional banks will normally finance up to 40% of the value of the deal (and more for larger transactions). Banks look primarily to the security that the company can provide (accounts receivable, fixed assets) and, increasingly, to the cash flows of the company (Cash Flow Loans).
Subordinated debt: Subordinated debt, sometimes called mezzanine debt, is a loan that has no tangible asset security and relies solely on the strength of the company's future cash flows. It ranks behind the bank, so is “subordinated” to the bank's first claim on the assets and cash flows of the company. Interest rates range as high as 18% and are normally tax deductible. This may appear to be very expensive debt, but should be looked at as cheap equity.
Payments to the Seller post-closing: This is where creativity comes into play when structuring the deal. These payments bridge the gap between what the owner wants for their business and what you want to pay at closing. These payments come in the form of a vendor note (VTB), royalty payments, performance related payments, or a minority equity interest in your new company.
Private Equity: Private equity (PE) can come from PE Funds, Crown Corporations, and private individuals. These investors are you “partners”, not your bankers. And they each have their unique cultures and methods of dealing with you. They typically look at exiting their investments within 5 years and look for Internal Rates of Return of 30%+.
Your Equity Investment: Your financial partners (even if it's only a bank) will want to ensure that you have a significant investment in this venture. And, if your strategy is to use this company as a vehicle to acquire other companies, you don't want to rely too heavily on the bank for this, your first deal.
And when bankers talk about your “significant investment”, their talking about the cash that you will be investing, and not the value of your time that it's taken to buy this company.
Regardless of who your financial partners are, you need to do your “due diligence” on them. These will be your “partners” for a long time so getting the right fit – working with people who you like and respect and who are experienced in helping private companies grow – is very important for your future success.
How long it will take?
Some of the best deals are the ones that take the longest to do. Why? Because most sellers want 100% cash at closing while you want to get them to provide some vendor financing. Through spending time with them – creating a trusting bond, getting them to buy into your vision, and demonstrating that they could possibly make more money if they “stay in for bit” – can often result in a “win – win” deal for you and the target's owner.
Are there any hidden costs I need to be aware of?
It's important to all know the costs that are associated with an acquisition. These can be quite significant and must be factored into your decision to pursue any acquisition, and include:
- Due diligence costs – accounting & others' due diligence fees, appraisal reports, environmental reports
- Closing costs – lawyers' fees, bankers' fees, financial advisors' fees
- Post closing costs - Many SME's IT systems are considered "ok" by the founding entrepreneur but are in fact outdated and inappropriate for your needs. This is the one area where most "platform" buyers discover that they need to spend money, any quickly.
In Their Words
Mike Bradley at The MBO Group NZ was great at helping us identify the target businesses to help us grow. Once we had the targets confirmed, Mike was instrumental at engaging these businesses and confirming the willing sellers.
We could then confirm the best fit for our business after reviewing key information about these potential acquisitions. Once we had negotiated the deal, then Mike was very thorough in following up on key dates to complete the purchase.
We felt well supported throughout the process and Mike was there to help at every stage. We look forward to Mike helping us on our next project.
Lance Davis Managing Director FIRSTFLEX CABLES
Managing Director FIRSTFLEX CABLES