Buying a business at a fair price

Know what you are buying – this article first appeared in the Australian Financial Review.

Question: My business has grown to 100 employees and I’m looking to take over a similar business interstate. How do I make sure that I am getting what I expect and at a fair price?

Answer: There are three issues to consider in this question:

What are you actually buying? How much should you pay for it? How do you realise the value of what you have acquired?

In assessing the target business, you need to look at five key areas:

1. The leadership team: is the business fundamentally dependent on the existing owner?  Will the owner be retained on an earn-out basis to ensure that forecast results will actually be delivered and to transfer relationship? Is there a good management structure? Which, if any, are important to the success of the target as a stand-alone operation? Is the leadership team going to be retained?
2. The operation: what is the capability of the target to deliver the sales and the gross margin that are required? What are its unique and complementary capabilities? Is it good practice, best practice, or is there substantial improvement opportunity? Is staff retention an issue?
3. The forward audit book is critical. What contracts or leads are in place for revenue and at what volumes? Are they sustainable when compared to the forecasts?
4. Intellectual property: are you purchasing a brand? Is that brand going to be maintained? Is there intellectual property in the business processes or in trade secrets – and how are these being protected, if at all? Is there any restraint of trade over the owner or can the business be readily replicated?
5. Past performance and past forecast accuracy. While it is fairly straightforward to build an attractive forecast of future years, have previous forecasts been accurate? How much you should pay is up to you. I would recommend getting a third-party valuation from an experienced adviser in your industry.

What is critical – once you have a baseline value for the business as a free-standing entity – is to decide if you are prepared to pay an increment to reflect the value of the two businesses as a combination.

Are there opportunities to actually strip out duplicated costs? For example: two administration teams, two purchasing teams, two sets of warehousing, logistics and inventory and IT systems. Is there an opportunity to consolidate these and reduce the overall costs?

Or is there opportunity to do more with the same amount? For example, by concentrating the purchasing power. Can you buy at better prices or in greater quantities to differentiate your product offering or increase your margins? Does the business combination free up capacity to specialise and increase the output of the business with little additional cost?

This assessment leads to whether you are prepared to, or need to, pay a premium to buy this business to secure some of these gains.

How do you realise the value of what you have acquired?
This is the area where most acquisitions fail: in the planning for, and integration of, the target business.

All too often, the focus is on getting the deal done and not on making sure the value potential is realised. Planning, communication, flawless implementation and evaluation are critical to success.

Clearly communicate to all staff what the integration means for them, how their jobs will be affected, whether there will need to be any relocations or changes in conditions or roles, and the future for the combined group.

Flawless implementation is a function of good planning and communication. This may mean appointing an integration manager who is focused on the integration to get the best value.

Finally, make sure that at regular intervals you evaluate the success of the integration and the delivery of the benefits in terms of revenue growth and profitability improvement. Assess staff retention and development. Failure to do this means that the opportunities that you foresaw will slip through your fingers.

While the acquisition of a new business can be very exciting and stressful, it has significant opportunity to improve the value beyond what you will pay for establishing a business of 200 people in a few states.

The key is knowing what you’re paying for, paying an appropriate amount – and more importantly, focusing on getting the transaction bedded down and getting value from it.

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