In all fairness, this is a great problem that many other businesses wish they had. However, failing to invest excess capital is like hiding cash under your mattress; it’s nice to know you have it if you need it, but it also isn’t working to generate more. For businesses, one of cash’s best uses is to invest it in growth or expansion. Acquisitions are usually the preferred method of expanding since you aren’t just acquiring a space; you’re acquiring clients, people, revenue, and potentially more profitability.
Unfortunately, successful mergers and acquisitions – defined by return on investment (ROI) meeting expectations – only hold true around 50% of the time at best, and 17% of the time at worst, depending on the study you read. So what went wrong with these transactions? More often than not, it comes down to a lack of strategy and an assumption that acquisitions will inherently pay dividends.
To prevent this from happening to you, there are three broad steps to consider when making an acquisition.
- Preparation for an acquisition is essential. This step helps you determine what type of company you are looking to purchase, how much capital you have available to acquire the target company, and how much capital you have to invest into the company after the transaction.
- First, you need to define your criteria for a target company. If you want a company that’s distressed, you may be able to generate even greater benefits by acquiring it cheaply. However, you should plan for greater investments down the line because the company is distressed for a reason. Conversely, a highly profitable company may require lower capital investments, but your ROI will probably be less due to a higher purchase price.
- Next, you should determine how much capital you want to invest in acquiring a target company. Spending too much of your excess capital on the acquisition could leave you open to risk if something goes wrong with your own business. For this reason, it is important to meet with your finance department and banker to determine the price threshold for taking on debt. In cases like this, it’s usually best to be conservative with your estimates.
- Finally, you need to decide how much to spend on integrating your new company. Notice that we separated acquisition from integration. This is important since it prepares you for any surprises that may come up, or the costs of closing an office, letting executives go, or combining infrastructure. If you don’t plan for this step, you can’t expect to realize all the benefits of economies of scale from acquiring another company.
- Developing realistic expectations for how much you can expect to receive is the key to avoiding disappointment with your acquisition. This is where due diligence, forensic accounting, and pro forma analysis come into play. If you have a company generating $5 million in annual revenue and you acquire another company producing the same amount, it’s tempting to say that your combined company will generate $10 million in annual revenue. However, there is always the risk that an acquired company will lose customers, which decreases revenue and profitability.
- Implementing an integration plan for the two companies will determine the success of everything else you’ve worked through to this point. You need to know who is staying, going, on the fence, etc. You also need to know who will oversee this process and how the work they currently do will get done. Even a talented owner/operator will struggle if tasked with running two separate companies. That’s why a clear vision and open dialogue with your existing and new staff on what to expect will prevent issues and reduce turnover of essential employees.
Successful acquisitions require a great deal of planning and honesty with yourself about the overall objectives of an acquisition. When done right, an acquisition will reward the acquirer with increased revenue, profitability, diversification, and a larger pool of talent to grow his or her business. If this is a strategy you are interested in pursuing, feel free to contact us at email@example.com.