Ths article will assist you in clarifying the business decisions that you should make even before you identify the company you plan to buy. In particular, before launching into your new business venture, you should consider three important questions:
Why do you want to buy a company?
What type of company do you want to buy?
How are you going to go about buying the company?
The answers to these questions form the basis of the initial plan you need to take to prospective investors and bankers. You will screen and locate appropriate business leads more efficiently if you start with an initial plan. You will also generate greater interest by bankers and prospective investors in your venture. We recommend that you need to address the issues outlined in this chapter before you begin your search. The initial plan should not be confused with the action plan you will need to develop once you identify the particular enterprise that you plan to purchase.
Clarify Your Goals for Owning a Business
Before you decide the type of company you want to buy, you need to clarify not only for yourself, but also prospective lenders, investors, and sellers, why you are buying a company.
The issues examined in this section affect the way in which others view the seriousness of your purpose and whether they are interested in being a party to the project. For instance, do you plan to buy just one company or several? Will you run the company by yourself or get others to help? Do you plan to resell the business once you have improved its value or do you plan to keep it for a long time? These decisions will in turn, affect the size of company you seek, the level of investor interest, and the types of people you will need to help run your company. In particular, you need to answer the following types of questions for yourself before you begin to gather and screen leads:
1) Do you want to run the business yourself or do you want others to help you? Is this a purchase you basically are doing to provide yourself with self-employment as an alternative to working for someone else, or do you plan to have other highly skilled people in your management team?
2) How long you plan to keep the business? That is, do you view this as a short term or a long-term investment?
3) Do you plan to buy other businesses over time? Many buyers view the business purchase as a once-in-a-lifetime career move. Others may view this first purchase as a stepping stone toward building a much larger business empire.
4) If buying additional companies over time, do you plan to buy related or unrelated companies? Until the 1980’s, the unrelated conglomerate was looked upon favorably by investors. However, the rapid growth in global competition in an ever-widening number of industries makes it much harder for companies to be successful in diverse areas. The related conglomerate has become an increasingly popular model for acquisition-oriented companies.
Who will run the Business
Many people buy a business to provide themselves with employment, first and foremost. This is certainly an acceptable objective, but if this is your intent, then you need to be careful to seek the size and type of company that you are prepared to manage on your own. Many first time entrepreneurs, whether entering by way of start-up or purchase of an existing business, are shocked to learn of the complexities of operating even a relatively small company. A sole proprietorship with perhaps one or two part-time people is a completely different operation to manage than one with even a few dozen employees, with the complexity of operating the business rising almost exponentially with the increase in employment size. A company of one hundred, not to mention a few thousand employees, can be daunting to the president who has successfully managed a company of twenty or twenty-five employees.
If you plan to start with an experienced management team, especially one that includes those who have managed similar businesses in the past, then it is realistic for you to consider a wider range of options, including larger companies or those in more highly competitive industries. If your company must support this team full-time from the outset, it may be necessary to seek a company large enough to support this overhead, as well.
How long you plan to keep the business
You should also consider whether you plan to keep your company over the long term, which we will refer to as the “keeper” or if you plan to improve its value with the eye toward resale in the short term, which we will refer to as the “fixer-upper.
The keeper Many business owners make perhaps only one or two purchases in their career, with the idea that they will buy the company with the intention of holding onto it for quite an extended period of time. This decision will dictate to some extent, the type of company you look for. If you are primarily purchasing the company as a life-style change, to become your own boss, then you need to consider very seriously the importance of selecting a company that already performs fairly well. Especially if the business is to be your primary means of support, you need to be realistic about the amount of time it might take for an underperforming business to be in the position of paying you well. Many skillfully led turnarounds may take a year or two or even longer, although the smaller the company, the more quickly you might be able to turn it around.
The fixer-upper: Some buyers look for “fixer-uppers”, to borrow a term from the real estate business. They are more likely to seek an underperforming business with the interest of turning it around, thereby dramatically improving its value and reselling it. This type of strategy works well if you have relevant experience within the industry that the company is in. Many small, family-run businesses establish a favorable market niche but lack the business management skills in-house to track and control costs, market effectively, or to introduce more efficient production and management techniques, for instance. They are often started by individuals lacking a formal business education and an understanding of the basic techniques taught in business schools. But at the same time, you should be cautioned against assuming that the introduction of such techniques alone will turn a company around. Experience in a particular industry is vital also, to assure that you make the appropriate strategic decisions over time.
J.P. Industries pursued this strategy, looking for underperforming companies that, nevertheless, manufacturing products with a solid reputation in the automobile industry. The company was founded with an experienced management team. Two key members of the team, including the CEO, came equipped with a mechanical engineering background and extensive manufacturing experience. This education and experience paid off rich dividends. Improvements in earnings for most of the acquired firms showed up in less than a year and the entire group was sold for a substantial profit to initial investors, about ten years after the start-up.
Key to J.P. Industries’ success was the selection of businesses, though underperforming, that had a strong product reputation and revenue stream. We do not recommend purchasing a company with poor product reputation. Turnaround in such cases is far more time consuming and less certain than in situations where the product is doing well but assets and expenses are managed poorly.
How many businesses you plan to buy
Investors and banks will also want to know whether your plans involve the intent to buy just one company or to buy several. You may be more likely to obtain interest in a project that aims to acquire a family of companies than a single company. On the other hand, such a project probably requires a much larger investment at the outset. It also requires a larger, more skilled management team.
At J.P.Industries, Inc. or JPE, Inc., banks would not have provided the multimillion dollar credit line just to purchase one medium size company. They extended credit based upon the credibility of management on building a multiple business group, successfully. In sum, if banks and investors know your objectives and strategy they may view your situation more favorably.
If buying additional companies over time, do you plan to buy related or unrelated companies?
If your ambition is to build a collection of companies into a larger corporation, then you have additional issues to consider. Do you plan to purchase several related companies and operate them together as a group? If you buy companies that are related, you have to understand the possible synergistic relations that may occur between the companies. This will tell you what types of people you need to have around you and what value you can generate due to synergies.
Another alternative is to assemble a group of unrelated companies into a portfolio, with the idea of improving their value for awhile and then selling them. It is beyond the scope of this book to go into detail about portfolio acquisitions, but once again, these goals will impact other decisions that you make.
What Type of Company You Plan to Buy
Although many books list a rather long list of candidates, the truth is that very few leads come in detailed books. Most will likely come from small brokers, who generally have very limited information at the earliest stages. But you shouldn’t ignore these candidates. The best way to handle them is to develop some rules of thumb about the criteria you will select by.
Though you are likely to develop more detailed lists of criteria eventually, the three pieces of information you are most apt to obtain from most brokers early on in the negotiations relate to industry, company size and profitability. You will eventually need to consider many other issues but practically speaking, at the start, you are not likely to get much more information than this until you sign a confidentiality agreement with the broker. Thus before you approach different sources for leads, you should clarify three issues in your mind:
1) What industry are you interested in?
2) How large a company do you want to purchase and manage?
3) How profitable does the company need to be?
The answers to these questions help you to narrow your pool of prospects from several hundred to several dozen over a period of time. Without clarifying these issues in your mind, up front, you might waste your time looking into companies that are not realistic for you to pursue.
The type of industry you plan to buy into
Depending upon your background, you might already know the type of business you are interested in looking into. Perhaps you would like to buy a business in an industry that you are already involved with now. Or perhaps you are confident that a particular industry is likely to do well. Be careful to research the industry you are thinking of entering carefully. What is the total size of the market, and is it growing or declining? Is there a particular niche within this industry that is doing particularly well? Be wary of jumping into an industry that you know little about. Try to find out as much as you can before making a final determination.
Which size of company you plan to buy.
The size of company you buy will determine the amount of capital you will need to raise and the complexity of the task of managing the company once you own it. Think carefully about the size of company you are comfortable managing and/or the people to assist in its management. Operating a company with only a few employees is far less complex than a company with a hundred, not to mention a thousand employees. If you have not managed large groups of people in the past, you might want to consider very carefully before buying a larger firm.
Profitability of the company you plan to buy.
A company that is already generating a stable profit and cash flow is far easier to manage than one that is operating in the red. The companies in the latter category may be cheaper to obtain, but may never generate a profit for you. If you have experience turning around companies, and understand the cost structure of your industry and its marketing better than the present owners appear to, then buying an underperforming company can prove quite lucrative. That was indeed the strategy at J.P. Industries. On the other hand, especially when the economy is robust, it may be difficult to find a good acquisition candidate that is struggling and there be more fundamental reasons that a company is doing poorly that are not easily remedied. Again, this comes back to your own experience in business and what you are capable of doing.
Your Plan for the Acquisition Process
Bankers, other lenders and investors will also be interested to see your plan for the acquisition process itself, that is, how you plan to go about looking for your business. Once you have decided on the broad criteria of what you are looking for, you also need to determine how you are going to go about purchasing your company. Some of these issues include the following:
1) Where will you go for the money?
2) Who will help you in your search?
3) What personal arrangements will you need to make until you find and purchase the company?
4) How do you plan to find the right company?
5) What is your exit strategy?
Where you will go for the money and what will you use it for
Investors and bankers will want to know what the money is for. Will you use it to build value in the company, pay down debt, etc.? They want to know how you are going to get your finances and manage your costs so that you get a higher output of results with a minimum of costs.
Even though you are not likely to get money from investors or a bank before actually locating the company you plan to buy, you cannot wait until that point to identify your funding sources. To gain credibility with prospective sellers and brokers, you need to work out in advance what type of financing arrangements you will use in case you do find a suitable choice. A bank will often give you a letter of understanding that will essentially say, “yes we will deal with you; find a company and then will look at it and tell you whether we will give you a credit line (or loan, or whatever).” This letter of understanding is important because it allows you to say to the seller that you have a personal relationship with John Doe at XYZ bank and that the seller can call to verify this relationship. Although it doesn’t guarantee, of course, that you will get your loan or credit line, it does contribute to your credibility with the seller. When founding J.P. Industries, the CEO talked to a couple of investment banks and came to an understanding on a deal by deal basis. They gave permission for him to use their name in a brochure. Especially at the beginning, this was very helpful in establishing credibility.
Who will help you in your Search
As soon as you respond to an initial contact from a broker or investment banker you have initiated the negotiations process and may say and do things that will affect the outcome of the sale. It is wise therefore, even if you plan to do much of the work yourself in contacting brokers and pre-screening leads, to seek input from your attorney and your accountant as soon as you begin to investigate particular prospects. You need to identify the professional people who will help you in your search early in the search process, probably even before you begin to accumulate and screen leads.
What personal arrangements you need to make
You should plan on your search taking between one and two years if you want to avoid rushing into the wrong deal. Depending upon the size of company you are seeking, you may need to leave your present job if you want to be taken seriously in your endeavor. When Psarouthakis founded J.P. Industries, he left Masco Industries before embarking on his search. He developed a two year financial plan, together with the immediate family. It helps to be sure that everyone understands and will be supportive within your immediate family.
How you plan to find the right company
This part of your plan might be a simple one. For instance, you will use criteria to find the right company, plan to run advertisements in the Wall Street Journal to establish a network of finders, and to begin relating to investment bankers. You will need to tell your backers you are going to manage your costs so that you can get the higher output of results with a minimum of costs. A later article will provide much more insight on the approaches to take in developing a lead flow of business prospects.
Your exit strategy
Finally, an initial plan needs to include your exit strategy. That is, how will investors be able to get their initial investment out of the business over time? Investors in particular will want to know whether you plan to go public or to sell the company. Or perhaps you plan to have a high level of dividend distribution of earnings. These issues are important to clarify right at the start because they might influence how you set up the legal structure of the company from a tax standpoint. For instance, with a regular corporation, you pay a double tax on dividends.
Of course, only a small subset of companies catch the public’s interest in the market, so if that is your goal, you might consider certain types and sizes of companies. Both J.P. Industries and JPE, Inc., were started with the idea that they would eventually be taken public.
Main Reference: “How to Acquire the Right Business”
John Psarouthakis & Lorraine Uhlaner
Published by Xlibris, 2009