Considerations When Making an Acquisition

Entrepreneurship by acquisition is one of the things people don’t think that much about. It is relatively lower risk to acquire a company as opposed to starting one. The company already has revenues, customers and hopefully profits. Therefore it is much easier to build on top of something that has already been established and been in operation for a while. There are many baby boomer business owners who are looking to retire. Many of them don’t have a clear succession plan and/or someone to pass the business. The lack of a successor provides a great opportunity for aspiring entrepreneurs to acquire a business. We have had the opportunity to work with several entrepreneurs looking to do acquisitions. Remember, that as the acquirer, you are buying someone else’s problems. 

Some key points we at Blackwell Hollinger & Company LLC consult our clients on are as follows:

Look for Companies That You Can Expand. Based on our client base, it is rare to find a target acquisition in a location where the entreprenuer will want to relocate to operate a targeted company with sufficient revenues. Therefore, target a company that you could grow either organically (add new customers in a different geographic area, add new product or service lines, etc.) or grow by acquisitions (pursue a roll-up strategy to add additional acquisitions that fit with the initial target acquisition through horizontal or vertical integration strategies).

Customer Retention / Key Man Risk. What is the danger that customers of the company you are acquiring leave with the owner. This is a particularly acute risk where the owner(s) are the key sales/business development people. We recently worked with a client looking at a company in North Carolina. The company did a reasonable size of revenues but all the customers were either homeowners or small businesses within a small community. There were no contracts so every sale had to be with the business owner and/or his wife who also worked in the business. Thoughts were that if he was a member of the local chamber of commerce, had roots in the community then it would work out well. But could the potential buyer replicate this?

Cash Flow / Debt Coverage. A key consideration is whether the company will generate enough cash to service the debt used in the acquisition. All the clients we work with are looking to leverage a potential acquisition through debt similar to other financial investors, e.g., Private Equity Firms. Therefore, there will be a monthly debt payment. Consequently, you have to ensure that the cash flow generated from the business will cover the debt service and provide the necessary working capital to keep the business thriving and able to grow. 

Cash generation is critical to obtaining debt to acquire the target. With one client we reviewed the cash flow to help identify the seasonality of the business. Revenues and cash flows dipped significantly in June, July and August. In this case, it was critical to determine whether the company generated enough cash in the first half of the year to set aside monies to cover the summer months. It is one thing to look at annual debt coverage. More importantly, it is critical to look at the monthly coverage and the seasonality of your cash flows. If there are several months where cash flow will not cover the debt payments then making up for it in the later parts of the year may not be sufficient to avoid technical defaults of loan covenants as well as missing periodic principal and interest payments.