If you are bored or frustrated by the slow slog of organically growing your small or medium sized business, then you might like to consider a mergers and acquisition strategy. Rather than worrying about sales teams and the changing nature of SEO and pay per click ads, with an acquisition, in a single afternoon you could double your turnover. You can do this too, without spending a penny.
Small businesses (making net profits of less than $2m) employ about half the people in the developed world. Yet they are often extremely challenged when it comes to raising finance, either being let down by banks or having to borrow at high rates of interest with personal guarantees for directors. Yet the world is awash with capital. There are around 500 asset managers working on behalf of global institutions (including the Church of England), family offices, sovereign wealth funds and so forth that manage $93 trillion. They invest in every asset class there is, even Bitcoin, but none invest in small businesses – despite small businesses representing 50% of the world’s economy.
Peel away the onion layers of what you might think is institutionalised crony capitalism, and you discover that most small businesses are, for global institutions, un-investable. They are too small; transaction costs of investing in them are too great. Being small, they are also risky, lack scale and so are often excluded from bidding for large juicy Fortune 500 and Public Sector contracts. They are also illiquid. Selling your shares may take months or years. For institutions, it is so much easier and cost effective to invest in the liquid S&P 500, where they can buy in the morning and sell in the afternoon.
So, if you happen to own a small business making net profits less than $2m and want raise capital for expansion – or you simply want to sell to retire – your options appear quite bleak. This is compounded by Baby Boomer entrepreneurs coming to retirement age, wanting to sell their businesses, increasing supply. There will always be business agents you can approach. Quite reasonably, they say they can attract multiple interested buyers, assuming your business is well prepared for being sold. But they can charge hefty fees and retainers with no guarantee of success.
So, in many cases, the best way to smash through the $2m net profit glass ceiling is not by organic growth, which can take years, but through merging with, or buying, other businesses. In one afternoon, you can double the size of your business by buying another.
Traditionally in small business M&A, in most business sectors, acquirers pay around 3 or 4x net profits for businesses making net profits under $2m. Above that level there are more buyers, so supply and demand means you get a higher valuation multiple. Acquirers tend to pay an initial payment – or “consideration” in M&A speak - of say around 20% of the valuation. The remainder is then paid over the next 1 – 3 years, sometimes more. That initial consideration could be financed by debt. But if the acquirer decides on invoice factoring, which uses outstanding invoices as collateral, that can put pressure on cash flow during the critical first 12 months.
Fearful of overpaying, many small business buyers by default are adversarial, offering less than a business seller expects to receive, regardless of the amount. But successful ones often have a more collaborative approach. When the seller says, “my business is worth $3m”, they ask on what basis. If it’s not a ridiculous number, they may well then reply “okay, let’s see how we can reach that figure”. Buyer and seller sit down on the same side of the table, share the same laptop, and work out the structure, agree it there and then, and draw up together an informal heads of terms agreement. That should include an arrangement to progress to due diligence without the seller touting the business to others.
There’s often a conflict: the seller wants as much money on deal completion as possible, whereas you, the buyer, want to pay over as much time as possible, from cash your newly acquired business generates. After all, whilst sellers always believe their business is growing and so is worth more, the reality is that all kinds of issues can occur – such as war, pandemic or customers going bust – that changes its prospects. Unlike a house, a business can vanish. (There are exceptions like in IT managed services and Unified Communications, where contracted recuring revenues can increase longevity.)
So ideally you pay the seller over 1-3 years on an “earn out”, whereby the agreed price is paid based on the business’s performance. Otherwise, you can use vendor finance – also known as deferred payments – whereby you pay set regular amounts for the business over 12 to 36 months, regardless of how it performs.
