10 Things to Get Right, to Avoid Abysmal Failure when Buying a Business

by | 22 Jul 2021 | Business & Corporate

Australia is a country of SME/SMB’s (small & medium enterprises/businesses); 2018 stats from the ABS showed that:

  • over 93% of businesses were “small” (584,744 with 1-4 employees, 197,164 with 5-19),
  • 6% were “medium” (50,995 with 20-199 employees), which left:
  • less than 0.5% of businesses not being an SME (3,717 with more than 200 employees).

Every day there are literally hundreds of new businesses opening their doors or new owners looking to taking over existing businesses. On the sale side, the number of businesses coming to market has undoubtedly been increasing, partially driven by a wave of SME owners being Baby Boomers wanting to retire – ABS stats from 2013 (now 8 years old) had a massive 38% of businesses being owned by people aged over 60!

COVID challenges aside, that means opportunities abound!

However, completing a business purchase (or an M&A (Merger & Acquisition) as it’s known in the corporate world) is far more complex and carries far more risks than many people realise. So much so, that in the corporate space, a study by Harvard Business Review found that 70-90% of acquisitions are abysmal failures.

So how do you make sure you’re NOT in the majority when making an acquisition?

Here are our Top 10 Tips to consider when buying a business:

It’s imperative that you get the right professionals with the right experience in the industry you are planning to get into.

1. Advisors

Keep in mind that these might not necessarily be your normal “go-to” people – if you’ve been using Dennis Denuto for years, don’t rely on him with M&A just because he’s done a great job of your conveyancing. The same goes for the nice accountant who seems to do a good job of your BAS and tax returns, or the banker who has only ever given you small loans and overdrafts.

Get the right team members around you. Accountants, Lawyers, Debt Advisers and, if you don’t have someone on your management team that has actually done M&A numerous times (“in the trenches”!), a specialist adviser that has been there done that.

2. Information

Get the right information and the right amount of it.

Before even deciding to move past step 1, you’ll want to get the last few years’ financial data (and that means a lot more than just the profit & loss statements) to work out what the proposed acquisition price is as a multiple of profit (usually a heavily adjusted (“normalised vendor financials”) when buying a business) as well as what it is relative to various balance sheet items (the importance of which varies from business to business).

If you’re moving past step 1, on one hand I would say “get as much information as possible”, but as businesses get larger and larger, this could end up being a ridiculously large amount of information. The critical points to consider here are – “what am I actually buying?” and “what do I really need to know?”.

This doesn’t mean take shortcuts but, if we take Microsoft’s acquisition of Nokia as an example, they weren’t really buying the whole business, they were just buying the IP – its technology and patents – everything else was pretty much going in the bin, so it would have been a complete waste of time and effort (and cost) to review a lot of Nokia’s business information. That example is extreme as most business acquisitions aren’t like that – you do need to invest time & money into your Due Diligence – we’re just making the point that the level of DD should be aligned to the value of the business and with a clear eye on what you need to know and what problems you need to identify and cover.

3. Systems & Processes

This is an area that is often overlooked, yet it is so critical. Many M&As are undertaken on an assumption that “we’ll bolt these two businesses together and we’ll get these efficiencies”. Then they realise how difficult it is to bolt the two together because of systems & processes.

Dig deep into the existing systems & processes within the business. Are they current, efficient and effective? Are there detailed process maps or job notes around each of the key processes? What’s the internal finance and accounting system and is it compatible with your accountant’s or bookkeeper’s system

4. Liabilities

I’m not talking about the balance sheet liabilities…

Dennis Denuto will probably miss this, but an experienced M&A lawyer will be all over the non-financial liabilities that you will or could be taking on board when buying a business.

These can include things like performance guarantees and obligations for work done in the past, employee entitlements, leased premises, make-good arrangements and other contractual obligations.

At one extreme end of the scale, old mines (and even the Saab car brand, remember them?!) have changed hands for literally one dollar, due in large part to the massive liabilities that the acquirer had to take on. Although the business you look to acquire might not be that extreme, liabilities that aren’t so obvious (and may well not be on the balance sheet) can be enormous, so don’t underestimate them.

5. Capital Equipment

What equipment are you getting as part of the purchase?  How up to date is it?  How much additional Capital Expenditure (“CapEx”) will you need to incur in the next 12 months, 2 years, 3-5 years (or even longer) and how will you finance that?

Depreciation is often “added back” to calculate free cash profits, using EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) as the “real profit” number. This can be completely fine for some types of businesses, but it can also be a very dangerous assumption to make.

If you are buying a business that really needs to replace expensive assets every few years, then make no mistake – depreciation is a VERY real expense. A trucking business is a perfect example – you’ll find a huge amount of depreciation on the P&L, but trucks do lose value and generally need to be replaced every 3 to 5 years – so the use of EBITDA is very deceiving in such a business.

6. People

How reliant is the business on the vendor? This is particularly important in a smaller business – plenty of small business owners will tell you that the business can operate without them, but the reality when they walk out the door can be very different.

Next, who are the key people in the business and what are they likely to do under new ownership?  Do you need to tie up certain people with new contracts (which is likely not even legally possible for normal employees) or incentives?

Don’t underestimate the value of people – there is a reason that good leaders say “people are our biggest asset”. Lose the A-grade players because they didn’t like the idea of the old owner leaving, and your business value could collapse very quickly.

7. Working Capital

The amount of required working capital is often badly underestimated when buying a business.

How much are the average debtors, stock and creditors and how long is this trading cycle? What are the trading terms?  Will you need funding to support this and if so, how much?

Just because all customers are on 30 days EOM terms, doesn’t mean that’s when they pay. And just because your vendor has 60-day terms from the suppliers he’s had solid relationships with for the last 25 years, doesn’t mean those suppliers will be so keen to give you, Mr Newby Who The Hell Are You, the same generous terms.

The WC requirement, particularly in the first couple of months, will also depend on the business sale terms. If the business gets handed over with the vendor taking all receipts from debtors outstanding as at settlement date, then you’re not going to get a dollar of revenue until after your customers pay you, after they actually buy something from you after the settlement date.

Inventory is even more complex – a whole piece could be written about that alone. Different questions need to be asked depending on what the inventory is (e.g. fresh food is very different to industrial parts), but some common questions include how much of what product is on hand, how long does each product typically take to sell (“inventory days on hand” or “stock turn”), is any of it obsolete or unattractive to buy (needs to be discounted to sell, maybe even below cost, or even thrown in the bin), could any be faulty, etc.

8. Equity

How much cash do you have to inject into the business purchase, versus what is actually required. And I say “actually”, to expand upon the last point. Have you actually accounted for all of the costs of acquiring the business, plus working capital, plus a buffer for unexpected hiccups?

Getting a bank to provide funding to the limit of what they’re willing to give you, then going back to them 30 days after settlement, cap in hand in a panic because you’ve run out of cash and can’t pay your wages tomorrow, is not ideal.

Having some cash set aside for the unexpected is an essential part of business longevity.

9. Risks

Doing this properly goes back to tip #1 – having the right advisors on your team, together with your own experience (in whatever that is), to undertake a full risk assessment during Due Diligence (i.e. BEFORE the purchase contract becomes binding).

Depending on the type and size of the business, whilst an accountant and lawyer will cover off on many risks, they’re only experts in what they’re experts in and so they won’t necessarily undertake a full risk assessment across the operations of the business. Again, the right people for certain roles.

10. WIIFM

Finally – “What’s in it for me”?  Many people end up running businesses that don’t provide the return they expected OR take up much more time than planned.

Make sure you are really clear about what you want from the business and undertake your assessment and planning based upon this imperative. 

Finally (ok this is a tip, so I guess that’s # 11), try not to get too emotionally involved in the decision.

Business is business. Emotional decisions when acquiring businesses often prove to be disastrous. A couple of mates buying a restaurant or a bar, who have zero experience in either but are in love with the idea, will probably get nothing out of it but “free” meals and drinks (and potentially a not so free divorce and insolvency practitioner’s bill!!).

If you are looking to acquire a business with a value of $3m or more, STAC Capital has significant experience and extensive relationships with the right people to help you unlock your opportunities and understand your risks. 

Feel free to reach out for a chat today.