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Growth through acquisition
Taking your business to the next level
Expanding a business requires hard work. Ensuring customers are happy, staying adrift of the game and simple old fashioned marketing tends to do the job. How many times did we hear the slogan ‘there is no shortcut to success’? Agreed. Success is only possible through hard work, dedication and a bit of help from the goddess Tyche! Contrary to common belief though, there is a shortcut to growth. Growth through Acquisition is too often considered the domain of big established companies. Below, we will be outlining why growth through acquisition is actually a quicker, cheaper and far less risky way to expand business than the strategy of escalating marketing and sales campaigns referred to as organic growth. Synergies, competitive and financing advantages are immediate and can be formidable.

First, let us define a synergy. A synergy is broadly defined as two things together being better than the sum of the two parts. In the context of firms merging, the combination of resources would have more value than the sum of the units standing alone.

Marketing and production synergies are the catalyst behind many acquisitions. One cannot realistically expect to increase sales twofold through one marketing campaign, at least not at an affordable price. Anyone involved in marketing would agree that marketing campaigns result in incremental increases in sales and profits. Inevitably, when launching an aggressive marketing campaign, a specific amount of capital is ‘invested’, this does not guarantee any specified return. On the other hand, if growth is achieved through acquisition, one would have a clearer idea of what the growth outcome would be, plus or minus possible customer attrition. Another important consideration is the timeframe in which such growth is achieved. Growth will only be achieved after several months of advertising, whereas if one acquires growth, this would be achieved overnight.

Expanding the customer base is not the only way to increase sales. Introducing complimentary goods to a business’s current portfolio could also do the trick. For example, AB Ltd manufactures pencils. AB Ltd has put in a great deal of effort to set up distribution channels to sell these pencils. Now it is very intuitive, those customers who buy pencils buy erasers too. AB Ltd is currently selling itself short. Steering away from the cleverness in business naming, BC Ltd produced erasers. If AB
Ltd acquires BC Ltd, AB Ltd can sell the erasers using its current distribution channels, and needless to say, sell its pencils using BC Ltd channels. This would lead to a significant increase in sales, without the necessity of increasing the customer base, or distribution channels.

Economies of scale always rank high among the classical textbooks’ reasons for any type of strategic growth. Inevitably businesses have bills to pay, whether it is a record breaking or utterly sluggish period. Fixed Overheads such as rent, licenses and depreciation are unavoidable and are to a great extent independent of production and sales. Through acquisition, savings on direct cost are easily achievable. Reverting to the example of AB Ltd and BC Ltd, if AB Ltd sells the newly acquired erasers through its current distribution channels, it is clear that besides the obvious increase in turnover, AB Ltd would also benefit from cost reductions such as transportation and sales personnel. These saving can be achieved by organic growth too, but again, the immediate saving achieved increases the appeal of growth through acquisition.

Whatever your chosen method for growth, this needs to be financed. If there is insufficient available capital to finance the project, these funds will need to be obtained from an outside individual or institution. Whether financing growth through a bank or an investor, strategic growth gives you more solid data to present your case to financers. As professional, realistic and elaborate your business plan may be, a banker or investor will always be more easily convinced by actual figures rather than a truckload of uncertainties and projections. Knowing that you are buying into a business that is already earning a return, and therefore the much desired cash flow to repay the debt, will always be more reassuring to the bank and should thus enhance your chances of obtaining the finance desired. Another option which might prove cheaper, is seller’s financing. In this case, AB Ltd could, for example, negotiate with the previous owners of BC Ltd to pay half the agreed price after the first year at a borrowing rate better than that obtainable from a bank.
Growth brings about risk. Every entrepreneur worthy of such a name knows that risk is inherent in any business. The general truism is ‘the more you want to expand, the more risks you must take’. Uncontestable as such a statement is, risk return tradeoff is not a linear function. Many businesses take excessive risks for a meager return, whilst others take little risk for quite a substantial return. This is what differentiates a good business strategy from a bad one. In a strategic growth scenario, risk is more quantifiable than is the case for organic growth. Going back once again to our example, let us say that AB Ltd sets a target of 50% growth in sales. Under strategic growth, the cost and timeframe of acquiring a firm to achieve the target growth is known. If on the otherhand, AB Ltd decides to take the more traditional route of sales and marketing promotion, it will face many uncertainties. How much is it going to cost to attain this goal? When, if ever, will this target be achieved?

Organic growth brings with it uncertainty when entering uncharted territory. Especially when moving out of the core area of business, there is expertise to acquire, capital to spend, projections to depend upon and a mountain of spur of the moment management decisions to make. Time is critical when trying to anticipate growth needs of the firm. Move too fast and you might find yourself sitting on massive underutilized capital, and thus costs. React too slowly and you risk alienating hard earned customers, and possibly losing business due to being unable to meet increased demands. Through acquisition, one would acquire not only a new customer base, and the necessary tangible assets to service these, one would also acquire a business with procedures, employees with the right expertise and assets already in place. One could step back and analyze the newly acquired business without the need to implement change immediately, as even though the business is new for the acquirer, for the current organization, it would be business as usual.

Uncertainty is risk. Factor in too many uncertainties into a business plan, and something is bound to go wrong. Expected growth, the cost of achieving that growth, the timeframe for achievement and the method of funding are all factors that can make or break any project. Strategic growth eliminates, with a certain degree of error, these uncertainties. Barriers to entry, lack of expertise and the dangers inherent with rapid growth can often only be overcome by strategic acquisition. On a final note, contrary to belief, target companies do not necessarily need to be up for sale. Targeting the ideal candidate for takeover is critical. Synergies must be powerful, targets realistic and disturbance to current business kept to a minimum. With these in place, market forces should prevail and a price that satisfies both buyers and seller ought to be attainable.

This is for informational purposes only. Karl Schranz A.C.C.A; M.A. Fin. Serv; M.Sc. Quant. Finance & Risk Man. (Bocconi) is a Corporate Finance consultant at Victor Schranz & Associates CPA. For any queries he can be contacted on Karl@victorschranz.com.