If you are looking to acquire a business, the first thing you need to consider is the value of that business. There are many metrics that can help you determine the company’s health before acquiring it.
These may include financial history, management, owner’s involvement, customer diversity, competition, relationships, and sustainable growth in revenues. While financial statements may outline the company’s growth, there are many non-financial factors that you need to think about before buying a company.
Numbers might be able to tell you about the company to an extent; it will not tell you everything.
You need to look at the growth trends.
- Has the company improved in the last couple of years?
- What is its growth rate?
- Are the earnings of the company improving, or have they been flat?
- How is the internal structure?
It might be the case that the owner has left the company, and it has been going downwind ever since (called the ‘glider effect’). However, acquisition entrepreneurs often fail to take these factors into account.
Having bought over seven companies in a decade and working across several industries, I suggest that the invisible driver of business value is the company’s impact.
It is the ultimate driver of the financial strength and value of the business.
As an acquisition entrepreneur, you need to see if the company is helping the most people it is supposed to help, i.e., it is creating an impact.
Measuring Good Growth
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These days you cannot just look at just the financial growth of the company instead you need to examine all the components of growth.
According to a recent PwC report, good growth must be real, inclusive, responsible, and lasting. Good growth should benefit everyone, including customers, stakeholders, employees, suppliers, and society.
The impact of a company cannot always incorporate conventional financial management reporting. The following are the components of good growth:
- Real Growth: Real growth means the company is tapping into new untapped markets, proactively trying to innovate, and providing solutions to meet the new unchanging needs and demands of people.
- Inclusive Growth: This kind of growth combines expansion in business output and improvements in living conditions and outcomes that matter to the quality of people’s life.
- Responsible Growth: Responsible growth emphasizes the impact of doing business rather than just financial benefits. It takes into consideration the environment and social impact of doing business.
- Lasting Growth: The growth should be sustainable over a long period. If the company is just focusing on its short-term financial goals, it may not be capitalizing on its real strengths and the underlying potential. Long-term growth is like the heart of good growth.
Getting Your New Business In Shape
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The best way to buy a company is to balance debt and cash. You can’t buy the entire company in cash. Using debt will reduce the risk of investment and attract value.
This means you can go to a bank and say that you want to acquire a company, especially if it has a good cash flow and generating value, and get debt easily. This is much better and cheaper than buying the company by raising equity because it usually comes with a high rate of return, and you would be giving the very value of the company you want to keep.
With the right amount of leverage, you are elongating the amount of time you’d need to take your business to the next level. For instance, if you take a 10-year loan, it may take six whole years just to keep the business operations running. This is especially the case if you are buying an old economy business with no industry tailwinds and no underlying trends. You’d need to elevate it to the level where you are able to drive real and holistic growth. It might take a while to build your business and continue innovating. Good debt will provide you that time.
In order to drive growth in your business, you need to constantly step up, take progressive measures, and innovate to keep your company in shape. Imagine the company’s assets are the body muscle, liabilities are the body fat, and the balance sheet is your body type.
Now, you need to constantly maintain your body type by reducing the liabilities (body fat) and increasing your assets (body muscle). If you are strong (or have a healthy body type), meaning your company has a good financial sheet, you will be able to make the impact you want to make. And the total value of your business worth is closely tied with the impact your company can have.
This is the ultimate driver of business growth.
Think about a stable company established by a baby boomer who has owned it for over 40 years. Their business has given them a lot, but they do not intend to take a debt to start a new initiative now.
They no longer invest in new technology and do not replace employees with poor performance. Not to suggest those businesses are not worth investing or buying; rather you will need a good amount of time and debt to bring such a company in shape if you want to increase the amount of impact that the company already has.
This all leads to my perspective that the true indicator of business value and financial strength is the amount of impact the company has. Building a strong body type for your company requires good investments, proper management of operating expenses, impeccable business strategy, valuable and meaningful customer relationships, and lots of hard work.
Planning on buying a business in the next 12 months? Consider applying today to the Acquisition Lab, our do-it-with-you buy-side advisory service. You’ll gain access to world-class education, support from our team of experienced advisors, a suite of tools, and a vetted community to help you succeed in that first acquisition or in implementing a grow-through-acquisition strategy.