An effective acquisition strategy will not only lead you to the right purchase price, it will inform you about the capital needed to operate the company once the deal closes.
“You have to dig into the numbers, beyond just how much profit the business is making,” says Wes Gillespie, ErieBank’s regional president for the Cleveland market. “How much cash is it using to operate on an annual basis? How often do they have to replace the equipment? What’s the gap in their working capital? Those are very important matters when you’re trying to determine the right amount of money to go out and raise or borrow to make the acquisition.”
Too often, dealmakers get so consumed by the art of the deal that they forget about what comes next.
“If you buy a trucking company, you’re always going to need to buy new trucks or repair trucks you already have,” Gillespie says. “If you don’t take that into consideration, you’re going to have a poor outcome a year or two down the road. You need to consider capital expenses that the company uses on an annual basis.”
We spoke with Gillespie about the bank’s role in this process and how lenders can be a valuable M&A partner, even if you’re not using debt to finance your acquisition.
What’s your rationale?
Companies looking at a potential acquisition need to be clear about why they want to buy another business. It sounds simple, but it’s a step that is often overlooked.
“There are a lot of reasons to acquire another company,” Gillespie says. “You could be looking at a strategic acquisition to help you sell more to your existing customer base. So it’s more vertical. Are you looking for the synergy of the new company to maximize expenses and enable you to do some consolidating? It’s important to understand why the acquisition is a good target. As a bank, we have that conversation upfront to determine next steps.”
This process can also reveal deal motivations that may not be good for your company’s future.
“It’s probably a tougher acquisition when you’re buying into an industry that you have no experience in,” Gillespie says. “There are reasons to do that. If you have a team of advisers around you that understand that industry quite well, you have a management team that is going to stay on and you put incentives in to make it happen, that could work. But those tend to be tougher situations to have a successful outcome. Not knowing the industry is one of the mistakes I often see made.”
Crunch the numbers
When you’re clear about the rationale behind the deal, you need to get into specifics about financing the acquisition.
“When it comes to buying companies, most people recognize that debt is going to be in the scenario,” Gillespie says. “Some business owners when they first start out, they’re proud of bootstrapping it and I’m a believer of that as well. Using your own equity, your own capital in the business to start is admirable. But it’s very difficult to grow a company without some form of debt. It can be very limiting.”
When you start to think about the capitalization that will be required, you need to examine the company’s current financial position.
“If there are a lot of assets on the books in the company, it’s pretty easy to finance it through a bank,” Gillespie says. “Banks like fixed assets, they like collateral. If it’s a business that generates a lot of cash flow, but is low on fixed assets, oftentimes you’re going to need more equity into that deal because it’s very low on real assets to collateralize the debt. In that case, you tend to lean more to equity. Either you put it in yourself or you raise it.”
Once you determine the purchase price and how much you can inject into the deal, the difference of that is how much capital you’re going to be looking for.
“This is where the understanding the total amount of investment needed to buy the business and operate the business is extremely important,” he says. “It’s not enough just to buy it. You need to operate it. That’s one of the things companies often don’t consider. How much working capital is required to operate the business?”
Tap into experience
M&A expertise can provide tremendous value at this stage. Even if the transaction will rely more on equity than debt, the bank can still play an integral part in facilitating the process.
“We try to bring other parties together that would add value to the transaction, whether it’s an investment guy, a broker or CPAs who have experience in M&A,” Gillespie says. “They’ve seen a lot. Ultimately, as the company continues to grow, the bank wants to be there during that growth and offer advice and other tools that are out there.”
