Buying a business can be a great way to enter business ownership for the first time. Stepping into an existing business has many benefits for first-time buyers but there are acquisition benefits to be seen by existing businesses, too.
Expanding a business’s operations through a merger or acquisition offers several key benefits for business owners in today’s economy.
What is the difference between a merger and an acquisition? What does acquisition mean?
Before we get into the details of benefits, this is an important distinction to make. Simply put, an acquisition is the purchase of a business whereas the combining of the operations of two different, existing entities is a merger.
To be clear, just because one business purchases another doesn’t make the transaction a merger; it’s the percentage of interest sold that really distinguishes the two terms. In an acquisition, the buyer is acquiring 100% interest in that business. Alternatively, a merger typically is not a 100% sale of a business interest. Oftentimes it’s some other percentage (for example a minority stake of 20%, a majority stake, or a 50/50 partnership). So you have two existing entities that are combining operations in a merger.
Is Buying an Existing Business Right for You? Why might you want to buy an existing business instead of starting one from scratch?
When making a business purchase, you’ve got a proven track record of the business’s operations. Their financial statements offer an established, verified, financial history, including known assets (including but not limited to property & furniture, fixtures, and equipment) and cash flow. There should also be an established customer base, labor base, and supplier and vendor relationships.
In this way, you have a starting point for the business which is why many find buying an existing business more attractive than starting one from the ground up. The starting point and documented history of performance make an acquisition a little bit less risky than starting a business from scratch.
What to consider before buying an established business? How do you identify the type of business that’s best for you to acquire?
There are many factors to consider when buying a business, not the least of which is ensuring a return on your investment. Consider the historical financial performance and the current cash flow generated by the business. What’s its earning potential? How quickly are you going to be able to pay back your investment?
Additionally, when identifying the type of business that’s best for you to acquire, consider factors like geography, operating hours, and industry. If a business provides an exceptional ROI but requires you to relocate, completely interferes with your current business’s schedule, or offers no path to improved efficiencies (ex: economies of scale or scope) within your industry, it may not be the right business for you to acquire.
What are the main benefits of acquisition? What are the advantages of taking over another business? How does an acquisition help a company in an expansion?
The top three benefits of business acquisition in today’s market are access to talent, access to resources, and economies of scale.
1. Access to Talent
Buying a business buys access to talent. Acquiring a company that has an existing labor pool is an incredible benefit, especially in the midst of today’s labor shortage. Labor challenges in today’s market are contributing to the uptick in acquisition as purchasing an operating business means walking into operations with employees that are already on-boarded, trained, and performing.
2. Access to Resources (including a well-established supply chain)
Just as a buyer can gain an existing employee base through an acquisition, a well-established supply chain can be acquired, too. In the midst of continued disruptions resulting from Covid-19, organizations are searching for reliable suppliers and distributors. Having access to a broader and possibly more established or available supply chain base is another factor that makes business acquisitions attractive.
3. Economies of Scale
Similarly to increased access to resources, the acquisition of one business by another can yield significant benefits. This is clearest in situations where one business buys another business within their industry. The result is a much larger business that has increased access to capital, lower costs as a result of higher production volume and better bargaining power with distributors. This is why we’re seeing an increase in industry consolidation: small businesses are being bought by larger entities within their industry to benefit from the economies of scale.
4. Bonus Benefit: Diversification of Risk through Portfolio Divergence
There are many perks to de-risking a business’s operations, including increasing the business’s market value. By acquiring a business within your industry that serves a different customer base or end market, you can diversify your performance portfolio, de-risk your business, and improve your business’s value.
How exactly does that work? Consider the aerospace industry. When travel was restricted as a result of the COVID-19 pandemic, manufacturing businesses that served the airline industry suffered. If a business produced metals used in airplanes, they lost work not just from individual customers (each airline) but also the entire end-market (all airlines). If that business were to acquire a metal manufacturer that served the medical community, it would no longer have all of its eggs in one industry’s basket and would be less affected by an industry-wide disaster. This diversification of risk always has a positive impact on business valuation.
What are the drawbacks of an acquisition?
There’s no such thing as a zero-risk business purchase. As a prospective buyer, the best you can do is ensure you are as thorough as possible throughout the due diligence process of your purchase. Thoroughly research and vet the business before making your purchase. Aside from reviewing financial statements to verify cash flow and justify the purchase price, consider things like the company’s reputation within all stakeholder groups. What do customers think about the company? What about vendors and suppliers? Do suppliers feel they are paid regularly and on time? Are they willing to continue working with the company or are they unhappy with the relationship? Being cognizant of these types of intangible factors can help you avoid a purchase mistake.
NEO Business Advisors
It’s not easy to navigate a purchase on your own. If you’re considering an acquisition, either as a first-time business buyer or an experienced business owner looking to grow, NEO Business Advisors is here to help. At NEO Business Advisors, we have our pulse on the market. Because of our relationships with accountants, attorneys, and lenders, we can see the broader picture of what’s happening in the market across industries, competitors, customers, and the supply chain. Now, more than ever, we’re here to use that knowledge and experience to help our clients navigate the challenges and obstacles of acquisition in the ever-changing and highly competitive market landscape. Contact us today so we can put our expertise to work for you.