Grow your business by buying someone else’s

Sep 18

In the ever-hectic race to increase the corporate bottom line, the mergers and acquisitions strategy for corporate growth has always looked like a bright shiny diamond. Once embraced, this strategy will allow you to keep growing profitably, and with luck, allow you to harvest operational efficiencies that can improve your bottom line.

Does it work?

You don’t have to be IBM, Microsoft, or Merck to buy a company. For smaller companies, it can make business sense to pick up a few accounts, a book of business, or a company with one or two employees whose operations overlap with yours.

You can use the purchase as a way to improve your current operations or to diversify your business. We learn early on that successful companies need multiple diversified lines of business to maintain their margins and balance against the buffeting ups and downs of the economy. Buying a small company that we can pay off in a couple of years makes logical sense as we grow our operating platforms. The faster we grow, the better our cash flow, and the stronger our cash flow, the larger the companies we can purchase. Organic growth is an option, but while organic growth works, it can be slow going.

But a word of caution is imperative. Companies spend more than $2 trillion on acquisitions every year, but the M&A failure rate is between 70% and 90% (https://orgmapper.com/why-do-mergers-and-acquisitions-fail/).

Company fit – Does the company you buy have similar business practices, ethics, and culture?

One of the first places to start is establishing a cultural fit. Clients of businesses are creatures of habit; they don’t like to change their patterns of doing business. If there is a change in practices and operating behavior that costs them more money, or is a change from their current way of doing business, they might bolt.

Bear in mind that we live in an environment with many different approaches to doing business, and many different operators with wide-ranging levels of education and expertise in managing their business. The first thing clients will want to establish is that you are skilled. Then they want to confirm you are trustworthy. Can you be trusted with their real estate investment? Will you communicate if there is a problem? Can you prevent problems from occurring? Can you prepare accurate monthly accounting reports? As you make decisions, will they be similar to the ones they would make in the same situation?

Leadership is key

It is paramount that leadership can communicate with clients, tenants and new and current employees. Lack of communication will quickly destroy what should have been a successful merger. Experimenting with smaller mergers first will refine the skills a business needs to be successful. Your systems need to be ready to take over the new accounts. The most important question will be: Is your software platform able to handle the new accounts you are bringing in? A flexible software platform is critical to a successful purchase. Doing it right from the get-go and making sure the property owners get their bills paid and rents collected will pay off.

Be visible and honest

If you build a company structured around honest and solid business practices, it will be easier for your staff to sign on and support you and your management team. That translates into real profits. Plan ahead to match pieces together to help meet your growth needs. Remember, as your company grows, so do the internal opportunities for your employees to grow professionally as well. You can build a solid team with low employee turnover. Your clients love this because they are not having to retrain your staff. It’s critical to have employee longevity. Employee turnover is exhausting for you, your tenants, and clients.

Don’t be afraid to find and use an experienced attorney and CPA

As your deals grow in size, find the right attorney and CPA who 1) you can communicate with, and 2) have experience, and will help draft the documents and prepare and double check your business and financial assumptions as you clear the path for a successful deal. Limited documentation is sufficient on small deals, but on large transactions that involve outside financing (Bank or SBA), it is imperative that you engage an attorney and a CPA. These might add significant costs to the deal that you need to plan for.

Financing

You have financing options when you buy a business. It’s up to you to be as creative as possible to find the best one. Here are some ideas for you to consider:

Pay cash – with a possible price discount.
For a smaller purchase, you can make a 25% down payment and have the seller carry back a short term (say 36 month) note.
For a larger purchase, if the seller does not want to carry the financing, you might need to borrow money from:
- Parents
- Friends
- Bank
- Hard money lender
- SBA - SBA: SBA 7(a) Guaranteed loans typically range from $25,000 to $5,000,000. The maturity rates can be found here.

Analyze the potential income and expenses business valuation

You must understand the value proposition. Modeling the purchase, the income, expenses and staffing are helpful when deciding whether to purchase the company. Set a realistic budget for attrition, given changes in staffing, and include reasonable assumptions and reserves in your model. See sample below:

Insure your downside

Your attorney will draft documents that make the seller responsible for items they do not disclose. It helps if the seller buys a trailing insurance policy to protect the buyer and the seller if something unexpected is discovered. Often the seller will also ask the buyer to self-insure by use of a hold back from the payout. In other words, the seller may take up to five years to pay off the buyer, using an escrow company to hold funds that are released over a period of time. These funds are usually used to deal with employees, clients, or other unexpected litigation against the seller for some detail that was missed as the transaction was assembled.

Why do mergers fail?

Here are some common reasons:

Overpaying due to not understanding the value and cost of operations of the company that is being purchased.
Unrealistic expectations for the combination; having expectations of efficiencies that do not occur.
Poor implementation of the merger.
Lack of a management plan.
Unclear communication to existing employees about what you are trying to achieve with the merger. When two companies merge, their employees often have different working styles and values. This can lead to conflict and tension between employees, which can ultimately lead to the failure of the merger.
The company being purchased was in regulatory trouble before the purchase.
The buying company does not have the resources to fund the integration.
The operating policies of the two companies clash – and a big explosion ensues when you try to merge them together.
Hidden financial problems or liabilities were not divulged or self-evident during due diligence.
Due diligence was not thorough enough.
Most importantly, when two financially and/or operationally weak companies merge, the new company will be weak. It typically does not make a stronger company — rather, it is a recipe for failure.

Summary

There is an upside opportunity to grow your company by buying another one, but with a 70 – 90% failure rate, it behooves you to walk this path very carefully. Just looking at the list of battles you have to overcome to attain a successful merger (see above why mergers fail) should reinforce the fact that you need to have excellent advisors and time to carefully review the company. Purchasing a company needs focus by you and your management team. Just delegating it to one person to manage could be a mistake. Buying companies and accounts can be a way to grow your company quickly, but there are many moving parts that need to be considered so that it actually improves your bottom line and helps you grow.

Clifford A. Hockley, CPM, CCIM, MBA

Cliff is a Certified Property Manager® (CPM) and a Certified Commercial Investment Member (CCIM). Cliff joined Bluestone and Hockley Real Estate Services 1986 and successfully merged that company with Criteria Properties in 2021.

He has extensive experience representing property owners in the sale and purchase of warehouse, office, and retail properties, as well as mobile home parks and residential properties. Cliff’s clients include financial institutions, government agencies, private investors and nonprofit organizations. He is a Senior Advisor for SVN | Bluestone.

Cliff holds an MBA from Willamette University and a BS in Political Science from Claremont McKenna College. He is a frequent contributor to industry newsletters and served as adjunct professor at Portland State University, where he taught real estate-related topics. Cliff is the author of two books, 21 Fables and Successful Real Estate Investing; Invest Wisely Avoid Costly Mistakes and Make Money, books that helps investors navigate the rough shoals of real estate ownership. He is the managing member of a real estate consulting practice, Cliff Hockley Consulting, LLC., designed to help investors and commercial brokerage owners successfully navigate their businesses. He can be reached at 503-267-1909 , Cliffhockley@gmail.com or Cliff.Hockley@SVN.com.