Blog written by Steve Seavecki , Magnum Print Solutions
Whether you would like to leave Corporate America and purchase your first company or if you have an established company and are looking to expand, this article is meant to provide some helpful tips.
After 20 years as a senior manager in the software industry, I was tired of the travel and wanted to spend more time in Seattle. Over the last several years, I purchased my first business and subsequently acquired 7 other companies. The first company I acquired had been in business for 12 years when I purchased them. The following tips are from lessons learned during various acquisitions. Each acquisition definitely provided new experiences and unique issues. From my first to the seventh acquisition, I learned how to reduce my risk by 70% and increased my net profits by 40%.
Since each industry is different, you really can’t find a perfect boiler-plate ‘how to’ recipe in making a successful acquisition. However, 75% of the questions and processes are the same across industries and that is what I would like to share with you. The 25% that is unique from industry to industry is related to such issues as – what is a good margin for each product line – what are the most difficult aspects of running a company in that industry – how much of an issue is retaining the key employees – what is the most cost-effective way to generate leads, etc.
Step One: Financing
In order to save yourself a lot of time and help narrow your acquisition parameters, it is important to understand what your options are for financing which will dictate what your options are for structuring a deal.
- First off is how much cash will you and/or the company be willing to invest in the acquisition? This often dictates how big of a loan you can get, regardless if you sign a personal guarantee or not.
- Will you need a SBA guaranteed loan? Based on your current company or personal debt, profitability and revenue growth, the only loan you may be able to obtain is a SBA guaranteed loan. For an SBA loan, 75-85% of the total loan amount is guaranteed by the US government, so that if you default on the loan, the bank can still recoup a majority of the amount it lent to you. Therefore, banks usually like to push you in the direction of a SBA loan if you don’t have a large amount of unencumbered assets to collateralize.
The down side of a SBA loan is that you pay in upfront loan origination fee and you don’t have any say in the terms. In addition, the rate is a floating rate. The SBA does not typically allow for a fixed rate load for business acquisitions. Therefore, if the rates go from 5% in today’s market to 8% over the next two years, you will be stuck with a much higher monthly payment. You will need to factor this into the overall purchase price as a risk component.
The SBA requires a minimum of 10% down. Most banks want to see the seller also carry a note for 10-20% of the purchase price. This is also something you should push for as it gives you an opportunity to use as leverage if you discover issues after the deal is closed.
Let me describe an issue I experience related to the advantage of a seller note. During my due diligence on one deal I asked the seller how many multi-year contracts the company had and what is the total financial exposure of those contracts that customers would be looking for me to fulfill. The seller told me the total was $35,000. After I closed the deal, I found out that that number was not $35,000 but $260,000!!!! Since the seller had taken a 20% note from me on the purchase, I was able to negotiate a settlement where we agreed that the note was now deemed paid in full, even though I hadn’t made any loan payments yet.
It was still a pain and led to some ill will as I had to go back to some of the customers and renegotiate the contract and require a supplement to cover some of my costs until thier contract was up. Since I purchased the company’s assets and not company stock, I was able to explain to those companies with contracts that I was not legally obligated to fulfill those contracts at all. You do not want to purchase another company’s stock as you then are liable for any known or unknown issues connected to that company. You only want to purchase their assets.
- Personal Guarantee. Unless you have a growing company with tons of cash and little or no debt, you will likely be asked to sign a personal guarantee. If you do your homework and follow the process, this should not scare you. But, if you just purchase a business because you ‘like’ the products or services they sell and don’t ask the tough questions, you may be in for some financial surprises.
- Cash. Cash is king. With the interest rates as low as they are, do everything possible to keep as much cash as you can. Put down as little cash as possible when making an acquisition. This gives you a war chest for future acquisitions. There is a reason Microsoft, Apple, etc. keep massive amounts of cash. It gives them flexibility to make deals when they need to. As long as you have the cash flow to cover your monthly debt payments, banks will still lend you more money. However, if you use up all you cash and run into cash flow issues, it doesn’t leave you many options as banks will not lend you more money easily. Also, interest on loans is an expense against your profits so instead of paying taxes on your excess profits you are getting, in affect, a discount on the loan rate.
Bank like deals with assets they can resell. They don’t like deals with large amounts of Goodwill. Therefore, if you are able include a building in the purchase of a business, you might receive more favorable terms on your loan and avoid a personal guarantee.