If you wished to scale your business by 5 to 10 times – what is the factor constraining your ability to do so? This could be location, distribution channel, export capability, finance and so on. If the constraint could be removed, how much more revenue and profit could be achieved. The strategic buyer is the one which can overcome the constraint.
Often firms lack the capability or capacity in a new area, new technology or new process. Sometimes the quickest way to solve this problem is to acquire it. Alternatively, the firm may be faced with legislative changes, changing market conditions or the loss of key staff. A firm which can solve the problem may be an ideal acquisition.
A threat occurs when a firm is faced with a potential or actual decline in current revenue. This would often come from an existing or new competitor. The firm may not have the luxury of time to create a competitive product and so acquiring already available products may help to eliminate or reduce the threat. A threat may also occur where the competitors are anticipated to undertake some action. Being first off the block may counter the advantage they otherwise would achieve.
A threat may also come with loss of a key distribution agreement, key account or key capability. Loss of key staff may create a gap in capability in any part of the firm. An acquisition may be used to resolve the problem as well as provide increased capability.
Forward integration is sometimes used to reduce the threat of loss of distribution capability. A key distributor might be acquired by a competitor or a distributor may be financially unstable. Rather than risk loss of the distribution capability, the firm may buy it out.
Alternatively, the firm may be facing a risk with a supplier. The supplier might be acquired by a competitor thus locking out a source of supply or they may be financially unstable. A supplier which is not developing products in line with a firm’s strategy may also be acquired in order to own the capability.
Scanning customers to find another company which sells to them will often indicate a potential buyer who can capitalize on knowledge of that customer sector. They may be able to cross sell products or utilise their own distribution channel to move new products.
If a key ingredient to the success of the firm is the use of a specific technology which is expensive or difficult or time consuming to acquire, another firm which uses that technology may wish to acquire the firm to increase capacity or enter new markets. For example, in software technology, many firms which merged used the same underlying language or database technology.
The customer base can often be a very valuable asset, especially if it provides opportunities for the acquirer to sell additional products or to break into a new sector.
A specialised technology, especially if protected with patents, or specialized staff with deep knowledge, can often provide a buyer with scalable opportunities.
Our selection process should have the objective of identifying those corporations which have the capability and capacity to fully and quickly exploit the strategic assets and capabilities of the firm. You want the potential buyer to quickly see the benefits of an acquisition and to recognize they have the capability to exploit its revenue potential.
You should exclude acquisition beginners or corporations wanting to enter a new market (unless that is their core competence). To be really pragmatic, you are seeking a potential buyer who thinks it will be easy to achieve the benefits of the acquisition because they understand it very well, have the capacity and capability to roll out the new product or service and already have experience in the target market.
Ideally, you are seeking a very large corporation which can bring your products to market quickly, has the customer base and/or distribution channels already in place and has the resources to do the job efficiently and quickly. If you can structure your company so that your strategic asset or capability can be rapidly scaled or replicated, which corporation has the best chance of taking it to market and generating the most revenue from it?
Your ideal buyer is a corporation which can take on the strategic asset or capability and quickly generate revenue from it by selling it into an existing marketplace where they already have access.
In order to tease out possibilities, I often take the ideal product/market scenario and look at who will make money out of it if it is hugely successful.
This could be the retailer, wholesaler, manufacturer, supplier, installer and so on. This will often help you identify who has the greatest interest in the solution becoming widely available. Another test is to work out who has the best capability of a large rollout. This will often identify the corporation which is best able to undertake the task.
As we have seen from our earlier look at net present value, early revenue is worth a lot more than later revenue. For example, lets say you have two possible buyers, each can generate $10 million in gross margin in the first two years. The better one is the one which can generate the revenue earlier. Using a 50% discount factor we get the following NPV on acquisition.
In scenario Buyer Two, the acquisition is worth 10% more to the buyer.
Smart Company is the leading online publication in Australia for free news, information and resources catering to Australia’s entrepreneurs, small and medium business owners and business managers.
