Growing by Acquisition: Strategy and Process
Very few businesses enjoy successful longevity without going through some form of expansion. Some businesses choose to grow organically, by expanding production, hiring more employees, and expanding their customer base, while others choose the inorganic route through mergers and acquisitions. The growth of small business in both ways but especially by mergers and acquisitions is expected to be a major driver of the U.S. economy as it begins to expand after an extended downturn.
Businesses hoping to take advantage of this much-awaited uptick in the economy should consider utilizing both organic and inorganic options for growth. Acquiring an existing business generally means lower startup costs than a new business. However, the price of a successful business could potentially exceed the costs of starting the same business from the ground up. Buying an existing operating business may also be an advantageous strategy for owners who need a quick infusion of cash for running existing operations.
If an acquisition is the right strategy, it is critical that the owners find the right company to buy. In order to do this, it is important to have clarity as to the objectives of the purchase and the growth strategy. As an example, if the buyer’s intent is to solidify their existing market share, then they should consider buying a competitor. However, if the goal is to increase synergies and reduce costs, then purchasing a company that is part of their supply chain, either a supplier or a distributor, would be a better option. Buyers may also consider acquiring completely unrelated businesses if the intent is to diversify and expand the portfolio holdings of the existing company. Other common reasons for acquisitions include the need for a new technology developed by the potential target or a target’s goodwill in the marketplace.
Once a suitable target has been selected, the first step is usually to contact the owners with a formal letter of intent. The letter of intent will serve as a stepping stool for further negotiations and will demonstrate the buyer’s seriousness. At this stage, parties often enter into nondisclosure and confidentiality agreements to ensure that no trade secrets and confidential materials are disclosed or used improperly during the negotiations or afterwards.
Once the letter of intent is signed, the due diligence process is the next step. This process allows the buyer to look into every aspect of the seller’s business to ensure that there are no hidden risks, costs, and disadvantages to the acquisition. Qualified professionals are often engaged to sort out financial statements and review environmental issues and other potential liabilities. The due diligence process also helps the buyer determine an accurate value of the target business, which can be used to negotiate the price of the purchase.
The due diligence process is also instrumental in determining any third-party or governmental approvals which may be necessary in the acquisition. For example, larger firms often face anti-trust actions from the government in the process of buying a competitor. Operation of the target business may also require special licensing and approval from government agencies, which in many cases is hard to transfer. Due diligence will also give the buyer a good idea of the employees or key contractors who need to be retained after the purchase. The buyer may also ask the sellers and key employees of the target to sign employment, confidentiality, and non-compete agreements to protect the acquisition.
The final step in the acquisition process is to document the transaction and conduct a formal sale and closing. Depending on the size and logistics of the target, the parties will also need a detailed transition plan that allows for a smooth transfer of employees, technology, and control on the closing date. The key to a successful acquisition is for all parties to have a well-thought-out strategy and process and to dedicate enough internal and external resources to assure a smooth transition.
[Business Insights is hosted by the Law Firm of Kumar, Prabhu, Patel & Banerjee, LLC. Sonjui L. Kumar is a corporate, transactional attorney and a founding partner of KPPB Law. She primarily focuses on serving as general counsel to privately held companies assisting them with all legal matters, including corporate governance, contracts, shareholder matters, mergers, and acquisitions. Disclaimer: This article is for general information purposes only, and does not constitute legal, tax, or other professional advice.]
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