In 1958, Dwight D. Eisenhower made a speech to the US Congress that outlined the expansionist threat posed by Russia that was, at the time, seen not only as a military threat but as a dangerous communist superpower.
In the speech, Eisenhower said the following as it relates to America’s strength:
“Our real problem is not our strength today; it is rather the vital necessity of action today to ensure our strength tomorrow.”
This speech was at the early stages of the cold war after the failed landing operation at the Bay of Pigs in Cuba in 1961, which changed the face of US/Cuba relations.
Since I was a kid, I’ve loved playing the board game Risk. For those who are not familiar with the super competitive strategy game, it’s a sure way to make quick enemies out of your best friends as you scheme your way to world domination.
One of my main tactics in the game is to deploy a defensive strategy. The longer I can hold off attacking offensively, while still fortifying my key defensive positions, the better my chance of winning when I eventually do go on the offensive. This is, in part, because while I am focusing on defense, my opponents are weakening each other.
Net-net … I sit back and wait, strengthening my armies until the opportune time to go on the offensive.
The title of this blog post is: Now is an Awesome Time to Acquire Your Competitor And Make a Killing
So what does the Eisenhower quote or the game of Risk have to do with acquiring a business?
The answer is … A LOT ACTUALLY.
I’ve been writing these blog posts for over two years now.
For those of you who have been loyal readers of my writing, you’ll know that there’s a consistent theme throughout much of my work.
My business perspective isn’t that different from the way I play the game of Risk. I operate defensively, sit back, and wait for the opportune time to act offensively, and then when that opportunity presents itself, I attack.
Many others play the game of Risk in a completely different fashion. They go on the offensive and weaken themselves too early in the game. In the end, they don’t have enough armies to defend themselves, and they lose.
If business parallels the game of Risk or war, then your time to attack is happening. It’s happening now.
There’s Never Been a Better Time to Acquire Your Competitor or a Business than Now
Unfortunately, most business owners don’t have more than a few months’ worth of cash to sustain their businesses during a recession or rough time. They wasted all of their armies too early in the game and left themselves so weakened that they have no choice but to fold.
And that’s when you step in.
If you’re one of the fortunate ones to be sitting on some extra cash even during these critical times, then now is the time to begin your offensive.
You can start by calling some of your competitors. You can call those either in the same city or country or further afield. And one call won’t do the job. You need to be persistent.
Just as in sales, you don’t make one sales call to a prospect and then stop.
You make many sales calls—thousands—to many prospects and eventually, some will be interested in your product or service.
What I am suggesting is that you do the same thing with regards to calling your competitors. I’m certain you know who many of your competitors are, and you can certainly research the others.
Get on the phone with them. You should be upfront and let them know that you’re in the market to expand your business. During the call you can hopefully glean some competitive information about their business, but the real nugget is when you find the prospect that is interested in selling their business.
You should let them know that you have cash and are prepared to make an all-cash offer with a quick sale. You can make some commitments like you promise to keep the main office in their city open and/or to maintain all or most of their staff and customers.
Of the dozens of calls you make, you will find some who are just plain “done” with the stress and pressure of running a business. They might be close to retirement, and you just happened to make the right call at the right time.
You’re looking to offer them a fair price for their business in consideration of the current recession and their current revenue and profitability, and while it is somewhat opportunistic, if someone is just tired of running their business, and you happen to be the willing buyer at the other end of the line, then, you would rather get the deal then your competitor.
Keep in mind that you will hopefully be able to shave some expenses out of the merged entity. For example, you might not need two accounting packages, two controllers, two offices, and so on, so not only will you find savings from the merged operations, but you will hopefully get a better deal today than you would have in the past.
How Does the Math of an Acquisition Work?
Let’s say your business has revenues of approximately $5 million a year with $500,000 in profits. You make an acquisition of a similarly sized competitive business so that, when complete, your two businesses combined now have $10 million in revenues and $1 million in profits.
Let’s say the business acquisition cost was 5×EBITDA, so you had to pay $2.5 million for the business ($500,000 × 5). If you’re a good negotiator or find the right opportunity, you might be able to find an acquisition from a desperate seller who is willing to sell for much less than 5 x EBITDA now that we’re in a recession.
Since you don’t have $2.5 million in cash sitting around, you borrow 50% of the purchase price and put down $1.25 million in cold hard cash. (Note: this can definitely work with more debt, but I digress.)
The day after the business transaction closes, you realize that you don’t need two office spaces, two separate accounting departments, two sales directors, operations managers, technical support managers, and so on. I’m not suggesting that you fire all the staff from the acquired firm, but I am suggesting that sitting inside the consolidated business, there are likely plenty of new redundancies. It’s those redundancies that are going to make you a lot of money.
Let’s say you’re able to remove approximately $500,000 from the business. If your labor cost is approximately 30% of the overall revenue ($1.5 million in yearly payroll), add rent costs, internet services, cleaning services, and so on.
Keep in mind that you paid 5× EBITDA for the business you just acquired. That being the case, you just managed to save $500,000 in the business, which at 5×EBITDA, translates to an increase in valuation of $2.5 million. Not too bad for an initial $1.25 million investment (your initial cash purchase).
If nothing else changes in the business, other than combining the two entities and rationalizing the expenses, your business now has revenues of $10 million and EBITDA of $1.5 million.
Before you started this process, your business had a value of $2.5 million. After the acquisition, your business has a value of $7.5 million ($1.5 million × 5).
You still have to pay the bank back their debt of $1.25 million (assuming you haven’t paid any debt back yet), leaving you with a business that has a market value of $6.25 million.
Enter Multiple Arbitrage
Something else interesting happens the larger your business gets, and it’s called multiple arbitrage. As a business scales above certain thresholds, the market of potential buyers expands, as do debt servicing costs, so not only does your business’s multiple improve but so does the cost of the debt itself.
It’s much harder to market and sell a business with revenues of $2 million. It’s easier at $5 million, $10 million, $50 million, and the larger the business, the larger the pool of buyers.
When your business had revenues of $5 million, you were only able to obtain a multiple of 5× EBITDA (for example), but now that your business has $10 million in revenues, you might be able to get 5.5× EBITDA. If your combined entity now grows at an accelerated pace post-acquisition, then you’re now talking about exponential returns on business valuation.
In multiple arbitrage you are increasing the worth of your business without necessarily making any operational changes, but, the act of combining two smaller entities into one larger entity in and of itself improves the overall valuation.
Expanding your business through acquisition will set the stage for rapid growth once the recession ends, and that brings me back to the Eisenhower quote from the beginning of this article: Our real problem, then, is not our strength today; it is rather the vital necessity of action today to ensure our strength tomorrow.
Now is your time to look for assets. Real estate, stocks, and everything else that is either on sale now or about to go on sale. And you, with your cash war chest, are the willing buyer to pick up those fire sales assets.