To acquire or to grow organically?

We see much in the financial press about business sales and acquisitions as being an important barometer of economic activity.  I thought it would be interesting to focus a little on this fascinating subject.

The question of how to grow, organically or through acquisition is one which always gives rise to debate among finance professionals, business advisers and businessmen themselves.  Yet the answer to the question lies in the question itself and comes from a mathematical truth: two plus two always equals four (except, according to physicists, in the case of a nuclear reaction – an event that we can safely conclude would be bad for business).  Growth can only ever be organic.  Acquisition may make a business bigger but it is not growth.  Though we should not make the mistake of thinking that it is there bad, and this article invites you to consider why you might acquire another business.

We could think of it as if I decided I wanted a bigger house.  I could buy the house next door, or I could build an extension.  The first option, acquisition, will quickly give me more property, but my house remains the same size.  I just have two of them.  The second option actually makes my house bigger.  But then, some say that size is not everything.

So before the owners of an SME decide to acquire another business they might be well to consider why they would wish to do so.  There are very good reasons for acquisition, and these may be about growth, but only indirectly.

What happens when you acquire a business?

In financial theory, the price you pay for a business would be its value.  Therefore, when you pay a proper sum of money for a business you reduce your wealth by the amount you pay, but you increase your wealth by acquiring a business worth that same sum.  The net effect is that nothing has changed, except those peripheral to the transactions (brokers, accountants and solicitors) will be better off.  More complex theories suggest that a process called arbitrage means that the buyer perceives a higher value than the price paid and the seller a lower value, meaning that both sides think that they have won.  But I perceive that I am twenty-one years old and a sportsman; I am not.

On the other hand, in a business acquisition, you also acquire people, assets, facilities, know-how, brand and reputation and you increase market share.  And it is these things that can render a business acquisition worthwhile.

The benefits of acquisitions

When a business acquires another business it will do so for one or more of the following reasons:

  • to acquire skills it needs;
  • to acquire know-how, patents or rights or other assets it needs but does not have;
  • to allow it to enter into a market otherwise barred to it;
  • to enter into a location where it is cheaper and more effective to acquire than start from nothing;
  • to increase market share or ranking;
  • to eliminate specific competition or consolidate a market;
  • to pander to the vanity of its owner.

The owner of an SME is entirely entitled to vanity projects, but it is best if they are not under an illusion.  When evaluating an acquisition, the owner should be aware that an acquisition is distracting and time-consuming, requiring much more management time both before and after the acquisition than they might expect.  There is a whole set of skills required to integrate an acquired business successfully, and these come with considerable cost.  There is much evidence to indicate that few acquisitions actually result in growth in profits of themselves.  Business-owners more often regret acquisitions than celebrate them.

Should all acquisitions be avoided?

Not at all.  There are six very valid reasons for acquisitions listed a couple of paragraphs above, and each of them should, if successful, lead to real, organic growth in a combined enterprise.  The list is not at all exhaustive.  The important thing is to know why you are acquiring, and what it is that makes the acquisition more valuable to you than it is to the seller.  For example, elimination of a key competitor might allow for considerable growth and even higher margins.

Often it is skill-sets that are the true target of an acquisition, but other businesses seek acquisition to create a vertical integration, allowing the business to improve margins.  Or, if the objective it to provide additional skills, these will translate into new (organic) turnover gains.

But if the objective is to increase turnover, then that will happen, but it is unlikely to give rise to benefits in the short or even medium term.  While sometimes an acquisition carries the benefit of consolidation in a market, or allowing a business unit to reach a critical mass that it needs to sustain itself, these are no about increasing turnover for turnover sake.  Golfers know that you drive for glory and putt for points; so in business, turnover is glory, profits are what counts.

An acquirer of a business should see the acquisition as a tool for aiding organic growth, because organic growth, is, in the end, the only true type of growth.  The tool is valuable.  The turnover is not in itself, all that.

Published by

Jonathan Franks

A man of limited intellect spurred on by a belief that if you say enough, some of it might be right. Also a specialist in self-deprecation.

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