Business Strategy. Acquisitions Part 2
Posted: Jun 10 2016 / Richard Bairstow / We are Underground
Business Strategy. Acquiring Another Online Business
Valuing a Target
In our last Business Strategy article, we considered the possibility of making an acquisition of another eCommerce business to complement your own. In this piece, we’ll be looking at how to value another business for your purposes and in the following article next week we’ll be offering some tips on how to get a deal done that benefits all parties.
So let’s say that you have found another online business that ticks all your boxes and doesn’t cross any of your ‘red lines’ – what comes next?
The key to a successful transaction is to try to structure something that benefits both you and the seller. However, in the end, neither party will proceed if they don’t like the proposition and you, as the acquired, should be quite prepared to walk away if the numbers don’t work for your business.
Reasons For Acquisition
There may be several reasons why you want to make an acquisition:
- To learn more about a new market with a readymade online business
- To acquire complementary customers and historical data
- To improve terms with complementary suppliers
- To help someone out who wants to move on
But the overriding reason has to be to make your business more profitable. So it’s best to focus on the financials and then look afterwards at the other factors that might improve the deal.
Apologies in advance here - but we now have some simple math to do!
No really. It’s very simple! Forget all those complex equations you may have heard - like multiples of EBIT or EBITDA.
The most important calculation you will make is the Gross Margin being achieved by the target business. If you go back to our Blog Post of March 29th we talk more on this subject - but essentially it’s the amount you make after all your variable costs of sale are taken into account such as product cost, logistics, packing labour, delivery and payment gateway charges. So let’s say you’ve targeted a business selling pet toys to complement your existing pet jacket business.
You’ve established that the stock can fit into existing space in your storeroom and that all your other systems and logistics can just pick up this business with little or no change to establishment costs such as rent, heat, light, insurance and IT infrastructure. Let’s say the average monthly Gross Margin of the target products is 60% and the annual sales are $200,000. So you should be able to add in additional profits to your ‘bottom line’ of $120,000 per year.
The question for you is how many months or even years of trading are you prepared to wait to get back your investment in a new business before it generates a net gain? There is just no right answer to this. It just depends on so many variables:
The opportunity cost of the money you would spend to buy the target – i.e. what else could you do with that money?
The level of uncertainty in the market for the business in the future – can you rely on those sales and gross margins or are there threats to that?
Whether it’s a buyers or sellers market for the target company
But as a rule of thumb, most small business entrepreneurs are happy to recoup their money within a couple of years. It’s a short enough time to see the light at the end of the tunnel but also makes the deal worth doing for the seller. So regarding valuation, you’d be looking at a figure of around $200k for that particular business - if you apply that thinking.
Now this is an incredibly simplified view and is just being used to illustrate the thought process you should adopt. If you make an additional $120k per annum on your bottom line, then you’d have recouped your investment within 20 months.
Don't Forget The Hidden Costs
Just don’t forget to add those hidden costs for the transaction:
- Cost of moving the stock and integrating it into your systems
- Any transactions cost (legal agreement, financial analysis)
- Your time and that of your staff
- Time and cost to make any IT or website changes
It would also be normal for the buyer to pay for the stock at cost. Just make sure you’ve checked it is the right amount for the sales profile of the business. Don’t buy slow moving or dead stock by accident! We’ll talk more about this in the next article.
One more thing – don’t panic at this point about needing to find $200k all of a sudden to make this acquisition. There are several ways to make deals like this ‘self-financing’ and we’ll cover those next week. In the meantime – happy hunting!