Business Strategy. Acquisitions Part 3
Posted: Jun 15 2016 / Richard Bairstow / We are Underground
Business Strategy – Acquiring Another Online Business
Doing The Deal
This is the third article in the ‘acquisition trilogy’ and here we make a few suggestions as to how to approach the process of ‘making a deal’.
Online businesses are some of the easiest to acquire because they are rarely location dependent and because the basic building blocks of most online operations are similar. You may be able to use their ecommerce platform or more likely spin up another Shopify theme to cover the front end processes and match your existing business.
If you are already an online business owner, then you and your team members will already have virtually all the skills necessary to make any commerce business a success. Sure, you may need some product knowledge if your acquisition target doesn’t operate in exactly the same market as your own – but that’s usually the easy part.
If we take the example from the previous article of a target business that will generate you an extra $200k in revenue and $120k a year in Gross Profit (GP) and let’s say you and the seller have agreed it’s worth $200k. However, you cannot be certain that the business you buy will continue to generate $120k a year in additional margin. It may be more and it may be less. What’s more you don’t have $200k spare right now!
The seller knows that you are the best (or perhaps the only) buyer and he wants to get the deal done also. So the best way to structure this for both parties is using either a Deferred Payment Plan or an Earn Out. Both options usually entail an element that is paid on the day of the transfer and both options are self-financing after that.
This structure uses an initial payment followed by a series of fixed payments that ideally enable you to be cash positive or neutral after that payment.
Let’s say that on an agreed valuation of $200k you can raise $50k on the day the business is transferred. That leaves $150k to go. If the business makes $120k a year in GP then every month you have an additional £10k. Paying that $10k to the seller each month over 15 months means you would pay off the balance completely and thereafter that $10k goes to your bottom line.
Obviously you can agree the ‘upfront payment’ to be more or less depending on your resources and the seller’s willingness to wait for the money. It’s sometimes even possible to make it completely deferred, depending on market conditions.
This process works in a similar way but is dependent on the actual future performance of the business rather the deferred payments being fixed.
Normally the deferred element in an Earn Out is based on a % of revenue achieved each month or quarter and would be based on the expected future performance as agreed between you and the seller. There are pros and cons for both parties to this approach:
- This method substantially de-risks the process for you as the buyer. If sales revenue falls (irrespective of why) then your payments are lower.
- If sales are higher, then the seller makes more than expected – and you don’t mind either because you have the additional revenue and a stronger performance after the Earn Out is complete.
- Sellers usually don’t like this approach because they can’t control the revenue after they sell you the business.
- A reporting and auditing process needs to be agreed to enable the seller to be certain the figures that you report each month (and thus his payment) are accurate.
As we’ve said previously, this is an incredibly simplified view of a possible transaction and there are many other factors to consider. But acquisition is one of the quickest ways to build your ecommerce empire and if you are smart – it’s also one of the most effective.
Here are a few final tips:
- Make sure you do your ‘due diligence’ on the seller and their business. You may have to sign a confidentiality agreement in order to see the information but ask for everything you can think of that will help you assess the ‘fit’ with your own business and the likely level of future performance. Don’t just take the seller’s assurances – satisfy yourself using facts.
- The seller will want you to take as much stock as possible. Make sure you only buy what is actually selling. If it’s slow moving or dead stock maybe take it on a contingency basis – where you only pay for items if they sell within a given time.
- Always err on the side of caution with your future sales revenue calculations.
- Make sure the seller has the right to sell all the elements you need such as trading name, copyright on designs, customer information etc.
Finally, do get some specialist advice if you feel out of your depth. You will almost certainly need a commercial lawyer to help you through the legal elements of the transaction and a good one will also have the skills to watch your back on the commercial elements as well. Happy Hunting!