#8 – Acquire a business
17 October 2019
Every week we take a look at a ‘Moment of Life’. In the eight blog about our Moments of Life we talk about acquiring a business.
Acquire a business
Companies are always looking for growth. In our last blogs on the Moments of Life, we have reviewed several growth moments for companies. Among others, a company can invest in new marketing campaigns to get their product known or invest in foreign commercial outlets to achieve growth. However, sometimes the best way to realise growth is to simply acquire another business, keeping in mind Two are better than one.
There are several ways a company can achieve growth through taking over another business. For example, a company can buy its way into new international markets to increase revenue. Or, if they were to take over a company in the same market, the company could increase its market position and gain market power. Another reason to acquire a company is to gain control of the underlying valuable assets, knowledge or patents. Moreover, the increased size of the newly merged company enables it to achieve economies of scale through, for example, more bargaining power over the suppliers or sharing production facilities.
But a takeover is not always a strategic move or a business to business transaction. A takeover is often a result of a so-called management buy-in opportunity. Logically, with a management buy-in, the new manager buys its way into the management of the company by taking over (a part of the shares) the shares. Generally these buy-ins happen when a former manager looks to retire.
Whatever the reason of the acquisition, it usually requires a large investment. If the entity taking over the other business is unable to finance it from their own funds, the company can request a loan with October. We have done a number of acquisition and management buy-in projects, such as UW-S, who borrowed €308,000 for a management buy-in after the former owner passed away.
Analysis by the Credit Team
Financing an acquisition requires careful analysis. Not only by us, but also by the party taking over the other business. Acquisitions can be risky. Our credit risk director has indicated that we have a higher default rate among acquisition projects. For example, because we have financed acquisitions where the seller misrepresented the value of the underlying business assets. The seller did not disclose overdue maintenance or fiscal debts. If this is the case, the buyer always overpays and the investment does not yield. Therefore, we now require the buyer to do extensive due diligence. Besides, the buyer should be able to show that it has sufficient knowledge of the sector.
Acquisitions also come with higher than average operational risk. For example through, mismanagement of the acquiring firm or a culture clash between employees of the different companies. It could result in job insecurity and will affect the productivity, revenues and in the end the repayment capacity. To absorb the operational risk, we require a higher minimum repayment capacity for acquisition projects. The FCCR should be at least 1.2, which means a margin of at least 20% to cover the loan repayments.
Nonetheless, acquisitions have great upsides if executed well. They often lead to an increase of sales and a stronger market position for the newly formed company. It leads to synergy and scale advantages. For example, marketing efforts can be combined and carried out with fewer people. Furthermore, all costs can be spread over more clients. Acquisitions ensure an easy way to reduce wage costs as well, because overlapping positions can be eliminated.
To reduce pressure on the management, we can reduce the financial burden at the start of the loan by offering a deferred capital repayment option. During a predetermined period, the borrower will only have to pay interest. A deferred capital repayment reduces stress and allows management to settle in and make sure the acquired firm operates at full capacity. After the deferred capital repayment period, the loan repayments follow a normal amortization schedule.
– Alexander en Bob from the Credit team in Amsterdam.
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