Why merge? Is buying to grow worth it?

 by Tony Vidler.

Last week I wrote about things to think about in valuing an agency business if you wanted to "buy to grow", and also listed 5 main reasons that advisers suggest as their reasons for acquisition of another business.  They were:

1.  Get new clients

2.  Increase business turnover

3.  Increased cost efficiency

4.  Diversify business lines

5.  Enhance market position

(http://tonyvidler.blogspot.co.nz/2012/06/you-need-to-know-if-youre-going-to-buy.html)

Now let's consider some of the common thinking around the rationale for buying another practice to fuel your own business growth.  

Before you read any further though, allow me to say that ALL of these reasons offered CAN be perfectly valid and logical moves for a smart business owner....

BUT....there are many occasions where some simple questions can head of a purchasing (and financing!) disaster too as growing through acquisition will compound problems, rather than lead to a better business.

So here's a little list of testing questions around each reason offered:

Get New Clients

The one question that I ask immediately when encountering this idea for acquisition is "what's wrong with the business you have?"

It may be that there's nothing actually wrong with your existing client base, maybe you just don't have enough of them to have a viable business.  If that is the case, then perhaps your business model needs reviewing, rather than simply throwing more damp wood on the smouldering "fire".  

Even if the business is fundamentally fine though, generally the desire to simply add more warm bodies highlights that there are some likely problem areas already within your business:

1.  Poor or inadequate marketing (which may be a wide range of things such as branding, positioning, value proposition, etc)

2.  Poor engagement (you're generating leads and business opportunities, but not engaging or converting enough of them)

3.  Inadequate sales skills (people in your business are blowing the good work done by your marketing perhaps)

4.  Poor business systems (inadequate information and data management; poor advice processes; etc)

5.  Providing the wrong thing (amazing but true!  often advisers with a business problem are simply not giving their natural - or target - market what it is they actually want and are willing to pay for)

Often there is a belief amongst advisers that simply having more people to see, or "fresh" clients to wheel out a tired old story to, will somehow transform their business.  What was that line about "doing the same thing but expecting different results...."?

Increase Business Turnover

No doubt, adding more paying clients will increase turnover, or gross revenue. 

As if that really matters.

Two simple starting questions here:

1. How much extra turnover, or gross revenue, will the new clients bring in?

2. How much of that gets to your bottom line?

The financial focus must be on profitability for the business, rather than turnover.  This is business 101 really, and is a simple (but often ignored) point.  This piece of rationale quite often highlights an existing business that has little internal financial knowledge or systems...in other words, a business where just adding bulk may well compound any existing problems.

Improve Cost Efficiency

Potentially a really good reason for acquisition, particularly in businesses that have relatively high proportions of fixed overheads and relatively low service delivery costs per client.

Two simple Questions:

1.  How does it improve your cost efficiency?

2.  So, how much do the anticipated cost savings add to the bottom line?

The first is a really big question that reveals very rapidly the level of understanding that the existing business owner has of their own business fundamentals.  Asking them to think through the areas where costs may be saved, and then identify the details of those theoretical cost savings, is illuminating.   It is also usually seriously over-estimated.

Most financial advisers (despite their personal financial literacy!) do not appear to have a clear picture of their own client profitability with their firm - how the different types of costs are allocated across different types of clients within the firm; what the marginal cost of each additional client will be in servicing or efficiency within their business; how the fixed costs will be affected by additional capacity requirements and so forth.

Diversify business lines

This is a particularly interesting piece of thinking...Generally this means "I will have access to new products or advice lines".   

When this is provided as a reason for acquisition it is a clear sign that there is a complete lack of strategic clarity and planning ability - or (at the opposite extreme) there is very good strategic thinking at work.  Business owners looking to acquire for this reason are either thinking "I need more stuff to sell", or, they have a clear idea of where their business wants to be positioned in the future and have decided logically that it is cheaper to purchase the next piece that moves them closer to the goal, rather than to spend the time and money in development themselves.

It is just a matter of working out which of those two conditions are prevailing....and once again a fairly simple question gets to the heart of it:

"how do the new business lines lead you more quickly to achieving your vision?"

You'll know soon enough from the answer to this question which end of the spectrum they are at.  However....it still has to make commercial sense, which takes us back to the points above.  Some further questioning is often required - even if the strategic thinking is good it may be that this particular purchase is not the optimal choice financially.

Enhance market position

Ah...the "bigger willie" syndrome.

Or is it?

It may be an egotistical drive or need of course, however it may be a very calculating and logical move that is fundamentally sound.  Bigger can certainly be more valuable sometimes.  

One of the best examples I have heard of was a financial adviser whose business had grown fairly large organically over many years, and after some sound strategic thinking they decided that "get big quickly" was the right way forward.  The reason?  To sell the business at a premium price and retire.  A series of rapid fire small acquisitions, a re-branding exercise across all new purchases, implementation of some standardized systems...and 6 months after all of that sell the lot at a vastly higher price then they could otherwise have done.

As an exit strategy it can be risky - but very worthwhile.  Whether it is worthwhile really does come down to that clarity of vision once again though.

In conclusion...

Buying another business to grow your own can be a great move without doubt.  But, one should really question the motivation, the rationale and understand thoroughly and logically what the benefits from acquisition are.  

If you do so, then there is a very good chance that the pieces will fit together well for you.


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You need to know if you're going to buy to grow..

 by Tony Vidler.

A common topic of discussion these days is whether an adviser should buy another practice - or more commonly, whether they should just buy a book of business from another practice.

 

The typical reasons suggested for wanting to grow through acquisition are:

1.  Get new clients

2.  Increase business turnover

3.  Increased cost efficiency

4.  Diversify business lines

5.  Enhance market position

All of these are good reasons to consider purchasing another business, and we'll consider them in depth in a separate article.  Generally it seems that the majority of transactions in financial services are still done on some form of multiple of sustainable earnings.  This is most often a "rule of thumb" type approach, where a multiple is applied to the passive income stream that the target business promises.

The main problem with rule of thumb valuations (such as just paying 3 x renewal income for example) is that they do not recognize the ease of integration, and this a critical factor in determining the success of the acquisition for the new owners.

How well matched are the two businesses?  How easy are they to bring together, and how well do they complement each other?  

There are any number of areas to consider, and you might begin by considering:

• Is it just an asset purchase, or are you looking to buy an entire business (warts and all)?  If so, what contingent and latent liabilities are lurking about?
• Similarity of client profiles between the businesses
• Geographical spread of business
• Demographics & statistics - average ages, portfolio size, product penetration or fee agreements
• Advice philosophy & values - how do product & process & philosophy work in each business
• Business relationships - suppliers, research, IT, transferable centers of influence or marketing arrangements
• Data management and CRM systems
• Workflow and advice processes - are they similar, or is substantial change required somewhere?
• Staffing - duplication of roles & responsibilities; individual skill sets; desired skill sets?
• Are there any "turnkey" or proprietary solutions that you are purchasing from the target business which would or could enhance your own existing business?

The better they are matched, and the easier & better the integration, then higher the potential value should be.

This type of analysis is in reality just a starting point however in understanding how the two businesses may mesh.  Having done that one can reasonably being to assess the cost and the benefits of integrating the businesses.  Be aware that the majority of purchasers do seem to optimistically over-estimate the "synergies", or benefits from the acquisition - and often seriously underestimate (or do not understand) the actual costs in terms of lost productivity impact and additional marketing requirements for a prolonged period.

The single most important thing to my mind though is that relatively few prospective purchasers seem to have formed a clear view or understanding of what stage the target business is at in ITS business lifecycle.

There is nothing at all wrong with purchasing a business that is perhaps heading into decline - provided you understand that decline is the inevitable path unless you have a good strategy for how to re-invigorate it.  Even if the target business looks to have moved into some self-sustaining cash-cow mode and has little organic growth within it, there may still be solid rationale to pay a premium price for it.  If the business can seamlessly be added to your own business, with highly complementary systems and data management, and opens up the opportunity for your (superior?) advice proposition to unlock latent value....then it may well be worth it.

However, simply valuing a book of clients or an advisory business on an "accepted" industry multiple, without any understanding of how or where superior value from the purchase can be derived makes little sense.

Like this?  Then share it with others...or visit www.strictlybiz.co.nz for loads more useful and interesting information.