BY: Jeffrey D. Jones, ASA, CBA, CBI
In Part 1 and Part 2 of this series of articles, I discussed six of the twelve factors that tend to kill a business acquisition after the sale. These factors were: (1) poor price and deal structure, (2) refuse to develop a relationship with the customers, (3) replace key employees, (4) refuse to training from the old owner, (5) absentee ownership, (6) and make significant operating changes in the first year. The majority of business acquisitions are successful. Those that were not usually fell apart within the first year following the acquisition. This article is not about cases where the buyer knowingly purchased a failing business and was not able to successfully turn the business around or changed the concept, or buyer fraud was intended, but rather this article will focus on those transactions where the business was profitable prior to the sale, but failed shortly thereafter. The following is a review of 3 other factors that commonly lead to business failure following a business acquisition.
- Purchase expensive and modern equipment to replace old, outdated equipment.
This temptation is almost too great to pass up. You have purchased a business that manufactures widgets. These widgets are currently produced at the rate of 40 per hour on a Widget Maker 87. The Widget Maker salesman has come to you and discussed the new and improved Widget Maker 2001. It can produce 80 widgets in the same hour. It is also automated. So it should allow you to cut at least one salary out of your budget, at least in theory. But more than that, you realize it can and will produce twice as many widgets as the old WM87. The cost of the new machine can be easily amortized by using the salary of the employee you can terminate and by factoring in the greater efficiency. Since they offer lease terms you can afford it (on paper, anyway), you take the plunge. However, while the new machine is theoretically more efficient, you have failed to consider the fact that, unlike the trusty WM87, the new machine is more complex than any of your illegal alien workforce can operate. Therefore, you must hire an MIT-educated engineer to run it. Or you did not realize that you only need to produce 40 widgets an hour and any more capacity than that is really just waste. But these realizations come too late and you are committed for eternity on the lease. It won’t take many of these types of decisions to torpedo your chances. This mistake turns up in just about every manufacturing business that we see having problems.
- Under estimated the amount of working capital needed to operate the business
Any business that has accounts receivable and/or inventory will need to have adequate working capital to operate the business. However, sometimes buyers acquire a business without verifying how much inventory is needed on hand to operate the business on an annualized basis. If the business is bought during a slow period of the business with a low inventory on hand, when the business hits the busy season, the buyer suddenly discovers he/she has to now acquire much more inventory and there is insufficient funds to do so. This will impact sales and profitability. Furthermore, this type of business will have accounts receivable. If the buyer did not buy the existing accounts receivable, they will need to have the necessary additional money to carry the business. If you purchase a business that has accounts receivable, always include them in the purchase price. It is an asset of the business that can be financed along with the other assets of the business. Banks usually will not provide working capital for accounts receivable, if you do not yet own the receivables which would serve as collateral.
- Allow your ego to make all the decisions, or put “your stamp” on the business.
It is human nature to want to make all the decisions and to put your own brand of management in place. Don’t do it. Don’t demand that things be done your way solely because of your ego. You, understandably, just want to be recognized as the person in charge. However, when a decision needs to be made, you want to appear decisive. When you should be gathering all the critical employees and asking their opinion, in essence building a consensus, you are instead relying on your own judgment. After all, if they were as talented as you, they would own the business. It is the road to ruin. Whatever steps you take, make sure they are taken for all the right reasons. Under no circumstances should you decide to make a change, or for that matter make any decision, just because you are the boss.
Jeff is President of Certified Appraisers, Inc. and Advanced Business Brokers, Inc. 10500 Northwest Frwy., Suite 200, Houston, TX 77092, (713) 680-3290, firstname.lastname@example.org