Mergers and Acquisitions For Dummies (11 page)

Capital needs:
A growing company, even a highly profitable company, usually requires more capital than the business generates from operating cash flow. Why is that? For most companies, cash flow lags behind revenue recognition, and revenue recognition lags behind expenditures required to support that revenue. A growth company that constantly needs to reinvest in the business (new employees, equipment and supplies, and so on) essentially has the capital needs of a much larger enterprise. Owners often decide they're no longer willing to put their money at risk, and as such, they're ready for another owner, perhaps a larger and better-capitalized entity, to swoop in and take the company to the next level.

The segue:
I'm not talking about those fancy two-wheeled scooters here. The
segue
refers to a natural phase during the life cycle of a company: the gradual shift from a entrepreneurial company to professional company.

As a company grows, it needs more people to manage, oversee, and support the company's new, larger size. With each new hire, the dynamic of the company changes; the entrepreneur/owner's influence on the corporate culture is diminished. This move isn't a bad thing; it's normal. The company, by necessity, has to shift from a centralized, seat-of-the-pants, CEO-is-in-on-every-decision organism into a diverse, decentralized, and highly structured entity.

Many successful entrepreneurs simply don't have the ability (or interest) to design, implement, and run a highly structured company and thus begin to pine for the days of yore. At this point, bringing in a larger, professionally run entity may be the best way for the company to continue its upward growth.

Chairman of the bored:
The major battles are won, the company is on a great footing, and everyone knows his job and does it well. So where's the problem? Believe it or not, many business owners, especially those of the entrepreneurial stripe, grow exceedingly bored with a well-run company. In this situation, both the company and the owner may be better off if another, more-engaged entity takes over.

An owner selling his business so that someone else can take it to the next level isn't indicating that he can't run the business; he may be setting his sights on his next business venture. He may be one of the vaunted serial entrepreneurs you've undoubtedly heard about. The world of M&A is rife with them, and everyone is better off as a result because entrepreneurs create jobs, new products, and better services.

Divesting a division or product line

An owner doesn't have to sell the entire company; selling a division or a product line is a very common M&A activity. Some of the reasons to divest a division or product line include

A bad acquisition:
Here's a bit of irony for a book about M&A: Bad acquisitions are often the reason companies sell businesses, thus fueling a less-than-virtuous cycle (for Buyer's shareholders) of making acquisitions at high prices and then selling them off at low prices, over and over and over. Sometimes Buyer is too large and the acquired company gets lost in the shuffle and declines from lack of focus and support from the parent. Other times, the acquired company suffers as a result of bad decisions by Buyer. I've seen far too many acquired companies go downhill because Buyer decided to cut costs by firing the sales staff! Getting rid of the sales staff often has the effect of — surprise, surprise — reducing revenue. As the acquired company declines because of these bad decisions, it may start to lose money to the extent that Buyer eventually seeks to cut its losses by divesting the acquisition.

An overleveraged Buyer:
Sometimes Buyer borrows too much money to finance the acquisition, and the slightest hiccup in the economy can impair the acquired firm, thus forcing Buyer to sell off the acquired company. Actually, Buyer's lending sources most often force the issue when Buyer is unable to service the debt incurred to finance the acquisition. Buyer has to sell the acquisition (often at a bargain- basement price), or worse, the creditors may end up taking over the acquired business, resulting in a total loss for Buyer.

A money-losing division:
The decision to sell a weak division is often very easy and straightforward, especially if the rest of the company is strong. Losses can drag down an otherwise-strong company, so instead of throwing good money after bad, a company may simply spin off a money-losing division to get rid of it and its offending losses.

A lack of synergy:
Sometimes one plus one equals three. Many other times the grand plan of combining two entities doesn't pan out. For example, say a marketing services company starts up a janitorial services division. Most likely, the parent company will discover two divisions in disparate markets are spreading the company too thin. The best course of action may be to sell off one of the offending divisions and focus on the core strengths of the company.

In the hands of the correct owner, divested divisions often rebound quickly. Far from being the bad gift that just keeps on giving, selling off a division or product line that doesn't fit with Company A may be a perfect fit in the hands of Company B.

The industry is changing

The decision to sell a company in the face of a changing competitive landscape is often a very smart move. But it's a difficult move because forecasting the future is so darn difficult. When people wanted to forecast the future in days of old, they would observe the flight patterns of birds . . . and then make up something. Today, folks read newspapers and the Internet, follow their gut instincts, and try to guess what's going to happen next.

Timing the market can be a dangerous pursuit, but if a business owner believes the future involves technology developments that will render his company a has-been, or worse, obsolete, he may be ready to exit the industry by selling the business.

For Buyers, changes in the industry are always a risk. Just ask any newspaper about how the Internet changed the way news is disseminated.