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When a family buys a business to expand

May 16, 2017
When a family buys a business to expand

A family will often look at purchasing another business in addition to the current one.  This strategy is quite common and can work well if considered properly.  Sadly, more often than not, the strategy of purchasing a new business is not as successful as first anticipated.

We go through a few reasons why families in business purchase or merge new businesses into theirs.

Synergies
If you acquire a new business you do enjoy synergy savings.  Your family business does not need two accountants, you do not need two head offices and you can start to enjoy volume rebates.

The important thing is to acknowledge that only a small amount of synergies actually come through to the new business.  Your internal accountant will typically want a pay rise and an assistant for the great workload.  The head office typically needs a bit of a spruce up to deal with the greater number of staff – things like employee showers start to become an issue.  And volume rebates from suppliers are often not all that cracked up to be what you think about.

Diversification
Perth is mainly a mining town.  And pretty much everybody who is in a mining related business wants to diversify into a stable annuity based income stream.  Likewise, people who are not in mining tend to look (at least they have done in the past) and the large profits enjoyed by mining-related businesses and have thought about assisting the mining sector.

What is certain is that a business with a volatile income stream has a capability and a culture to manage that.  And businesses with a steady income, annuity based, income stream also have a capability and culture to manage that.  Typically both type of cultures of mutually exclusive.

If you are thinking that the “grass is greener” it isn’t.  Both models are difficult to run and own.  Competition is fierce in every market.

Creating opportunities for the next generation
If your business is not big enough for everybody in your family: buying another business might give junior family members somewhere to learn and “cut their teeth”.  This is especially important in Perth as the smaller size of our city can reduce opportunities in niche markets.

Giving employment and learning opportunities to your family is a valid reason for buying a business.  However we should all take a step back.  What is the purpose of your family and how are you intending to foster the growth of all of your children?  If the child fails at this business (like Jamie Packer did with Onetel) how much of a loss can your family take?  If you buy two different businesses and one child exceeds all expectations and the other is bankrupt how will the family handle this?

There are many ways a family in business can assist a younger generation.  Any strategy you take must be considered from an overall perspective.

A great deal
Almost every business we investigate has a compelling story as to buying it.  It is fair to say that the accounting profession is skilled at making businesses look very attractive.

It is rare to buy a business asset for less than market value.  And while Dr Google will give you a multitude of amazing outcomes that other people have done also remember that their are more failed outcomes that people prefer to keep quiet about.

As accountants we have often uncovered some unpleasant truths about buying a business.  And while it is never fun to shut down a deal it is much better to do that then waste another 5-years of a families life trying to untangle the mess they have ended up in.

Access to infrastructure
Some business models have infrastructure assets that are simply not available unless you purchase that asset.  It might be a strategic location or an in-built system that is unique to the business.

If you buy a business of this type you will almost always pay a premium for it.  And while you will buy a great business it will always come with legacy issues.  New technology and machinery is always better than existing technology.  Barriers that were previously in the market are breaking down with innovative use of new technology.

A good question, before you buy another business, is “what could I achieve with this money if I started from nothing”.

Easier finance
The concept of cash-flow lending among banks is by-and-large a myth.  Most lenders will be reluctant to lend a family 100% of the funds to buy a business without guarantee’s or support from the extended family.

As a family separating and understanding the structuring of your loans, and security positions, is essential to managing a business asset.  Typically we see new families starting out with the finance facility fully integrated across both family assets and business assets.  However, as time progress the desire should be to make the business stand-alone for lending purposes.

A great cash cow
We rarely see new businesses become cash positive from day one.  Your family will need to make redundancies, change processes and invest heavily to assure customers, suppliers and employees about the change.

And while great cash cow businesses do exist and we often see them transacted: they come at a price.  The purchase price of the business also needs to be repaid.  And the repayment is typically from after-tax dollars.

A carefully considered 3-way forecast will help families understand the true cost of buying and integrating a new business asset.

What is important is that any new acquisition is carefully considered from both a family and a business perspective.  If a critical eye is passed over the new business, and tough questions are asked, your family could enjoy a long term benefit by making a key acquisition to add to your legacy.



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