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How To Evaluate The Potential Of A Business Acquisition

Business acquisitions are an increasingly common way for large businesses to achieve more dominance and for growing businesses to grow faster or in new ways. That said, not all acquisitions are created equal. Some acquisitions can instantly multiply the value and efficiency of your company, while others can ultimately serve only to drag you down. So how can you tell the difference?

Business Acquisition
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There are some high-level factors that can immediately attract you to a potential deal; for example, some business entities, like LLCs, are easier to acquire than others. But beyond that, you’ll have to do some digging to determine whether a particular business acquisition is worth your time and money.

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Why Seek an Acquisition?

There are many motivations to seek a company acquisition, but some archetypes are more likely to be successful than others. These are some of the most important ways you can acquire a business to make your own business more successful:

  • Improving performance or efficiency. Some acquisitions are meant to improve your performance or your efficiency, either by reducing your costs or allowing you to improve profit margins and cash flow. For example, you might acquire a company with a similar business model that has access to more advanced equipment and processes, which would allow you to refine your own processes and potentially multiply production.
  • Taking advantage of excess capacity. In other cases, you might acquire a company to take advantage of excess capacity that might otherwise be wasted. For example, if you own a chemical production plant, but some of your factories are unoccupied and unused 25 percent of the time, you could acquire a company that could potentially make use of those wasted hours, ultimately making you more efficient.
  • Expanding or accelerating market reach. This scenario is extremely useful for companies trying to expand as quickly or as far as possible. The idea here is to leverage a business’s geographical presence or demographic reach, acquiring them as a kind of shortcut to reach a bigger target audience with their core services.
  • Acquiring technologies or skills. Many big tech corporations (like Alphabet) pursue mergers and acquisitions for the purposes of acquiring technologies or skills that would take years to develop on their own. Startups are frequently better able to take big risks and innovate in novel ways, ultimately producing technologies that bigger companies can put to good use on larger scales.
  • Exploiting scalability or logistics. Some acquisitions are meant to improve scalability across one or more dimensions of the industry. For example, two different businesses may employ similar, but distinct product models; combining these platforms under one umbrella could allow for the development of products that can utilize both platforms.
  • Nurturing promising young businesses. Some companies acquire businesses that seem promising but are unable to grow on their own. This is half motivated by a desire to nurture the company to maturity and half motivated to exploit the promising business’s potential for the larger company’s gain.

Key Factors to Judge

Assuming you have one or more of these motivations in place, you can turn to various financial factors to see if an acquisition is worth your initial investment:

  • Obviously, you’ll need to know the relative value of the company you’re acquiring. This will often dictate your offer for the company. There are a few distinct potential approaches here, so make sure you’re relying on the average of multiple evaluations or you’re using the method that makes the most sense.
  • How much money is this company currently making? This is a factor of both revenue and cost, so it’s a good indication of how the company is performing. Startups focused on growth may neglect or postpone profitability intentionally, but otherwise, high profitability is a good sign. Of course, low profitability may serve as an entry point to secure a better acquisition deal.
  • Current and future growth. How fast has this company grown so far? How is it planning to grow in the near and distant future?
  • Acquiring a company typically means acquiring not just its assets, but also its liabilities. How much debt does this company have? How leveraged is it overall?
  • How big is this company currently? Small companies often make for better acquisitions because the logistics of integrating their current assets are easier. However, if you’re out to expand your reach or scale up your productivity, a bigger business may be better.
  • Finally, consider how liquid the business is. Could you easily sell off the assets of this business if push came to shove? How much cash does it currently hold?

These are just some of the most important financial factors you’ll want to use to evaluate the potential of an acquisition. You’ll also want to consider more subjective factors, depending on how you’re going to integrate the company, like the quality of their leadership and staff. Business acquisitions are complex, and impossible to concisely evaluate given the advice of a single article, but these descriptors should help you better understand their complex landscape.