- Why you need the right people and processes in place before making an acquisition.
- How to test whether you can effectively allocate capital.
- How to identify when the pieces are in place to grow your business through acquisition.
- What a roll-up is and why it’s such an effective growth method.
There are two ways to grow revenue: organically and acquisitively.
Growing a business organically means investing in systems, new services or products, marketing endeavors, and people so that the company can grow slowly under its own steam. When we talk about acquisitive growth, we’re typically referring to growing the business through mergers or roll-up acquisitions.
Growing a business through roll-ups is generally a much faster approach that can instantly generate new revenue, resources, and talent, and introduce you to new markets. But these acquisitions also come with a heavy cost in the form of time and money.
Still, the possibility of quickly growing a business through acquisitions is often a very attractive prospect for many acquisition entrepreneurs (AEs). But those AEs also need to be careful they don’t get lost in the excitement. Pursuing an acquisition can become a part-time job in its own right, which can lead people to become distracted from their existing operations.
In order to avoid this potential pitfall, we’re going to walk you through how to decide when to focus on acquiring a second business.
To decide this, you need to answer two questions:
1. Do You Have The Right People and Processes In Place?
A company that is run by a team of leaders is much more effective and more likely to be able to support growth.
Most home services businesses are owner-run operations, which means a single person is responsible for overseeing the operations and ultimately responsible for any new initiatives. Those owners are usually preoccupied with resources and they will prioritize satisfying customers above growing the company’s capabilities.
By transitioning to a management-run company, where a team of leaders oversees the various divisions of a company, you are able to ensure that you have the right priorities, processes, and people to support growth.
At a management-run company, the leadership team will be the ones asking for more resources and designing the processes of the organization. As a result, they’ll be the ones growing the company’s capabilities.
Before any business owner begins thinking about growth through acquisition, they should ensure that they have the right people and processes in place to support growth.
Imagine you have an HVAC company and you want to expand into plumbing. Whether you buy a plumbing business and roll it into your existing operation or build out a new plumbing division, you’re going to need people to oversee the work. If you don’t currently have the capacity to shift someone to manage this new plumbing division, then you should look at hiring someone new or redefining certain responsibilities.
You also need to ensure that the business has the necessary processes in place to support the additional workload and that everyone in the organization is adept in those processes.
These processes will vary depending on the type of business, but systems like payroll, collections, hiring, and onboarding should be well-defined enough that nothing gets missed when the company expands.
Pursuing an acquisition can become its own job. If you don’t have someone in the business who is able to oversee the search, appraisal, close, and integration of the business, then it’s probably not a good time to make the acquisition.
Once you’ve built out the proper systems and instilled an effective leadership team, then you can move onto the second consideration.
2. Can You Effectively Allocate Capital?
In order to ensure that your business is ready for growth through acquisition, you first need to test the company’s ability to create new products and services and allocate capital.
For example, if you take our imaginary HVAC company and its plumbing ambitions, you may be tempted to just buy a plumbing company and roll it into your existing operations. However, before you take that step you should first ensure that the company is able to support such an expansion.
The easiest way to do this is by simply bootstrapping a plumbing division by hiring a plumbing team and necessary tools and taking that team to a few choice builders to test out if you can get a return on your investment.
Let’s imagine you hire three plumbers each making $50,000 per year, including a tool allowance, and a manager making $80,000 per year. That costs $230,000 per year. If the new plumbing division is able to earn the company $460,000 in gross profit then you have proven the company's ability to internally allocate capital at a comparable return to a leveraged acquisition.
Whenever you buy another business there is additional risk, leverage, debt, and more weighing over the company. If you are able to prove that you don’t need to buy a business to increase profits, then you should avoid buying that business.
These elements – people and processes – are so important to a business’s growth that we built a whole training system around the concept. The ACE Framework is specifically designed to bring an organization from owner-run to management-run.
So When Do You Make An Acquisition?
Now we know when not to buy another business. But when does growth through acquisition make the most sense for a business?
If you conduct the same experiment above where you bootstrap a new product or service division, but the internal return on investment (ROI) is not a large enough sum to be meaningful, then you should consider buying something.
Let’s imagine that our HVAC company is making $5 million per year. If you allocate $2 million toward creating a plumbing division and can’t make $4 million in profit from that division, then it’s likely time to look at growth through acquisition.
You should only consider growth through acquisition once you understand the ROI of internal capital allocation and you know that it’s below 100% per year.
Put more plainly, you should only consider growth through acquisition once you understand the ROI of internal capital allocation and you know that it’s below 100% per year.
Avoid “Deal Fever”
The purpose of the questions above is to help business owners avoid acting too rashly. It can happen to the most systematic and rational business owners out there: they get so excited by the prospect of rapid growth that they don’t stop to think about whether their business can support it or whether it’s necessary.
If you do have the systems in place, the people to oversee the endeavor, and you’ve proven that your business can’t grow organically through proper cash allocation, then it’s probably time to pursue an acquisition. But even if all of these points are true, don’t let the excitement of the deal blind you to the facts.
We often see people who are so excited for a deal to happen that they will ignore their own due diligence, relying on their gut to make decisions. This is why having a well-defined investment thesis is so important, even if you’re pursuing an acquisition for growth purposes.
An investment thesis is a set of rules that defines what you will and won’t invest in. In terms of acquisition entrepreneurship, a properly defined investment thesis will ensure you know what type of business to look for and where to look for it.
A properly defined thesis can help investors evaluate potential investments and quickly disqualify bad deals while helping them avoid “deal fever.”
Why Roll-Ups Are A Good Growth Option
Once you’ve confirmed that you have the processes and people in place to support growth, you’ve proven your ability to allocate capital internally with new ventures, and you’ve built a well-defined investment thesis, you’re likely ready to start looking at roll-up acquisitions.
A roll-up – sometimes referred to as a “tuck-in” – is when a business buys another company in the same market and merges it into its own operations. These mergers combine multiple small companies into a single large entity that can take advantage of its larger size.
Roll-ups have a number of benefits that can help a company grow, including:
Increased purchasing power and brand recognition: As the number of competitors in a sector shrinks due to consolidation, the combined companies will gain more purchasing power. Moreover, once the business is acquired and folded under the buying company's name, the buyer's brand recognition increases.
Earning multiples: When a company with a higher Price/Earnings (P/E) multiple buys a business with a lower P/E, it results in what is known as an arbitrage of earnings multiples.
Also known as “multiple arbitrage,” this practice is used to increase the value of a company without making any operational improvements to it.
Economies of scale: A roll-up acquisition is sometimes used to take advantage of economies of scale in a given industry. By combining companies, the acquirer is able to boost output with a minimal increase in its operating costs. When average costs begin to fall as output increases, economies of scale are created.
The roll-up strategy can increase your earnings multiple rapidly. If a business owner can buy a company that is making $1 million in EBITDA and apply the systems they’ve already built at their first business to the acquired company, the combined company suddenly becomes much more attractive.
Moreover, it allows you to expand your services and offerings to your existing client pool. That means you have built in customers if you’re able to offer them something new, which can cut down on the time it takes to market a new service and prove its product-market fit.
Conclusion: Don’t Put The Cart Before The Horse
Whether you’re growing your business organically or through acquisitions, you need to make sure that your business can support that growth.
You will need to ensure that the right systems and people are in place to help shepherd any growth initiatives and confirm whether the business is capable of allocating capital properly. And before you rush out to buy a business, try growing your capabilities first.
Don’t get ahead of yourself. Before pursuing an acquisition you should make sure you and your company are ready. The first thing you need to ask yourself is whether you have the processes and people in place to support growth. If you have those in place, then you need to prove your ability to allocate capital.
If you haven’t tried to prove that ability, you first need to try bootstrapping a new venture or offering (rather than buying another company outright). If you’ve tried multiple new ventures and you still can’t seem to make the money back, only then should you consider growth through acquisition. Also known as a roll-up or a tuck-in acquisition, this method can be a very effective tool for growing a company quickly – assuming the company is ready.
Acquira’s ACE Framework is a change management system designed to integrate, systematize, and grow newly acquired businesses, with a special emphasis on culture, systems, and servant leadership. The purpose of the Framework is to help turn an owner-run company into a management-run company. By emphasizing people and processes, the Framework can help many businesses position themselves for success when it comes to roll-up acquisitions. It is only available to members of our Accelerator Program.
If you’d like to learn more about business acquisition and how we can help you, schedule a call with one of our representatives today.
- Don’t consider buying an additional business until you have the right people and processes in place.
- Don’t consider buying an additional business until you’ve proven your ability to allocate capital.
- Don’t focus on a second acquisition until you understand the ROI of internal capital allocation, and you know it's below 100% per year.
- If you determine that organic growth isn’t enough, roll-up acquisitions can be a very effective way to grow your business.
Acquira is a business acquisition in a box service. We help entrepreneurs buy businesses and we invest in them and their chosen businesses. We are here to help ensure that each business we work with is posed to make the biggest positive impact possible for its owners, employees, and community.