The most important questions to ask when buying or selling a business in a downturn

Economic volatility creates a dynamic environment for merger & acquisition (M&A) activity. Some organisations become more cautious, preferring to hold onto cash reserves until the outlook is clearer. But challenging economic times also create opportunities to acquire businesses suffering low-grade stress, often at a lower price than you might otherwise expect.

Mergers can deliver many advantages, from greater market share to efficiencies of scale. Buying a distressed or even failed company may deliver value such as customer lists, infrastructure and equipment, and intellectual property.

So what factors should businesses look at when they are deciding whether to acquire another company, or sell themselves in today’s economic environment?

Identifying the M&A Motivation

The most important thing is to be clear about why you are considering a merger or purchase/sale and what you want to get out of it. What is the primary motivation? There are many different types of entrepreneurs or business owners, and depending on the category, the purpose and timing of a transaction may differ. Three of the most common include:

Lifestyle businesses

This is a business owned by someone who wants to draw a wage or dividend to cover their lifestyle costs, i.e. “I want a job but I don’t want a boss”. The goal is a steady income without the overarching ambition of significant growth. Such businesses rarely consider a sale unless the owner has reached the end of their career and wants to realise gains for retirement. These business owners seldom consider buying another business if the current operations are stable enough to provide the lifestyle outcome the owner wants.

Growth and sale

This involves entrepreneurs aiming to grow their businesses and sell in the future to create personal wealth, or, as one CEO put it to me, ‘when doing this is no longer fun’. These owners may target other acquisitions as part of their growth play, to expand geographically, add more services or bolster their customer book.

Societal impact

This is a niche category where business growth and potential acquisitions are driven by the desire for more significant societal influence. Examples could include the consolidation of NDIS care businesses in complimentary niches or a not-for-profit in social housing that merges with another organisation to create a more resilient offering for the community.

No such thing as a merger

Once you’ve identified the motivation driving your M&A activity, one of the most critical things to realise is that there’s “no M in M&A” – you never really merge businesses because one culture always predominates. This can cause tensions on both sides and present challenges in integration.

A smaller business may sell out to a larger business, but then be put out when the larger business wants to impose its culture. That’s part and parcel of being acquired, and something an owner needs to consider and accept no matter which side of the transaction you’re on. When a larger, successful business buys a smaller company, it will want to push down the processes and procedures that made it successful, particularly if the smaller company is in distress.

In two similarly sized organisations, the leadership team needs to know that the culture and values of the new organisation will likely be driven more by one company than the other, oftentimes as a result of which leader assumes the role of CEO in the new entity.

When larger organisations buy highly innovative smaller companies, they typically do so because they want the innovation, speed, mobility and agility that a smaller company enjoys. In this situation, the management of the larger firm needs to reflect on how their culture may need to adapt to allow that innovation to thrive. All too often, large businesses acquire an innovative firm, only to find that the product or innovation evaporates as the larger organisation’s culture and processes overwhelm the acquired company.

Whatever the case, an M&A transaction will always lead to an overhaul in the business, whether that’s structural, or in terms of culture. Thus, it’s crucial for both buyers and sellers to have realistic expectations of what the impact of a transaction will be on their company, and to plan for success up front.

Valuing a business

Sellers need a realistic view of what their business is worth. While tangible assets like machinery are more straightforward in M&A, intangible assets like company culture, customer relationships, brand reputation and intellectual property often hold more significant value in modern business valuations.

Google bought Motorola Mobility largely for the value of its patents: at the time of acquisition in 2011, Motorola Mobility held approximately 17,000 patents and 7,500 patent applications related to wireless communication technologies. Three years later it sold off Motorola Mobility’s handset business while retaining the majority of the patent portfolio.

Conversely, Tesla bought NUMMI — a joint venture between General Motors and Toyota — to ramp up vehicle production when it had outgrown its original production facility. Acquiring NUMMI gave Tesla a ready-made auto manufacturing facility with established assembly lines, tools and machinery.

How did Tesla and Google value the potential to their businesses? Remember that strategic buyers will typically pay higher prices for businesses they acquire, as the value of the assets in their hands is worth substantially more than the value of the business on paper.

When you’re thinking of selling, make sure you have good independent advice on what the value of your company may be, and note that this will also depend on who you intend to sell it to.

When to sell?

While the timing and readiness to buy or sell are individual decisions for business owners and stakeholders, external equity holders, like private equity firms, tend to work to fixed timelines, such as a five-year investment cycle that triggers an exit event.

For owners who plan to sell, again, consider why you’re selling. Just as you have reasons to exit, remember that the key is to also understand potential buyers’ motivations and values. Think about alignment: don’t just focus on the dollars. Both sides need to determine the desired outcome and set a clear timeline for the M&A process. This should include a post-acquisition strategy that actively manages the change process to ensure smooth integration and preservation of the value the deal creates.

A company that is getting ready to sell should ask themselves questions such as: Are customer contracts in writing? Are financials in order and is the supply chain secure? Are assets such as manufacturing equipment in good condition with a good life left in them? Do we have quality documentation around the company charter, strategy and processes? Are our HR contracts and policy documents well managed? Getting the company in order signals that you are ready to change hands and will attract better-quality buyers.

Companies ultimately need to be strategic in their approach to M&A. This means having clarity about what owners want from the deal. This becomes even more critical during a downturn. It’s important to have a clear purpose for the M&A process, instead of choosing to buy because you have an upper hand or choosing to sell just because a buyer comes along.

The why of an M&A process is ultimately the key to a successful outcome for all parties and will be an essential component to the longevity of any post-transaction business.

Ryan Williams is a playford professor of business growth and director of the Australian Centre for Business Growth, part of UniSA Business.