Mergers and Acquisitions For Growth: An Exit Does Not Mean The End
Most founder and/or family-owned and operated businesses think of mergers and acquisitions (“M&A”) as the finish line. An exit of their business means retirement, right?
M&A is a catalyst for growth, allowing businesses to grow well beyond the capacity of most founder and family owners. M&A brings capital and resources to allow businesses to grow and scale beyond their own abilities and capacity.
Debt: No More Free Money
The days of 0% interest rates are over, and the cost of capital continues to rise. Coupled with the instability of the banking sector and the public markets, small business loans are becoming harder and more expensive to obtain. New data from the Federal Reserve details that 46% of lenders are tightening their standards for commercial and industrial loans in the second quarter of this year.
For construction loans, it is even tighter, with 73.8% of lenders tightening standards. As such, these lenders report a nearly 56% decrease in demand for loans. Loan delinquency rates are up and are expected to worsen, especially for commercial real estate loans as owners’ ability to refinance is extremely difficult. This will further contribute to bank instability and contraction of available debt in the marketplace for smaller businesses.
A lack of access to debt will constrain many business owners and limit, or end, their ability to grow. Inflation remains high, increasing the cost of labor and supplies, which in turn, puts compression on profit margins. Companies won’t be able to generate as much cash from operations to fund the growth, and when compounded with no access to debt, leaves many businesses with nowhere to turn. They are forced to power through the down cycle and wait it out, unless they look to alternative growth strategies. This is where M&A is a powerful, and lucrative, alternative to the status quo.
M&A: A Bag of Cash to Fund Growth
What would you do in your business if someone handed you a bag of cash to spend? How would you put that capital to work? M&A allows owners to find partners who will bring that proverbial bag of cash, along with other resources and expertise, to grow companies. Many founder and family-owned businesses grow to levels that are comfortable to them; however, if given the proper capital and guidance, they could become major enterprises well beyond their current scale.
Investment partners provide capital for resources to fuel growth, such as additional marketing, new supplies/equipment, geographic expansion, additional headcount, and so on. It brings speed to expansion that individual owners wouldn’t be able to fund on their own.
Beyond capital, investment partners bring access to resources. This is the “it isn’t what you know—it is who you know” ideal. Investment funds, like Private Equity (“PE”) or Family Offices, utilize funds raised from high-net-worth individuals and organizations to make their investments. These investors are all business owners and influential people who can provide access to their network for the portfolio companies they are invested in. An example: a facilities management company was acquired by a Private Equity firm, and one of the investors in that fund is the second largest investor in multifamily real estate. This investment put that company in front of thousands of new customers overnight. That company has since grown 200% organically in 2.5 years.
In addition to cash and tangible resources, investment partners are very experienced in professionalizing and scaling businesses. They have done it for hundreds of their portfolio companies, and they have best practices to help fuel growth in a strategic and profitable way. For example, in healthcare services, the investment partner creates a central business office (“CBO”) to put all the back-office resources in one place to service all companies in the portfolio. This keeps overhead costs down and creates operational efficiency. In addition, the CBO can leverage the scale of all the companies in the platform to negotiate better insurance contracts, increasing revenue and profits. All of this is often impossible for individual owners to do for themselves, as they lack the scale to be able to implement such a structure or have leverage with payors to negotiate better reimbursement rates.
This is not specific to healthcare, as we see the same economies of scale across all industries. In industrials, companies can get better pricing on supplies and equipment and have enough scale to negotiate regional or national sales agreements with clients. In business services, companies can hire professional staff faster and with higher quality to service client needs. Across all industries, having a partner with experience in scaling businesses makes the task of growth faster and easier.
The Second Bite
PE investors who partner with founder and owner-operated business employ a “buy-and-build” model to create return for their shareholders. They buy one company, known as the “platform.” This is the foundation that the rest of the business is built upon. Think about it like a house—the platform is the concrete foundation, and the owner and their PE partner grow organically and through acquisition, which adds the walls, additional floors, etc. They build it into a much bigger house with the intention of selling that larger house in the future for a very large return.
This is also extremely lucrative for owners, as they can monetize their business twice. They sell most of the business to PE and retain a minority percentage. They, alongside their Private Equity partner, triple the size of the business in 5 years. At that point in time, owners and their partner sell the larger entity to a new buyer, allowing the owner to receive a return on the equity they retained. This return is oftentimes 4-5 times the cash invested (or more).
To illustrate: An owner sells his company to PE for $50 million. He retains a 20% ownership interest post-close, netting him $40 million in proceeds on the first transaction. In 5 years when the company is sold again, the owner would net another potential $50 million ($10 million investment x 5x return). That means the owner netted $90 million in total proceeds across both transactions.
This return is far more lucrative than if that same business owner had kept their business and exited in 5-10 years. They would receive 50% less cash over that same time period, all while still slaving away each day in the business. They’d be surviving rather than thriving during that time.
Most owners view M&A as something to be considered when it’s time for retirement. However, M&A is a powerful tool for owners to grow their business and set themselves up for more wealth and success from their business. Owners who are proactive and use M&A to setup their futures are far better off than those who wait and react. Don’t wait to plan for the end—let M&A be the beginning of the next chapter. Contact our team to learn how.