Buying Businesses3

In today’s blog I present the last case study of a business we bought in November 2009. For a while my friend and I have been running or rather have been attempting to run a Wealth Management Company. In that process I met a business broker – a person whose job is to locate businesses for sale and then source buyers for the businesses. We tried doing a few deals together in 2008 but due to the nature of the economy we failed. However in late 2009 he gave me a call stating that he had some two businesses that he was selling. The businesses were related and were in the steel engineering industry. My wife accompanied me to view the place and was impressed by the potential of the businesses. Although initially we were viewing these for purposes of our potential clients we then felt we should consider acquiring them ourselves.

When we analysed the two businesses we realized that one had immense potential while the other was a loss leader. We opted to buy the one business and not the other. To confirm our analysis the sellers immediately auctioned the equipment of the loss making business but reserved some critical equipment from that business for us.

A friend had indicated to me that some building societies had started giving out mortgage funds repayable in ten years. So we decided to structure a purchase of the building and the equipment and fund them through mortgage financing. However before we could conclude the deal the building society stopped the structures because of the unstable economic environment then, when the Prime Minister partially disengaged his partners in the Inclusive Government.

Our main interest lay in two things namely the value of the real estate underlying the business and secondly the fact that the business had potential in at least four sectors of the economy namely mining, agriculture, manufacturing and construction industry. Inherently this meant that you are not restricted to the challenges of one sector of the economy.

As negotiations proceeded we changed tactics and opted to buy just the assets of the business rather than the building and business as it had been operating in the negative for the three months prior to our negotiations.  We created an option to buy the building at a later stage. In our view this would also reduce the need to purchase the good will. This was agreed to and at that stage we offered to pay a deposit of about 20% of the purchase consideration and the balance to be paid in three equal monthly instalments. We had based our decision on the fact that our other business was doing well and could easily fund the acquisition.

We had also been shown the list of prospective contracts – these were worth at least about four times the purchase value – and were told that there were at least three contracts which were imminent which were worth the value of the full purchase price. Hence the deal would have been self liquidation. However we later discovered that we were misled into believing that these contracts were cash upfront contracts when in actual fact payment was spread over eight months. Two of the contracts that were imminent indeed materialised but the majority of prospects never materialized. This taught me the need for a proper due diligence to be done by the purchaser. In this case we had trusted the report and due diligence done by the business broker. Secondly the deal was done hurriedly –which was an error on our part. Negotiations were completed within one month. We could have taken our time.

Coincidentally a key client who comprised about 80% our other business’ revenue suffered a mishap and so completely stopped doing business with us. This completely cut off the possibility of funding this purchase through this avenue. At this stage we had already paid the 20% initial deposit and informed we were to take over management of the purchased business by 1st of December 2009.

By a miracle of God our bankers whom we had approached for a bank loan some three months earlier for some other structure suddenly informed us that the loan had been approved. We then used these funds to pay our next two instalments to bring total paid to about 67% of sale price. We finally managed to get the balance as very expensive money from another bank. In effect the business was acquired on only 20% cash upfront and the balance was based on debt instruments. The major portion of the debt has since been repaid but the company struggled to pay the balance. This was exacerbated by the fact that the business had been predominantly focused on mining and yet early 2010 was bad for that sector after the gazetting of the indigenization regulations. However God has been faithful even during those hard times.

The learning point is that when you fund some business purchase with debt be sure that you have sufficient assured cashflow to finance it. One also needs to clearly understand the current customers of the business and what they are going through. An analysis of the potential business’ customers is very critical to assure success of a business purchase. Equally an appreciation of the political and economic environment of the host country is vital as this can easily affect the post-purchase performance of the business.

Another learning point is that when you purchase a business via a purchase of assets you should have sufficient capital to inject into the business because you inherit a business with no cash at all. We had hoped that the expected initial deposits from contracts that were imminent would become start up capital. This however proved tricky. It is therefore critical if purchasing a business using the assets acquisition model that you plan to have working capital allocation. We have had to create innovative financial structures to work past these challenges.

The final learning point from this acquisition is that when you inherit the staff of a business you purchase quickly assert your authority and chart the direction of the business. In our case this took time because the purchase was done over three months and the seller was still exercising influence behind the scenes. The business had had at least four failed acquisitions in two years and so for a while the staff had loyalties to the seller and thought the transaction would fail. In future when I acquire a business I will immediately effect managerial control.

Effectively acquiring a business requires a lot of thought and foresight. It is also critical to plan for some unexpected things to happen.

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  • Reply Norman August 16, 2010 at 11:02 am

    Very informative Sir. Thanks for the models and examples.

  • Reply Revolutiön Senda August 16, 2010 at 2:21 pm

    The reason why l follow Dr Makoni’s models is that they are applicable to every level of bussiness.He gives lessons from his own challenges which makes him unique in every way.l am indeed grateful for a man like him.

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