Authored by: Timothy Meyers
After years of strong growth and increased market share, many successful businesses ultimately find themselves plateauing and unable to maintain the growth that made them successful. The revenue plateau figure varies, depending upon market and industry, but the symptom is universal: year-over-year growth becomes ho-hum. Changes in the business that once yielded significant upside now barely move the needle. The base business has grown to a size that only significant and “unnatural,” or unforeseen, changes will have the potential to yield the growth that had come in the past.
These “unnatural” changes could be what is described as inorganic growth strategies. These strategies, when properly planned and executed, can help companies grow and increase enterprise value, ultimately creating an organization positioned for strong compound growth.
Partnerships and purchases
Companies can pursue inorganic growth in several ways, from strategic relationships that benefit both parties to traditional mergers and acquisitions (M&A).
Many businesses have used strategic partnerships as a method to leverage their business. These partnerships allow complementary organizations to generate mutually beneficial revenue synergies and cost savings. In some cases, this is a great way for a potential acquirer to better understand the partner’s business. In the software world, many of these strategic relationships create channels into new markets. Fonteva, a software company that builds membership and event management solutions, uses referral and implementation partners to expand its customer base. A strategic partnership with Salesforce has allowed Fonteva to take its product previously focused primarily on associations and charitable organizations to new markets—state and local governments, including municipal utilities and recreational departments. This has helped Fonteva increase its addressable market exponentially.
Growth through mergers and acquisitions
M&A offer a means to expand into new markets and/or to improve buying power. In addition to acquiring new customers, talent, intellectual property and the ideas that come with these, purchases of another company can optimize the supply chain by eliminating pass-through charges or improve efficiency and economies through scale.
M&A can also increase the metrics by which the valuation of the organization is based. For example, a $100M revenue company that has similar margins as its public competitor of $500M will be valued at a lower multiple of earnings or revenue. As that $100M company grows through M&A, its value multiple will increase and may overtake its public company competitor based on their respective growth rates. Through the ability to sell each company’s products and services into the other’s customer base, the combined company has the ability to grow revenue and reduce costs much better than if they stayed independent.
M&A can also be the strategy in markets where scale and market coverage drive revenue. Cresa Global, Inc. was created by a recent merger of 15 entities that allows a group of single office service companies to come together under one executive team to provide a strong network of like firms and create an international footprint to provide their Fortune 500 customers a complete service line around the globe. By doing so, the entity has grown significantly and now has the resources to compete against public companies that are exponentially larger than other firms.
Considerations during mergers and acquisitions
While the rewards of inorganic growth can be great, so are the potential hurdles that should be considered. Developing a sound execution strategy requires an objective look at the organization’s current strengths and weaknesses, coupled with clear understanding of all of the risks associated with attempting to grow through M&A.
Loss of focus. Whether buying or selling, the negotiation process carries emotional and financial risks. Both parties often become emotionally vested in the deal, which can make it hard to objectively review all the elements and make the decision to back away if required. Furthermore, negotiations and the due diligence process can distract from the companies’ fundamental day to day business. For a successful M&A to occur, businesses must continue to perform throughout the transaction. Not only can a company’s value drop and jeopardize the deal, but failed negotiations can also leave both merger candidates in worse shape than when they started.
Transactional risk. As much as a deal may look “perfect” in the beginning, nothing is easy and definitely not guaranteed when progressing through all the required elements of a deal. Organizations need to navigate many obstacles for a successful outcome including detailed deal terms, due diligence, legal and regulatory issues, personnel retention, integration and upgrades, and of course financing. Some of these factors lie beyond the key players’ control and defining those issues at the onset is very important. Setting the goals and objectives with potential off-ramps to terminate the deal will help ensure progress towards a successful outcome, or reduce the wasted time and money spent on a failed deal.
Due diligence risk. Due diligence during an M&A process can also create vast unintended consequences. The dangers are especially high in companies with significant value in intellectual property. There are numerous examples where a public company expressed interest in buying a smaller company and agreed to an NDA as part of the initial due diligence process. After completing the due diligence, the potential acquirer passed on the acquisition only later to release a product based on technology that was reviewed under the NDA. To protect the intellectual property, a potential acquisition target should not allow a prospective buyer to access trade secrets for current or future products or services. For both parties, it is wise to use an outside firm to review these materials to avert any future litigation.
Cultural risk. Melding cultures is critical to a successful merger or acquisition — and a task that becomes harder as time passes. An organization that prizes flexible schedules and quality of life, for instance, may lose key personnel after merging with a firm where employees’ presence is required in the office. Attempting to force-fit two disparate cultures will likely end with some of the most valuable talent finding new employers.
Business complexity. The more complex the business operation, the harder it will be to introduce changes. Organizations need to analyze the complexity of their systems, as well as the viability of integrating new concepts or businesses. Instead of trying to merge complicated operations, maintaining separate entities with separate leadership may be optimal in some situations.
Building the right team
When contemplating inorganic growth opportunities for the first time, many entrepreneurs question their ability to drive the process. Such soul-searching reflects sound judgment because the answer is invariably “no,” regardless of the individual’s business acumen and achievements. Negotiating a successful merger or acquisition requires building an experienced team that can ask the right questions and provide sound advice throughout the process.
- Internal champion. In many cases the champion for a deal is the CEO, but to ensure independent thought is maintained on the pluses and issues of an opportunity, someone else in the “C” suite should be the internal champion.
- Board of directors. A strong, experienced and independent board will provide a great sounding board for a prospective deal. In addition to understanding the opportunities and challenges of the proposed deal, at least one experienced board member needs to play the role of “Dr. No” to the internal champion to force deep analysis of all the potential issues and risks in the beginning of the process, as well as at final close and integration.
- Executive teams. With in-depth understanding of the business and respect for both sides, the combined management teams need to work collaboratively to minimize post close risks and to plan for integrating operations.
- General counsel and outside counsel. These key players need to be in a position to work through the legal issues as they arise, as well as provide viable business solutions. Special attention should be made to the interpretation of the documents under various scenarios to ensure that if conflicts arise, all agree on the outcome. Extensive M&A experience is critical to understanding the potential ramifications of ignoring or not seeing the consequences of the agreements post close.
- Investment banking team. In many cases, leveraging an investment banking team that is industry specialized provides efficiencies throughout the purchase. This team will work closely with all parties involved, internally and externally, to navigate the sale process. This is a core component to the overall deal team and has the ability to lead the efforts and make the overall process as seamless as possible.
- Banker. A seasoned banking partner who understands the sector and business involved can help secure and structure the right debt vehicles and understand all the elements necessary to bring in additional subordinated debt and equity to optimize the financing for the proposed deal.
- Financial team. This group will play two major roles. First, it will be the team that deals with much of the due diligence activity. Second, they will require a lead financial expert that will be the driver of the post-close budgets and financial projections that will be required by the acquirer’s board and will drive much of the execution post close.
- Due diligence team. These experts of both internal and external groups will help identify risks associated with the deal, including customer and market impact. This team should have a direct reporting process to the CEO and the Board.
Reaching the next level
When an organization plateaus in its financial performance, inorganic growth strategies can produce new efficiencies and opportunities, but carry significant considerations. Baker Tilly’s emerging and high growth practice has extensive experience advising companies in building boards and management teams, cultivating channel partners and strategic investors and providing strategic advice around the elements of inorganic growth strategies.