We all want to grow our business, which often leads to this question: Why don’t we just buy our way to growth? It’s easier to buy than to build, right?
The short answer is, not really. In fact, this sort of logic usually leads management teams to overpay for an acquisition. This may explain why most acquisitions destroy shareholder value instead of creating it.
Let’s start with one fundamental finance point that would-be acquirers often ignore. When you buy a company, you are paying the current owners for the present value of all the future profits that the business is expected to create. You must assume that the current owners understand the profits their business will create and if you paid them any less, they would choose to continue operating the business themselves rather than selling out. (Or, you must assume you are getting an amazing deal, which most acquirers believe but few actually achieve.)
This assumption sets a pretty high bar for success. As an acquirer, you have to believe that you can create even more profits than the current owners AND you would not be able to create those profits on your own.
Management teams often assert their own growth strategy as a justification for an acquisition. Reasons include entering a new geography, acquiring new customers, or gaining access to new product lines. The problem is, to justify these reasons, you must believe you will receive more economic benefit from buying a company vs. building a product or service line on your own.
Consider approaching the issue from a slightly different angle by asking these four questions:
The best management teams use these questions to uncover profitable organic opportunities or identify more targeted acquisition opportunities that allow them to create far more value than they would otherwise. At minimum, this approach minimizes the pursuit of expensive, value-destroying acquisitions.
You can still be acquisitive–and create a lot of value in doing so–if your M&A strategy begins with a hard look at organic growth opportunities.