The Art of the Acquisition

By Adam Stites, an EO Portland member and president of iStores, Inc.

In early 2008, after 13 years of organically growing our internet company, I decided to learn everything I could about buying a business. Later that year, we acquired two companies that met our criteria.

Purchasing on the Cheap
The first acquisition was a direct competitor. We heard through the industry grapevine that this competitor was having trouble. I looked up the company’s lien filing to determine who their bank was. I then contacted the special assets division of the bank and negotiated an agreement to purchase the bank’s lien position. The bank agreed to assign their lien position (which secured more than US$700,000 in debt) to us, provided that we pay an US$15,000 success fee if we were able to obtain the assets from the competitor.

I now had a legal right to the business. What I expected to be a quick procedure, however, involved six months of legal process and fees. With the help of our attorney, we eventually foreclosed upon the assets and took over a Web site that was once doing uS$10 million a year in sales for only US$25,000 in legal fees. The acquisition fit easily into our business and provided a return on our investment in less than six months.

Buying into Debt
Our second acquisition was in a completely unrelated industry. This company sold gifts and training aids to firefighters. While there was no apparent synergy in terms of customer overlap, operationally the business was identical to ours. So, we put together pro forma income statements and balance sheets as if the business to be acquired was operating as a subsidiary of our company.

This 28-year-old company had lost hundreds of thousands of dollars over the past several years, but we forecast the ability to quickly turn that loss into a profit. The only problem was that the business also had a fully drawn bank line of credit that vastly exceeded the book value of its assets. As with the other business we acquired, the bank held a UCC filing against all tangible and intangible assets. After much discussion, we were able to negotiate a price with the seller that was ultimately approved by the bank for much less than what was owed on the line of credit. I believe the bank saw an opportunity to get half of what they were owed, as opposed to getting nothing in a bankruptcy procedure.

Here are the top five lessons we learned from these acquisitions:

1. Understand why you are pursuing a growth strategy through acquisition.We had become very good internet retailers, but we were in a declining industry. Buying other businesses gave us the ability to apply our skills in different markets with room for growth.

2. Know what you are seeking. Without written acquisition criteria, I could have easily lost focus among the thousands of listings, and on the type of business I was looking to buy.

3. Listen to the grapevine. I learned who was struggling in our industry by speaking to our vendors. They tipped us off to the struggling competitor we bought from the bank.

4. Balance risk with opportunity. By comparing the forecast earnings of an acquisition—operating as a subsidiary of our company—against the total debt service used to finance the transaction, I determined the amount of risk (expressed in the debt-service coverage ratio) and the reward (expressed in the earnings before interest, taxes, depreciation and amortization [EBiTDA]).

5. Anticipate that the best financial forecasts will be wrong. While I knew our operating costs and could apply those to the new business units we were acquiring, there were still unexpected costs and problems. Though I couldn’t eliminate these risks, I was able to mitigate them by making reductions to the seller’s holdback financing.

In the end, I learned that by using our existing facility, staff and expertise, we could purchase existing internet-retail businesses to dramatically increase our profits. Also, our acquisition strategy is complementary to our organic growth strategy, which let us apply improvements from one business unit to another. The result is that we now have a proven, two-pronged approach to growth. More importantly, I’ve learned valuable financial lessons that will set us up for continued success.

Adam is the president and founder of iStores, Inc., which owns and operates multiple internet-retail Web sites. iStores acquisition criteria are US- based online retailers with annual revenue of at least uS$2 million. E-mail Adam at adam@istoresinc.com.

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