Gettler: Hope and fear on the merger trail

Times are tough and the business needs to expand to find customers and bring in technologies and skills. Buying another business, getting snapped up or merging operations are obvious options. But how does one enter that sort of discussion with another reseller? What strategies make it work? And what are the pitfalls?

First, be aware that mergers and acquisitions are never easy. More often than not, they fail. Studies from overseas show that 70-90 percent of big corporate mergers fail and the evidence suggests it is just as difficult for smaller businesses. There is a good reason for that: many business decisions are based on hope or fear, what others are doing or on what seems to have worked in the past. They are often not that well conceived and planned.

In the reseller space, many mergers and acquisitions could run into problems over personality issues. Most operators believe they have gone about their business the right way and do not want that disrupted.

Nonetheless, the reality is that today's economic climate will drive mergers and acquisitions with some smaller businesses of 15 or fewer workers going at bargain-basement prices. The ripe businesses are small resellers not in a position to do anything more than sell components with a mark up. They do not have the staff or resources to value-add with services and new technologies. With the prices of components being driven down and the economic crisis stifling demand, box-shifters will struggle.

The first issue for any business contemplating a merger or acquisition is liquidity and credit risk. That needs to be fully valued. It is a good time to buy, provided you have the right capital.

For any business looking for a suitor or planning a merger, another critical step is getting a valuation. If you want to pitch your business to the market, you have to know what it is worth. How much is that? Whatever someone is willing to pay for it. That is difficult and painful with the credit crisis in full swing.

In the boom, resellers were being valued way over their earnings as more companies were opening offices and expanding. Some were getting valuations as much as 16 to 24 times their earnings before interest and tax (in other words, up to 24 years to earn the money back). Much of that was driven by that unknown X-factor: how much promise the business had and how much it could be earning years from now.

But in a tougher market, there is less optimism. Earnings have slipped and valuations have fallen to about four-times earnings before interest and tax. Senior bankers say that is now the standard and for the next two to three years that is unlikely to change.

The key for a small business looking to merge or buy is to get support from the right banks.

Second, there needs to be full due diligence on the personality issues. Know the other party and their business inside out. Due diligence also needs to focus on business models and the customer base.

How does one find a suitor? For some businesses focused on a geographical area such as a growth suburb or the central business district, finding partners or targets would be relatively straightforward. In other circumstances, some resellers might resort to word of mouth or even scouring the businesses for sale sections in newspapers.

Still, the businesses for sale there are usually corner store operations, not value-added resellers. Another alternative is to use a business broker to hunt down a suitor or target, a process similar to hiring a headhunter to get through the corporate gatekeepers.

An area to consider might be combining back-office functions such as ticketing and help desks. Resellers could combine back offices through a joint-venture subsidiary to charge the partners when the service was used, similar to a franchise model.

The benefit is that back offices are fixed costs. They cost the same, regardless of sales. A subsidiary model changes this to a transaction.

While some anticipate growth in back-office mergers, it is more likely to happen at the smaller end of the industry. Big resellers are unlikely to be interested because they have already invested heavily in the infrastructure. It is more likely to interest the small-scale operator looking to keep a lid on fixed costs.

Buying a business or getting bought is difficult terrain to navigate. If it is done badly, without due diligence and careful planning, it will burden the business with horrendous costs. Done well, it is a win-win. Resellers looking to go down this route must follow a careful plan.

Leon Gettler is a leading author and presenter who specialises in IT and management issues.