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M&A

Balancing Your Pathways to Growth: Organic, Acquisition or Both?

Victanis Advisory Services GmbH
2020-03-24
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Does Organic and Acquisition Strategy Mix?Both!” is the obvious answer most companies would give to the question posed in the title. Who doesn’t want to have a business that combines the strength of a demonstrably successful business model that outperforms its competitors in the market along with the strong leaps in size and market presence that acquisitions can bring? 

But to do both successfully and sustainably is rare. Two hypothetical examples (but based on experience and real situations) can illustrate this.

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Does Organic and Acquisition Strategy Mix?

Example A

Yours is a business (“Bright & Shiny Inc.”) that has seen strong growth in a market offering sound, long-term demand trends. Business A has outperformed the market as a result of an innovative business model that has made its offering highly attractive to clients as well as developing a market-leading profit margin. To further its position, Business A is aware of Business X (“Lacklustre Industries”), a competitor who has had low or stagnant growth for several years and whose profitability is under pressure.

Poaching their best people to your business has been easy and as a result you have a good understanding of how the business is run and where improvements are needed. The plan is to acquire Lacklustre, change the operating structure, overhaul its product development and implement Bright & Shiny’s sales and customer management model, Simple? Possibly.

Example B

Carthorse Services Ltd. is a sound but unexciting business. Plodding along in a market where growth is consistent but rather meagre, a situation that has been the case for as long as anyone can remember. Despite the low rates of growth, the business model is such that high levels of profitability are seemingly effortless. However, the new Managing Director decides that the business can be transformed through acquisition of related businesses that operate in adjacent markets, markets that offer far more stimulating rates of growth. Carthorse would provide the platform and the stability to build a group of companies that combine solid cash generation with high growth add-ons. Fortified with a large war-chest courtesy of debt finance at very attractive rates, the MD makes acquisitions his priority for the next 5 year planning cycle.

Year 1 sees 4 additions made to the group. But Year 2 is less successful as a result of large amounts of time and energy taken with sorting out a number of unforeseen problems in the newly acquired businesses, some personal problems with the management teams of one the newly acquired companies and difficulties with staff leaving from Carthorse. By Year 3, margins have dipped within Carthorse, the business’ main competitor has refreshed its service delivery and improved productivity as well as streamlining its offering to customers. As a result, Carthorse is losing market share, margins are under pressure and servicing the company’s debt is now a consistent issue with the CFO and, more aggravatingly, with the major shareholders on the board.

These are hypothetical examples in which aspects of what could go wrong are exaggerated, but they are designed to draw attention to the fact that organic growth and growth by acquisition do not take place without impacting the other. We could have given several other examples of how one has enhanced and contributed to the other as well, but as this note is designed to warn businesses (and in particular SMEs who may have less experience with acquisition strategy) about the pitfalls of embarking on acquisition strategy we have stressed the negative for now.

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A Checklist for a Balanced Growth Strategy

Organic and acquisition growth; the cautious would warn an SME that to do both in parallel means doing neither well. We disagree. Even for the small business, management can be ambitious with their organic growth plans at the same time as pursuing a well-defined, appropriate acquisition strategy.

In our view, planning, investment, organisational competence and the demands on management’s time are all significantly different across the two strands of growth strategy. What is needed up front in both instances require different approaches, but both growth strategies are not necessarily incompatible, even for a company with small resources. What we offer below is a short, high-level checklist to guide executives in their thinking about organic and acquisition growth and their relationship to each other.

To read - Reasons to develop an M&A Growth Strategy

Organic Growth

What is organic growth?

What do you understand as organic growth? What does ‘growing organically’ mean to your business and how does the company’s culture interpret the phrase?

Understand the different types of organic growth

Growth through new products or additional services? Growth in new markets, either geographic or sectorial? Acquisition of market share or acquisition of new customers? Which competitors will you target for market share, and what new customers will you aim to add to your existing customer base?

The Pros and Cons of Organic Growth

Be aware of the advantages and limits of organic growth, especially within the constraints of your sector and markets.

Organic growth tends to be slower as a rule than growth by acquisition. Conversely, (and with due deference to those who manage to achieve organic growth through considerable effort) it is, in some senses, easier than acquisition. As long as it entails no radical departures from the existing business model, organic growth is usually the product of fine-tuning, extending and nurturing existing operations, market approaches and identified ‘best practise’. If this is not the case, you might be in the wrong sector to start with – or the wrong manager!

Assessing the Risk Profile of Organic Growth

The risk profile of organic growth is therefore much more defensive than with acquisition growth. It is essentially sticking with activity and an environment that you are familiar with, even if there is some significant changes that need to be made to turn stagnation into growth. Furthermore, there are generally a few less potential uncertainties than there are with acquiring a business with different products or services, different management and culture or different business models and customer relationships.

Acquisition Growth

Proper Planning and Preparation Prevents….[1]

Just like organic growth strategy, acquisition strategy must be fully developed and must focus on the task of ultimately identifying a realistic number of specific targets. We may have said this before (!) but assurance concerning what would constitute a suitable target for your business, expressing this in a series of achievable and relevant criteria and then being honest when looking for targets that they meet most if not all of the criteria is a good way (there are others) of ensuring that not only you will be pursuing targets that are relevant to your business and that you understand to the degree that you are able, but furthermore it enables you to explain the rationale to the potential sellers at an early stage. The ability to describe the intended path to value enhancement, synergies etc. is essential at an early stage and significantly enhances the prospects of ultimate success.

To read - Steps to Growth through Successful Acquisitions

A Demanding Process

The process of transaction is usually intense for management as well as being expensive in transaction fees. Plan for this and put in place mitigation plans should anything happen in the wider business that will also require the focussed scrutiny of senior management. Also, there is a need to accept that, for a period (and it usually takes longer than expected – not always, just usually), other priorities will likely have to take a back-seat and be kept in a holding pattern. The aim is not to ignore these other priorities completely, but to keep them in play sufficiently that you and your team can pick them up once the transaction and any subsequent integration is completed.

Keeping ‘the Goal’ the Goal

The value creation of acquisition is not in the transaction itself but lies in the subsequent integration and the achievement of synergies, whether operational, commercial or financial. Again, start the planning for this at an early stage and in cooperation with the new company’s management. However intense a deal process may seem, it is the following few months and then the first 1 or 2 years that are critical to achieving the aims laid out in your acquisition strategy in the first place.

Assessing the Risk Profile of Acquisition Growth

The risk profile for growth by acquisition is therefore much more ‘aggressive’ than compared to organic growth. As mentioned previously, there are inherently more ‘unknown unknowns’ and that’s before you confront the potential for unscrupulous vendors! There is inherently more uncertainty in acquisitions although it is by no means impossible to build resilience and counter-cyclicality into your overall business through judicious acquisitions.

To read - Organic Growth vs. Growth by Acquisition?

Conclusion

Growth by acquisition and organic growth are by no means incompatible. They are, however, different and ultimately require an organisation to adopt different dispositions, with implications for the rest of the business. Sometimes, businesses avoid a focus on acquisitions because they are growing at such a rate that all their energy needs to be centred on capturing those opportunities. Alternatively, other businesses are so focussed on the temptation to build the size of a business quickly through acquisition that they neglect to orientate the core business around a successful, scalable and sustainable business model.

But for most businesses with ambition, a combination of the two is a good route to growth and developing an existing business in ways that enhance shareholder value. The key for management and owners are to be aware of the demands of the two approaches and to weigh up what the key ‘arbitrage factors’ are likely to be between the two options in order to arrive at a balanced and deliverable growth strategy.

[1] - N.B. There are 7 ‘P’s; the last one is Performance. A serving or former member of Her Majesty’s Armed Forces should be able to supply you with the 5th. and 6th.!

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