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During a Recession Cycle:

Consider Types of Mergers (Part 2)

A recession cycle is a challenge, and also an opportunity for small businesses. Consider a vertical merger, or other types of mergers, as a way to control costs, improve efficiency and as a way to grow your business.

There are very few recession proof businesses (some can be found in the health care industry and in the food industries). For entrepreneurs looking to become stronger, acquisitions or mergers can be a successful strategy.

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The Advantages of a Vertical Merger

A vertical merger of businesses can provide quick growth and better control of the costs in the supply chain; this is a particularly effective strategy during a recession cycle.

If it makes good business sense to merge, a recession cycle can be one of the best times to invest in this growth strategy.

However, it is important to recognize that your operation needs to have relatively strong financials to effectively merge; and/or the 'other' operation needs to have good cash flow.

Do not proceed with a vertical merger (or acquisition) if it is not a fit for your strategic direction and vision.

Business Growth, Mergers and Strategy

The reason that a vertical merger is a good strategic consideration is that this type of merger allows you to reduce your dependency on your supply chain and to increase your efficiency while lowering costs.

Once you've defined the parameters (see Vertical Merger, Part 1 for a list of parameters to consider) that are applicable to your business, and you develop your own assessment of whether or not the acquisition or merger is a good strategic decision for you, then determine how much you are willing to pay for the deal. Merger agreements can be challenging to develop - to be successful,they need to be considered a 'win/win' by both parties.

Is there a valuation for the business (if so, is it recent; do you trust it - if not, get a valuation done, it's worth the cost)?

Set a 'walk away price' for the business after you have done some initial due diligence. Be firm on that price; don't get caught up in buying and negotiating.

Be prepared for competition - especially if the company is a good 'buy'. In a competition, the best deal for the selling company might not be price alone but how you plan to manage the employees. Will you offer them all a job? Will you cut staff? For a retiring business owner who is committed to the organization's employees, communicating your plans for the employees could be a key decision point.

Consider the cost of the acquisition (don't forget the pay-outs you will have to provide if part of the deal rests on the synergies from laying off some staff). Consider the payback of the acquisition. Compare both the cost and the benefit (return) to the cost of other opportunities. For example, should you buy the business or should you pay down/off debt? Do a thorough analysis of your options.

When making a decision on whether or not to go ahead, consider the impact on your strategy in business, particularly during a recession cycle (a recession weakens even strong businesses but good opportunities can be found during slow economic times).

Consider the Impact of Acquisition or Merger Agreements on Your Business:

  1. Understand how the acquisition fits into existing operations.
  2. Make sure you understand the other organization's unique value proposition and service or product differentiation - and that it's a fit with yours.
  3. What is the service or product life cycle; and where is the service or product in its life cycle stage?
  4. Have a look at the business plan (for the past 3 years if possible, as well as the current year and the next couple of years forward).
  5. What is the operation's market positioning? What is the operation's product positioning?
  6. I think it's important to get a list of key customers (representing at least 80% of the sales volume).

Ensure that the business does not depend on one large account (defined as 20% or larger); that would be high risk (and even more so, during the low period of a recession cycle - because you need to know and understand that account's survival prospects).

Once you've looked at the customer list and the sales volume, pick four or five off the list and ask if you can speak to the key customer contacts; you want to know how they are perceived.

If that is not possible (for confidentiality reasons), then ask if they have completed any customer surveys or if they have feedback from customers in emails or letters.

You need to get an understanding of the relative worth of the brand identity to the customer base.

Do you have competition for the purchase of the business?

Are there other potential 'suitors' (that usually means a bidding war; great for sellers, not so good for buyers).

Before you begin the process of developing the merger agreements and conditions, you will want to see the business financial statements (for the past 3 years, as well as the current year, and forecasts (along with assumptions) for future years if available). Prepare financial projections and scenarios for after the acquisition or merger.

Include cash flow projections. If you need to finance the merger or acquisition, ensure that you talk to your lenders and get an acquisition loan in place before you make the offer (or make your offer conditional on getting your financing in place).

The structure of acquisition or merger deals often starts with a Letter of Intent (LOI) which enables you to do the due diligence necessary to move forward to a purchase agreement. The LOI will define confidentiality agreements, access to information and to company staff, a time line, whether or not you want to do an appraisal and/or a business valuation, and specific terms and conditions that relate to your offer. It is important to have a lawyer refer your Letter of Intent before you sign it.

Types of Mergers

Merger agreements need to be reviewed by your lawyer and your accountant; consult with these advisors to ensure that the deal you make is legal (some countries have strict competition laws) and that the acquisition accounting and financial statements are reviewed by a certified accountant.

A vertical merger can be one of the most productive types of mergers; if done well and analyzed thoroughly it can help make your business stronger - particularly during a recession cycle.

On the other hand, a horizontal merger typically results in improving synergies and a reduction in staff but can also be highly effective if the marketplace accepts the new organization (be careful to assess how the market will feel about a dominant business if that is the result of your horizontal merger).

Recession and growth are part of the business cycle. Consider mergers and acquisitions at the right stage of the recession cycle. Remember that there are truly no recession proof businesses - even though some businesses are more at risk than others (high cost luxury businesses) - but also remember that sometimes you can gain strengths in merging with, or acquiring, another operation that would take years to achieve organically.

A vertical merger is a significant commitment in money, time and other resources. You need to make sure that you get a good return and that the investment is a good fit for your business. Do the due diligence necessary to thoroughly understand the risks and the rewards of going forward.

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Read More:

What key actions should you take during an Economic Recession?

How to Survive a Recession? Find out what financial and non-financial metrics will be helpful to your business during a recession cycle.

Return from Recession Cycle, Vertical Mergers Part 2 to Vertical Merger, Part 1.

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