IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Seth Rudin. Mr. Rudin is a senior M&A Intermediary at IBA (www.ibainc.com):
Should a Business Owner Grow Organically or Thru Acquisition?
Savvy business owners understand the end game. That is a successful exit at the highest possible valuation paid by a buyer.
Excluding unicorns – those companies who maintain some unique technology or possess a rare competitive advantage in the market, the mainstream privately held or family-owned business owner can achieve their highest possible valuation by maximizing sales and profitability.
For these business owners, they will most likely seek to grow their company’s top line and increase their customer base. They have two options available to them. They can elect to grow their business organically or they can buy their way to growth by acquiring and/or merging with an existing company.
Of course, to acquire another company, the business owner must have access to capital and find a willing business owner to sell to him. The question really becomes how best should the owner use their precious capital to buy growth and add profits to his stakeholders?
Owners will first need to assess how much growth the business can afford to acquire and be successful managing. Owners typically set a strategic business and financial plan together. By setting an achievable plan, the owner will understand and set the company’s north star for the employees to aim for.
The owner will assess the gap between the company’s current sales versus the targeted sales in 3 year and/or 5 years down the road (or whatever timeframe). Now, the owner must establish strategies and tactical plans to achieve the desired sales growth and customer acquisition.
Organic growth naturally comes with a cost. And thru IBA’s vast experience in dealing with various business owners every day, most business owners do not understand what is their company’s CAC or CoCA.
CAC stands for Customer Acquisition Cost and is sometimes also referred to as CoCA – which stands for the Cost of Customer Acquisition. This is a very important metric every business owner should fully understand.
CAC is the cost of acquiring a new customer. In its simplest definition, CAC is calculated by taking the total costs of acquiring new customers and dividing by the total of all new customers over a specific time period – typically a year. CAC is just one of many important considerations for assessing marketing spend such as advertising as well as the decision to grow organically or thru acquisition. Business owners often find it challenging to measure the true expenses associated with acquiring a new client.
While there are many variations to calculating CAC and may also vary by industry a company participates in, let’s agree to use this straight forward formula:
(Sales Expenses plus Marketing Expenses) / Number of New Customers
Sales expenses can include all employee and non-employee related spend for acquiring a customer. Inside and outside sales, sales managers, the cost of software for your CRM tools (Customer Relationship Management such as Salesforce, MS Dynamics, Hubspot, etc.), cost of proposals, travel, etc.
Marketing expenses typically include all expenses related to online marketing and advertising, trade shows, traditional advertising, payroll expenses for marketing resources, and any marketing tool or tracking software.
Given the nature and smaller size of many privately held and family-owned businesses, the owner may need to allocate expenses of the owner plus his other C-level staff members for their time allocated, or spent, on the company’s sales and marketing.
Once the owner calculates the historical CAC from the previous years, the owner can forecast his future CAC based on known changes to payroll or other factors impacting sales and marketing.
The owner will also want to estimate the average lifetime value (LTV) for each customer over the same time period. This is essentially the total sales a customer will generate as your buyer of your goods and/or services.
As an example, let’s say an owner is planning to increase the company’s sales from $2,000,0000 to $6,000,000 over 5 years, then the owner will need to assess the cost of acquiring the incremental $4,000,000 over the next 4 years:
As shown above, the owner can reach his $4,000,000 goal but at an expected cost of $2,500,000. If the owner can find a profitable business with $4,000,000 in sales for $2,500,000 or less, the owner can acquire the growth much faster and increase profits as well each year with additional cash flow. The targeted company being acquired should be profitable to follow thru on an acquisition of this kind. If a company with gross revenues of $4,000,000 that generates a 17% in net profit was bought for $2,500,000, it would generate an additional $680,000 of cash flow and after debt service of $278,660 annually (10 year SBA loan @ 7%) an additional $401,340 of profit. This is easily the better option for the business owner as the owner will find the acquisition more financially rewarding and less risky as a business acquisition will facilitate growth over a marketing campaign that will most likely not result in adding incremental income each year.
In summary, business owners should understand their cost of acquiring a new customer and their Lifetime Value. And, most importantly, owners should know the options available to them for achieving their end game – how to exit at the top.
If you have questions relating to the content of this article or the process associated with selling a privately held company or family business, Seth Rudin would welcome the opportunity to talk with you. Mr. Rudin can be reached at (425) 454-3052 or firstname.lastname@example.org.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.