Google bought out YouTube in 2006; Facebook acquired Instagram in 2012, and just this year Apple took over SensoMotoric Instruments; to name a few big name acquisitions. But even for smaller businesses, buying out the competition – albeit on a smaller scale – is an amazing feat on its own.
So when is it okay to buy out a competitor? Purchasing a competitor is a huge step to take and often, a costly one. Buying a business doesn’t come cheap and prospective buyers will need to invest a lot of time and money.
Equity funding or using one’s own money is a sensible choice for some starting out. However, other prospective business owners may find it easier to find alternative sources of funding. In this post, we ask the question: Would you borrow money to buy a competitor? Should you?
You can invest your personal money in the business by using your savings, selling off some assets or cashing in an inheritance to put up the required capital. However, this carries risks and can drain your finances. With the initial investment and operating expenses, it usually takes time before your newly acquired business starts turning over decent profits. It may work if you can rely on another source of income from family or close friends to cover household expenses while your business takes off the ground.
The other option, of course, is to get a loan. It must be mentioned that banks have stringent assessment criteria and documentation requirements for approving a business loan. Shaun McGowan, CEO of business loan comparison site Lend says “You will need to present a strong business case and prove it’s a low-risk proposition. Ideally, any acquisition is going to improve your reach geographically and compliment your existing business”.
What should you consider before buying a competitor?
Before you consider buying out a competitor using a business loan, there are a few considerations to make:
Why do you want to buy the business?
Could acquiring a competitor present a more efficient way to build your revenues, profit and/or market share? In today’s economy, it’s also possible that you may be approached by a troubled competitor interested in selling.
Do they have something you don’t?
Businesses often find themselves in competition with an organisation that simply has something they don’t, whether it be superior equipment or simply recognisable branding. An acquisition of a competitor often makes the most sense if they have some competitive factor that you can’t acquire. In many areas, this can simply be that the business is already established within the region. This type of reputation can be very difficult for a new business to fight against.
How much does your market overlap?
The best competitors to consume are the competitors that have markets with very little overlap. Acquiring a competitor that is in a nearby but non-overlapping market is one of the fastest ways to expand and grow your business (as the examples used at that start of this article demonstrate). While it can make sense to acquire a competitor in your same market — especially if they are performing as well or even better than your business — it isn’t the ideal situation. It’s more likely that you will lose their existing clients if you purchase a company within your own market, as these are clients that have already made the decision to work with a different business.
The bigger picture
Does the competitor have a complimentary product/service offering to yours? You should think twice about buying a company that doesn’t compliment yours in some way. It takes too long to integrate wildly dissimilar companies into yours and it’s important to look at this aspect of the combined company. It is rare when it makes financial sense to buy a company simply because you will be taking them out of the market.
Customers come first!
How strong are your competitor’s customers? You may be buying a company that only sells to those accounts you don’t want. Be very careful during your due diligence process because you ideally want to buy companies that don’t overlap your customer base too much but are good paying customers. Customers who consistently pay on time are critical to cash flow and your ability to repay debt. Take note of the payment habits of your customers and consider incentives to get them to pay early. Check with associations and competitors to make sure your payment terms are in line with your industry’s standards.
Where are you?
Does it make sense from a geographical perspective? If your target acquisition is in another city or town you don’t currently do business it might make more sense than if the company is in your own backyard. Calculate this into your potential buying price. If your company is in your own marketplace but is struggling, why not just go after their customers rather than take on the potential hassle of taking the whole company.
What stage in the business life cycle are you at?
Debt financing can be dangerous in the early stages of entrepreneurship. You’ll probably be losing money at first and this can hurt your ability to make payments on time. Your net income will be low so the tax advantages of debt will be minimal. As your business grows and matures, debt becomes a stronger option. The tax advantage will be greater, your cash flow will be more predictable, and the risk you face in potential bankruptcy decreases since you have been operating longer.
As you can see, there are more questions involved in deciding whether taking out a business loan to buy a competitor is the best idea. Answer questions like this and you’ll gain much more clarity. Have you bought a competitor business before? What insight can you add?
Camille Storms is freelance copywriter and storyteller, she writes for all kinds of industries and loves to learn the ins and outs of businesses – big and small.