It is an approach used by many iconic and fast-growing businesses in the world including Google, who has made more than 200 acquisitions since 2001; Microsoft, who acquired more than 200 companies since 1987; and Amazon, who acquired more than 100 companies since 1998, to name a few.
Understanding the benefits of acquisitive growth is important for both buyers and sellers. Buyers can use it to quantum leap the value of their business in a shorter space of time and clever sellers, armed with this knowledge, will be able to identify businesses that will benefit the most from buying them and trying to secure some of these expected benefits through a premium price on exit.
Buy-side alchemy, how does it work?
The value of a business is effectively driven by two factors namely, the expected future cash flow a business will generate and the risk that those cashflows will be generated. Buying a business can tick both those boxes.
In terms of expected future cash flows, the positive impact of synergies such as shared costs, economies of scale, cross-selling products into each other’s client bases, and competing more effectively with the newly acquired capabilities will result in the merged cash flow of the two entities being greater than the sum of their parts and so to the value of the merged entities. 1+1 will equal 3.
In terms of risk, the lower the risk of a business the lower the discount rate and the higher the value. If the risk of the merged entity is lower than the risk of the two separate entities, then the combined value of the merged entity will be greater than the sum of the two separate businesses, again creating value from nothing.
Some of the risks that will be positively impacted by merging two entities will be firstly, customer, market, and product diversification; Secondly, it can help to achieve economies of scale and greater profit with less likelihood of the business failing. Thirdly, it can help to increase market share and reduce competition, which can lead to increased pricing power and profitability. Fourthly, it can help to gain access to new technologies, products, and services, which can help to drive innovation and growth and thus competitive advantage; and finally, if your business has a dependency on the owner, it will reduce this dependency and associated risk.
Growing acquisitively is risky but, with the benefits of Alchemy up for grabs this approach cannot be ignored, especially considering that all the risks of growing acquisitively can be managed.