Mergers and acquisitions fundamentals

Why it matters

Acquisitions concentrate risk. A failed growth project might cost a few months of profit; a failed acquisition can cost the business. But for an established business with a repeatable model and spare management capacity, buying can be cheaper than building: you pay for proven revenue rather than hoping to create it. Many of the best small-business acquisitions are also succession solutions for the seller, which means motivated vendors and reasonable terms for buyers who are well prepared.

Be clear about why you are buying

Good acquisitions start with a strategic reason that would make sense even without the particular target: entering a new region, adding a capability customers already ask for, consolidating a fragmented local market, or securing a key supplier. From the reason comes a target profile: size, location, customer type, what must be true and what would rule a business out. Without that profile, buyers fall in love with whatever is for sale.

Be honest about the alternative. Compare buying with building the same capability organically. Acquisition is faster and brings proven revenue but costs more upfront, carries integration risk and often requires debt. Organic growth is slower and uncertain but cheaper and under your control.

Structure: assets or shares, and how the price is paid

In Australia a small-business acquisition is usually structured as either an asset sale or a share sale. In an asset sale you buy specific assets, such as customer contracts, equipment, stock, goodwill and brand, and choose which liabilities you take on; the seller’s entity stays with the seller. In a share sale you buy the company itself, with everything inside it, including liabilities you may not know about. Buyers generally prefer asset sales for that reason; sellers often prefer share sales for tax reasons. Transfer duty on business assets varies by state and has been abolished in some, so the choice has real cost consequences that need advice.

The price is rarely all cash on the day. Common structures include a deferred payment, an earn-out that pays more if the business hits agreed targets after completion, and vendor finance where the seller lends part of the price. These share risk and keep the seller motivated through the handover. Employee entitlements also need attention: when a business transfers, accrued leave and continuity of service are governed by the Fair Work Act and need to be dealt with in the contract.

• Asset sale: choose what you buy and which liabilities come with it.
• Share sale: simpler transfer of contracts and licences, but all liabilities come too.
• Earn-outs and deferred payments align the seller with the result and reduce upfront cash.
• Employee entitlements, leases, licences and key contracts all need consent or assignment.
• Larger deals may require notification to the ACCC under the merger regime; most SMB deals fall well below the thresholds, but check.

Due diligence is where deals are saved

Due diligence is the structured verification of everything the seller has told you. Financial diligence tests the accounts against bank statements, tax lodgements and customer invoices, and normalises earnings by removing owner perks and one-offs. Legal diligence reviews contracts, leases, licences, intellectual property, employment agreements and any disputes. Commercial diligence talks to key customers where permitted and tests how much revenue depends on the owner’s relationships. Operational and technology diligence looks at systems, data and whether anything would break on transfer.

Use diligence to decide three things: whether to proceed, what price is justified, and what protections, such as warranties, indemnities or a retention of part of the price, you need in the contract. Your accountant and lawyer should run most of it; your job is the commercial questions only an operator would think to ask.

Plan integration before completion

The deal does not pay back at completion; it pays back when the acquired customers stay, the staff settle and the promised savings or cross-sales appear. All of that happens in integration, and most of it is decided in the first hundred days. Decide before completion what will change and what will not, who will lead the combined team, how customers and staff will be told, and which systems will be merged in what order. Communicate early and honestly; uncertainty is what drives key people and customers away.

How to approach a first acquisition

1. Write the strategic case and target profile Why you are buying, what a good target looks like and what rules one out.
2. Build the team An accountant and lawyer with transaction experience, and a funding adviser if you will borrow.
3. Find and approach targets Brokers, industry contacts and direct approaches to owners nearing retirement. Sign confidentiality agreements early.
4. Make an indicative, non-binding offer A price range and structure based on the information you have, subject to due diligence.
5. Run due diligence Financial, legal, commercial and operational, with a clear list of findings and their effect on price and terms.
6. Negotiate the contract Structure, price mechanics, warranties, employee arrangements, restraints and conditions.
7. Arrange funding and complete Debt, equity, vendor finance or a mix; satisfy conditions; settle.
8. Execute the hundred-day plan Communicate, stabilise, integrate and review against the deal case.

Real-world example

A Melbourne electrical contractor buys a competitor

Bayside Electrical has 14 staff and revenue of about $3.2 million. The owner, Marco, learns that a competitor in the neighbouring suburbs, whose owner is retiring, is for sale with revenue of $1.6 million and reported profit of $310,000. The strategic case is clear: the same trade in an adjacent area with a strong maintenance-contract base. His indicative offer is a range around $700,000 to $800,000, subject to due diligence.

Diligence changes the picture. Reconciling revenue to bank receipts and removing the owner’s unpaid hours and a one-off insurance job brings normalised earnings to about $230,000. Two maintenance contracts worth a quarter of revenue have change-of-control clauses needing customer consent. Marco restructures the deal as an asset purchase at $580,000: $430,000 at completion, funded by a $350,000 business loan and cash, and $150,000 as an earn-out paid over two years if the maintenance customers stay. Employee entitlements of about $45,000 are deducted from the price and carried over. His hundred-day plan has him and the seller visiting every maintenance customer together in the first month. Eighteen months later, 90 per cent of the acquired revenue has been retained and the combined business carries lower overhead per dollar of revenue than either did alone.

Common mistakes

• Buying because it is for sale Without a strategic case and target profile, you end up paying for someone else’s problems. Decide what you want before you look.
• Trusting the seller’s profit figure Reported profit often includes unpaid owner labour, personal expenses or one-offs. Normalise and reconcile to bank receipts.
• Skipping customer and staff diligence If revenue depends on the owner’s relationships or two key employees, you may be buying something that walks out the door.
• Paying all cash up front Earn-outs, deferred payments and vendor finance share risk and keep the seller engaged through handover.
• Treating completion as the finish line The deal pays back in integration. Without a hundred-day plan, customers and staff drift away while you celebrate.

KPIs to track

• Revenue retention after twelve months Acquired revenue still with you a year on. Above 85 to 90 per cent is usually considered a successful handover.
• Key staff retention Share of identified key employees still in the business at twelve months.
• Normalised earnings versus deal case Actual earnings from the acquired business compared with the figures the price was based on.
• Synergies realised Cost savings and cross-sales actually achieved against those assumed in the deal case.
• Return on acquisition Annual earnings from the acquired business divided by total price including transaction and integration costs.

Frequently asked questions

What is the difference between a merger and an acquisition?

In an acquisition one business buys another and the buyer remains in control. In a merger two businesses combine into one with shared ownership. Among small businesses, almost every deal is legally an acquisition even when it is described as a merger.

How long does due diligence take?

For a small business, typically four to eight weeks once the seller provides information, longer if records are poor. Resist pressure to shorten it; most expensive surprises are found in the last week.

Should I buy the shares or the assets?

Buyers usually prefer an asset purchase because they can leave unknown liabilities behind. Sellers often prefer a share sale for tax reasons. Transfer duty, contract assignment and licences all affect the answer, so take accounting and legal advice on the specific deal.

How do I fund an acquisition?

A mix is common: a business loan secured against the combined business, your own cash, vendor finance or an earn-out, and sometimes outside investors. Lenders will want to see normalised earnings, your integration plan and how the combined business services the debt.

Key takeaways

• Start with a strategic reason and a target profile, not with a business that happens to be for sale.
• Compare buying with building before you commit; acquisition is faster but concentrates risk.
• Due diligence decides whether to proceed, at what price and with what protections; follow the cash.
• Structure the deal to share risk: asset versus share, earn-outs, deferred payments and warranties.
• Plan the first hundred days before completion; that is where the deal pays back.