CHOOSING THE BEST TIME TO EXPAND

Going up in size can be daunting, but there are a number of options to be considered while doing it.

Mike Owen

Recently, we’ve been approached by several businesses looking to expand, most of them asking about what criteria to use to be in the best position post expansion/acquisition – the answer is simple, follow your entrepreneurial nose! The real question is, has your current business got enough strength to support such an acquisition?

All businesses follow a basic maxim and that is of generating a return on investment. If a company generates sales of a million pounds and a profit of £100K then this is a return of 10% – simple. If you look at that same company and say that the investment in premises, stock, working capital is £250k then the return on investment is 40%; the invested money has rotated four times and generated 10% each lap – ‘circulation of funds employed’ multiplied by ‘return on sales’ equals ‘return on investment’. This is not supposed to be a lesson in accountancy but a yard stick that can be used to evaluate a business’s readiness to expand.

Using the above company again and extrapolating the figures forward some strange things start to occur. The £100K profits this year, after dividends, tax and a myriad of other distributions, is reduced to perhaps £30K and this amount is held within the company then the investment is increased to £280K, circulation drops to (£1m / £280K = 3.6) and the return reduced to 36% and so on – all the time profits are replacing borrowed funds the investment remains the same; once the profits (or reserves) are building up inside the company then the investment increases – time to expand.

LEAN AND FAT
Rule number one – Fat companies become complacent! Lean companies fight for survival, stay alert to every opportunity and cost increases. In general terms the worst thing to have in a business is money; money should be invested in stock and ‘turned’ but overstocking is the ultimate in stupidity. Businesses that ‘take offers’ that exceed their immediate stock requirements can adversely affect the equilibrium of their returns.

Once a company becomes fat then it needs investment to keep the speed of circulation up and maintain the returns so here is a basic requirement that needs to be satisfied in considering further expansion. Another is the ‘gearing ratio’, the amount of borrowed funds to equity; equity equating to the company’s own funds. We look at this a little differently to most and believe that, particularly now, the ability to repay the interest on, together with the pay-down of the principal amount, of any borrowings is the ‘grail’ rather than the amount borrowed. We considered it good practice to keep repayments below 25% of cash profits – exceeding this may throw you under the bus if rates increase or the cost of stock goes stratospheric post-Brexit.

But of course business expansion looks good on paper – that’s why we do it; reality generally removes the rose-tinted glasses very quickly. Experience dictates that a business planning for expansion rarely gives consideration to the detriment that will happen to the existing business. Most accountants and finance directors will suggest that it brings ‘economies of scale’; basically, if you are taking over another company you will take out the acquired management in favour of current management overseeing both businesses, this rarely works. Surprisingly we often overlook the ‘involvement’ of management in day-to-day operation and how unavailability due to being ‘elsewhere’ will frustrate staff and customers alike.

The most important aspect of business expansion is policy transfer – ask yourself ‘how many times a day do staff ask me…?’ Each of these questions state, in big letter, there is no policy for this item so staff either ask you, don’t want to be held accountable (due to insufficient delegation) or are too lazy to take a decision; before you start expanding getting this right simplifies life post purchase. Instilling missing policies and procedures in the new business will tax your tolerances, putting it into two (or more) is the absolute stuff of nightmares.

DIRTY TALK
Now we must really talk dirty – Health and Safety! If your current business is not squeaky clean then it damn well should be! You owe every member of staff the right to be safe at work and return home alive. H&S does little more than this and whilst it would test the patience of a saint, it is a necessity – No business owner can abdicate responsibility by delegation even to an HR officer so, post purchase, you will have your head on two blocks. Two options present themselves; employ an external specialist company or get your own ‘Gestapo’ but have monthly meetings with them, minute the decisions and make it happen; the Health and Safety Executive, should they swoop, will expect these to be available together with actions taken.

We test readiness of companies both financially and structurally prior to undertaking their expansion programmes and it is an ongoing source of amazement at how much within some companies is left to assumption – assuming that staff know what is expected of them leading to incredulity when they don’t.

MODERN CURIOSITY

Now for the up-side. This is a good time to invest and to expand your business. The day of ‘the old curiosity shop’ business is over – this is the time of the professional; at every level. The days of holistic growth is gone, as is the premise of just opening a new depot in the hope that customers will come in just because you are there; it was former New York City Mayor, Rudy Giuliani, who stated “‘change’ is not a destination, just as ‘hope’ is not a strategy! Ensure that any intended change is not based on hope? Create a plan and test the it with as many ‘what ifs’ that you can imagine – one of them is bound to happen! Any expansion must then be measured against that plan and progress and performance religiously monitored; any shortfall or deviation is costing you money.

Acquisition is often the lesser evil as, whilst you will acquire some problems, you start with a going concern. Don’t miss out on performing your ‘due diligence’, don’t just delegate this to accountants; bean-counters can check the finances but you know about the business – use your expertise and be sure you are buying an asset rather than a liability.

Expansion is the land of the bold not the silly; of course you should look to grow but rather like buying at auction it’s no use asking those around you if you’ve done the right thing – if they thought it was right they’d have done it first! ‘Tener cojones’ and self belief is your starter pack everything else follows!

This post was written by:

- who has written 156 posts on CAT Magazine.


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