How Smaller Companies Can Use Acquisitions To Drive Growth
Using acquisitions as tools to drive growth is an often overlooked mechanism by SMB and lower-middle market B2B technology companies. This is usually due to the fact that most companies of that size have a preconceived notion that they are too small or lack the necessary cash to make acquisitions. And this simply is not the case.
There are typically five levers companies can use to successfully make acquisitions. And only one of those five levers is cash on hand. Variables that include debt, equity, seller financing, and earnouts are all at the disposal of opportunistic and savvy acquirers. So, when taking all of these levers into consideration, smaller companies with less cash on hand can actually be more accretive than they think, and drive meaningful inorganic growth.
Immediate Financial Impact
When done correctly, companies will see an immediate positive financial impact from an acquisition. When acquiring a financially healthy acquisition target, companies will realize an increase in total revenue and bottom-line profit. This, of course, not only has an immediate impact on the financial profile of the business, but also creates an opportunity for greater reinvestment into growth-oriented activities that in turn should accelerate year-over-year revenue growth.
Growth in Enterprise Value
Whether we’re talking about an IT services firm that is typically valued off of an EBITDA multiple, or a software company valued off of a multiple of ARR, an acquisition of a large enough asset will impact the overall valuation of the company in two ways.
Number one, an increase in the metric used to determine valuation will naturally increase the overall enterprise value of a company. So, in a scenario where an IT services firm is doing $3 million in EBITDA and may receive a valuation of seven to eight times that EBITDA number, that company would be valued at roughly $21 to $24 million pre-acquisition. If that company was to go out and acquire a smaller IT services firm that was doing $1,000,000 in EBITDA, the new EBITDA of the combined entity post-acquisition would be $4 million. Using the multiple above of 7 – 8 times EBITDA, the new combined entity would be valued at anywhere from $28 to $32 million. But that’s just the start.
Where things get interesting is when we take into account that an increase in financial metrics like EBITDA or ARR also impacts the valuation multiple a company receives. In other words, companies at a higher revenue run rate and/or a higher EBITDA run rate, typically receive a higher multiple. So, in this scenario above, the 7 – 8 times EBITDA multiple a company would have received prior to making an acquisition could, in theory, slide up to an 8 to 9 times EBITDA multiple given the higher EBITDA or run rate post-acquisition. So, now we are looking at an asset that could essentially receive another bump in valuation just because of the increased EBITDA multiple, and be valued at anywhere from $32 to $36 million in revenue.
Acquisitions offer an increase in scale. By increasing resources focused on product development or product delivery, as well as sales and marketing, companies will realize greater output across these lines of business functions. This also offers companies the ability to eliminate redundant resources in these areas and reinvest in resources that will have a greater impact on accelerating these outputs. And the classic M&A analogy of 1 + 1 equaling 3 can come to fruition in this scenario.
BIG TECH’S PURSUIT OF SMALL TECH COMPANIES
In the dynamic and ever-evolving tech realm, the age-old adage “big fish eat little fish” holds true, as M&A remains a dominant force driving innovation and competition among startups, small companies, and tech giants.
Tech Companies on the Fast Track
The pursuit of innovation and market dominance has led to a significant trend in mergers and acquisitions (M&A) involving big tech companies and their smaller counterparts. The growth of the tech sector has led to a wave of consolidation through mergers and acquisitions (M&A).
For big tech corporations, acquiring smaller tech companies offers opportunities to diversify their portfolios, enter new markets, and gain access to advanced technologies that would take years to develop in-house. More so, big tech corporations are eager to acquire these smaller firms, driven by desire to secure solid financials and tap into a pool of talented human resources.
For example, Google has acquired over 200 companies since its inception, and many of these acquisitions have been of small software companies such as JotSpot which later became Google Sites. Amazon has also acquired hundreds of small software companies over the years. One of these companies is Twitch Interactive, which has since become a famous live-streaming platform for video games. Strategic acquisitions of these software companies helped big tech solidify their position as industry leaders, outpace competitors, and maintain market dominance.
What Big Tech Wants: Financials and Human Resources
When big tech companies consider acquiring a small software development company, they look for two key things: financial performance and human resources.
Financial performance is important because it indicates the target company’s growth potential and profitability. A strong financial track record increases the value of the acquisition and makes it a more attractive prospect for the acquirer. In 2012, Facebook acquired Instagram for $1 billion. At the time, Instagram was a small photo-sharing app with just 30 million users. The acquisition of Instagram was a major financial success for Facebook. Within a few years, Instagram had grown to over 1 billion users and was generating billions of dollars in revenue.
Human resources are also essential, as small software companies often have talented developers, engineers, and designers. Acquiring these businesses gives the acquirer access to this talent pool, which can help accelerate the development of new products and technologies. The human resources within these companies are invaluable in driving innovation and maintaining the acquirer’s competitive edge.
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The Role of a General Counsel in the Acquisition Process
The tech industry’s pursuit of small software companies through mergers and acquisitions continues to gain momentum. For big tech companies, these acquisitions present unparalleled opportunities for growth, innovation, and talent acquisition. As a result, small software businesses are increasingly becoming the focal point of interest for major players in the tech space.
When considering a potential sale of their company, small software business owners often seek legal representation . While engaging a law firm is crucial, having a competent and experienced general counsel leading the process is equally vital. The general counsel serves as the central coordinator, overseeing every detail of the transaction and ensuring that all parties involved do not overlook essential aspects that could jeopardize the sale.
The sale of a company involves complex negotiations, contracts, and due diligence, which can be overwhelming for business owners without proper legal guidance. A skilled general counsel possesses the expertise to navigate through the intricacies of the deal and advocate for the best interests of the business owner.
With the right legal guidance and expertise, business owners can leverage this trend to their advantage and achieve their business objectives. Gabriela N. Smith Legal Counsel | Asesora Legal offers the legal experience needed to navigate the complexities of such deals. If you are in need of legal counsel or an international law firm for any business-related matter, take the first step towards a successful future by availing the services of Gabriela N. Smith Legal Counsel | Asesora Legal.
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