The single most important consideration in any deal is that it has to cash flow. Plain and simple.
What this means is that the stream of cash flows from the acquired business (once combined with your existing business) must be enough to cover the acquisition debt payments.
In other words, money in must be greater than money out.
Simple. Obvious. Often overlooked.
Here’s a hypothetical example.
- New business purchase price is $20 million
- Estimated annual cash flow from the new business is $1.5 million
- Bank loan is $15 million, 10 years at 6% interest
- You come up with the remaining $5 million in equity
- Based on the terms of the bank loan, annual debt payments are $2 million
In summary:
- Money in from new business $1.5 million
- Money out to make loan payments $2 million
- Money in of $1.5 million minus money out of $2 million = Uh oh
This hypothetical example is overly simplified, but the main point remains the same: money in must exceed money out.
I know what you’re thinking, you would never do a deal like this, it doesn’t make any sense. And I would agree, except, sometimes we want the deal so bad we lean hard on ‘synergies’ and anticipated cost reductions.
Synergies are the financial and operational benefits created when two beer wholesalers combine – essentially, opportunities for the combined company to be more profitable or efficient than the two businesses operating separately.
These may include eliminating duplicate positions and facilities, consolidating delivery routes and warehouses, increasing purchasing power, and spreading fixed costs over a larger sales base.
The challenge is that sometimes, the synergies aren’t realized. They look good on a financial spreadsheet, but reality has other ideas.
Before you do the deal, run the simple cash flow test: Will the cash coming in comfortably cover the cash going out?
Then stress-test the synergies and assumptions. Build a best-case, expected-case, and worst-case scenario, and make sure the deal still works when things don’t go according to plan. Because acquisitions happen in the real world, not on a spreadsheet, and reality rarely follows the plan perfectly.
P.S. Whether you’re planning a transaction next year or ten years from now, we’re here to help you build a business that’s ready when opportunity comes. Learn more about my 1:1 financial coaching packages here.
