Buying and investing in other businesses

Expansion can be an exciting and beneficial move for your business, but only if you use the right tools and follow the appropriate steps. You need to consider the total cost when purchasing another business – it could be far greater than the agreed number on the signed contract.

Reasons to consider expanding

Reasons to consider expanding

There are several reasons you might want to expand your business by buying another.

  • Horizontal expansion: If there is a successful, existing competitor, you could purchase them to obtain their customers.
  • Vertical expansion: Tired of paying your supplier? Then consider purchasing them to reduce the cost of the materials you require. Likewise, if you are a supplier, you could buy a client and sell directly to the public.
  • Obtaining IP: Intellectual property becomes more valuable every day. If another business owns knowledge that you need or value, then consider buying it to gain full rights to the intellectual property. Learn more about the value of IP from the Intellectual Property office.
Decide if it will complement your current business

Decide if it will complement your current business

Even if a new business seems like a good deal, it needs to support what you have already built. Unrelated expansion can spread your resources too thin and cause everything to collapse.

  • Does the new business fall under your skill set to manage? Will it benefit a cause you believe in?
  • Will the new business fill an existing hole in your organisation or create new ones?
  • Will it give you a competitive edge in the marketplace?
  • Will it bring new customers who want your products?
  • If you bring staff together from two different places, how will they work together? Will they support the new direction of the business?

If the expansion will not support your current business goals, then you probably should not expand.

Determine what the business is worth

Determine what the business is worth

Before you part with your hard-earned cash, you’ll want to know how much the business you’re considering buying is worth. Determining a market value for a business can be quite subjective, and the amount you’re prepared to pay will be based on what the business is worth to you, as well as the market value.

It’s not as simple as reaching a sum of the amount the current owner has invested. They might have over-capitalized in some areas or invested poorly. Conversely, they might have intangible assets such as an exclusive license to sell certain products in a particular area, or have secured future orders that reduce the risks associated with buying the business.

You obviously don’t want to pay more for the business than it is worth. To avoid this:

  • Find out more about the industry and future trends. Speak with a member of the Westpac economics and strategy team to learn more about future trends in the New Zealand economy.
  • Arrange a paid valuation to determine the market price.
  • Investigate the location of the business and any future developments and plans for the area.

Research future profits and risks

A business is not worth what it made last year, but rather what profits it will produce over the next five to ten years.

  • Past profits can work as an indicator for the future, but they are not a guarantee. Is it reasonable to expect a continued flow of profits?
  • Is the annual net profit you anticipate earning a worthwhile return on the amount of money you’ll need to invest in the business today? Some small business owners would be better off financially if they put their money into one of Westpac’s fixed term deposits, rather than toiling long hours in their low-profit business.

The amount you’re prepared to invest when buying a business will also depend on the level of risk involved. Follow the Ministry of Business, Innovation & Employment’s clear directions on performing due diligence to ensure the business is in good shape and in a growing market.

  • If the business exceeds expectations, you’ll be prepared to pay a higher price.
  • On the other hand, if it’s a new business or a new product in a low-growth or untested market, the risk involved means you should prepare to buy the business at a lower price.

Establish how much you can afford

Once you’ve arrived at a value for the business, you also need to ensure you can actually afford to make the purchase.

You’ll probably already have a financial limit in mind based on a combination of these factors.

  • The cash you have available.
  • The amount you’ve been able to secure as a loan. If you have not done so, investigate the different business loans offered by Westpac.*
  • The amount partners, investors and venture capitalists are prepared to put in.

It’s a mistake to think you can spend the full amount you have available on the business purchase. You’ll need additional funds:

  • To cover additional purchase, transfer and set-up costs.
  • To carry you through any unexpected delays and teething problems.
  • To cover the finance charges and interest payments (if applicable).
  • As a contingency reserve.

The total amount of capital available, less the money you need to keep the business running until it breaks even (including interest payments and loan repayments), defines the top purchase price you can afford to pay.

Use Westpac’s cashflow forecast worksheet^ to determine how much money you will need to set aside to cover operational costs.

If you need financing to buy the business, you’ll need to consider whether it’s still a worthwhile investment. You might have to give over control of the business to an investment partner or provide security for the finance, possibly risking your family home if the venture fails. In some cases, this additional financial burden can make the purchase a far less lucrative option.