Whether your expansion strategy involves growing organically or through acquisition, the associated costs usually require financing from a third party. In order to obtain it, companies must have concrete justification for the expansion and a well-crafted game plan for how the new venture will be incorporated into the existing business.
Before embarking on an expansion path, companies must have a solid reason for doing so, emphasizes Richard T. Christensen, general manager of United Visual in Itasca, IL. "Perhaps you want to move into doing more digital signage, for example. If you have a specific goal, you can expand your horizon," he said. "You have to pick and choose why you want to grow."
Founded in 2000, Pentegra Systems in Elmhurst, IL, implemented a growth-through-acquisition strategy from the get-go: over the last eight years, it has acquired five companies specializing in varying disciplines, such as audio, video, and IT. Ed Karl, CEO, explains that when assessing an acquisition prospect, Pentegra's management team analyzes its uniqueness, potential synergies, and what overhead savings will result, as well as the company's reputation in the marketplace.
"The overhead savings, when we are putting together the projects, is a big part of it," Karl underlined. "We look at it and say, 'this company made $500 and now this other one makes $300, it should be a combined $1,000.'" The fixed costs that are eliminated as a result of combining the organizations should be reflected in the bottom line, he says. "If you have a pretty organized plan and you are going to finance, you show the historical financial statements for both companies and show the combined, and show why, you get credibility, and that will usually work."
Where some companies run into trouble is accounting for the necessary cash flow to do the business gained as a result of the acquisition, notes Kelly McCarthy, president of Genesis Integration in Edmonton, AB, Canada. "For instance, if you grow your business 30 percent over the course of the year, your challenge is typically-depending on how you are set up-making sure that you have the money to do that business," he said. "You need the additional inventory to float whatever expenses you have to float for the year, but to also handle the work on hand."
To work through this process, McCarthy suggests that companies expanding through acquisition make the initial buy a relatively small one. "The first one is where you are going to make all of your mistakes," he said. "With the next one, you will have an idea of what you are getting into."
While banks may offer a number of different financing options, Karl-whose professional experience includes a stint as a CPA-notes that for combined companies that generate under $12 to $15 million of revenue, lenders generally require some evidence of net worth. "They only do asset-based loans," he said. "They are not going to loan based on these great projections that you have based on the industry."
He adds that while other industries tap into equity and venture capital for financing, the systems integration business doesn't really suit this model. "The only thing you can finance off of in that kind of marketplace is if you have a great recurring-revenue service contract business. That is something where contracts are signed for multiple years, and you have a chance of getting money financed off of that."
Generally, banks will finance against assets such as buildings, vehicles and equipment, and, in some cases, working capital such as inventory and equipment. "If you have a relationship with your lender, usually the best you get off of inventory is 50 cents on the dollar," Karl estimated. "With receivables, it varies. You are probably not going to exceed the 80 to 85 percent range for a bank deal. It usually goes for 70 to 75 percent." How willing are banks to do this these days? "When times get tough, it's more difficult to do. When you work with somebody for a while, it's usually better."