Businesses may seek organic growth but acquisitions are the most effective way of expansion. But acquisition strategies can easily fail if handled incorrectly.

While every business owner seeks organic growth, acquisitions are the most effective way of expanding quickly. But acquisition strategies can easily fail if handled incorrectly and entrepreneurs need to plan carefully if they are not to undo all their hard work.

Peter Cullum could achieve the ambitious entrepreneur’s dream in the next few months. If the executive chairman of insurance broker Towergate – which has become one of the biggest UK insurance players in less than 10 years, following the ambitious acquisition strategy he’s driven – sells out, he stands to become a billionaire.

Since Towergate was established in 1997, it has acquired more than 100 niche insurance businesses and now manages premiums in excess of £1.6 billion. It also reported record profits for 2006, with Ebitda up by 51% at £94.4 million.

Towergate is now attracting interest from private equity firms and could be sold for as much as £3 billion. If a deal goes through Cullum, who owns 65% of Towergate, could net some £2 billion.

While Cullum’s is a dream result for an acquisition strategy, mistakes can often result in dire consequences for a business. For example, publishing group Highbury House Communications plc went into receivership in January 2006 unable to cope with almost £30 million debts racked up by a three-year acquisition spree.

Despite the presence of former Sun editor Kelvin MacKenzie – who attempted a rescue bid – Highbury, which at its height had a market cap of £250 million, collapsed with a value of only £2 million. At the time analysts blamed Highbury’s demise on expanding too quickly, not properly integrating acquired businesses and paying too much for acquisitions.

This demonstrates the importance of planning an acquisition strategy carefully before any deals are struck. “Behind everything [in an acquisition strategy] you have to have a clear brief about your objectives,” says Ian Blackburn, chief executive of snack and confectionary maker AIM-listed Zetar plc, and a veteran of some 50 acquisitions in his career.

“You should have focused targets in mind in terms of sector coverage so that you’ve got experience of the operational aspects of the business that you’re actually buying,” Blackburn adds. “This ensures that you have a certain degree of management cover in the event you have management issues with the target business.”

“The further away from a target sector that you move… you’re increasing the risks of the acquisition not being successful.”

For example, Blackburn had a clear acquisition strategy for Zetar, born of his drive to re-enter the food sector, where he had previously had success at Perkins Foods plc. He identified a fragmented but growing sector of the market and sought to bring several businesses together that would benefit from being part of a group and sharing resources.

Time consuming

But executing an acquisition strategy is difficult. Even getting to exclusive terms with a target is tricky because of the increasing number of sales conducted by auction.

“Not only have you got the basic transaction risks associated with a deal not getting done, but you also have the risk that other people are bidding against you,” says Jonathon Martin, a partner at corporate finance boutique Spayne Lindsay.

But if a business is successful in an auction, it is still important that managers do not underestimate what is involved in making an acquisition. This is all too easily done by SME owner-managers, many of whom will have not been through the process before they embark on an acquisition strategy. Therefore, recruiting outside advisers early on in the process can be crucial to whether a deal makes it to completion and the strategy is successful.

“Appointing an experienced adviser who can manage the sale process, advise on the preparation and… planning is very important,” Martin says.

Indeed, the myriad processes and requirements a business has to go through when putting together an acquisition could overwhelm an inexperienced owner-manager.

For example, in the deal process, large amounts of time need to be spent on management presentations, site visits, various management meetings and follow-ups and its attendant legal documentation, which can take up a huge amount of resources, especially for a smaller company. “During that time, if the people who are responsible for managing the [acquisition] process in the company are also the people responsible for managing the business [it] can create a lot of problems,” he says.

Indeed, pursing the acquisition strategy can result in managers losing their focus on the day-to-day running of the business, which can affect revenues and possibly cause a deal to collapse. This also applies to vendors; many deals have failed to complete because the target’s revenues have fallen so much during negotiations that it does not make the deal viable.

But if these pitfalls are avoided – and with good advice and clear focus on the deal and day-to-day running of the business they can be – then an acquisition strategy can be as rewarding as it has the potential to be for Cullum at Towergate.