Growth through acquisition should not be considered an option reserved solely for large or Public Companies. Small and mid-size businesses that opt to grow by acquiring other companies, rather than growing one new customer at a time, can gain benefits in addition to increased sales and profits.

Timing is Right - Two elements have combined making growth through acquisition an attractive option for small and middle market companies.

Demographics - The maturing of the Baby Boom generation, many of whom own their own businesses, will increase the number of owners willing to consider selling to an historic high.

Financing - Money is available to finance small and middle market acquisitions. Banks and non-traditional lenders are aggressively pursuing acquisition lending at a level we have not seen in twenty years. Cash required to do a deal is at an all time low.

Profit Pays the Bills Profit and Value are two main financial components of every business. Profits are essential and therefore on every businessperson's front burner. Value, on the other hand, is an elusive and intangible issue. Unlike Public company presidents, whose effectiveness is measured daily in their firm's share price, private and family business presidents need not be concerned with their company's value as their shareholders, if any, typically focus upon profit only.

Value Measures the Size of Your Pile

Shareholders of Public Companies measure their wealth (or the size of their pile) using share value not earnings per share. Successful CEOs, therefore, develop strategic plans for growth and profit that maximize shareholder's value. Mergers and Acquisitions is a fundamental element of most strategic plans to grow profits and value simultaneously. What follows is an overview of Public Company strategies to grow profits and value through acquisitions and how to adapt these strategies to private and family businesses. Although the topic may seem technical and complex it is really quite basic and straightforward.

An Overview Adding earnings or profits is self-explanatory. We will, therefore, focus primarily on the value component of growth through acquisitions.

We know a Public Company's Price/Earnings Ratio measures the amount investors are willing to pay for $1 of company earnings and that a P/E ratio of 15 for a well-run company is not unusual. Consequently, company BIG with 100 million dollars of earnings and a P/E Ratio of 15 has a value of 1.5 billion dollars. We also know private company P/E Ratios are much lower than those of Public Companies.

Strategy #1 - Acquire companies with a smaller P/E ratio than yours

Example: The Transaction -- Company BIG with a P/E Ratio of 15 acquires company SMALLER and pays 10 times earnings (P/E ratio = 10). Company SMALLER's 10 million dollar of earnings are added to those of company BIG. Increases in Value Calculation -- SMALLER's earnings are now worth 15X instead of 10 times earnings resulting in an immediate increase in value of 5X earnings or $50,000,000 (5 times $10,000,000) over and above the value paid by company BIG.

Strategy #2 - Reduce expenses through economies of scale

The picture gets even better if eliminating duplications and other economies of scale will reduce company SMALLER's expenses. Every dollar reduction in expenses translates into $15 of value (P/E Ratio of 15 X $1). Increases in Value Calculation -- Company BIG is able to eliminate 1 million dollars of redundant expense - $1,000,000 X 15 = $15 million dollar increase in value.

Strategy #3 - Acquire according to a strategic plan

BIGs acquisition of a company in order to gain specific benefits such as: proprietary products, technology, channels of distribution or talent base for example, can result in an improved outlook for company BIG. Whereas the P/E ratio usually reflects expectations of future profits, a strategic acquisition often produces a P/E ratio increase. In this example company BIG's P/E ratio increases by a dollar from 15X to 16 times earnings after the acquisition was announced.

Increases in Value Calculation -- Every point increase in company BIG's P/E ratio equates to 111 million dollars of added value (original $100 million in earnings plus addition of SMALLER's $10 million plus $1 million in reduced expenses times 1).

Calculation of Increased Value to Shareholders: In the above example, company BIG's acquisition of company SMALLER not only has increased earnings by $10 million but has increase company BIG's value as follows.

Increased value of $10 million in earnings $ 50,000,000

Reduced SMALLER's expenses by $1 million 15,000,000

Increase of BIG's P/E Ratio from 15 to 16 111,000,000

Total Increase in SIZE of PILE (VALUE) $176,000,000 This CEO has made the kind of a deal that makes shareholders happy. No wonder there is so much M&A activity in the marketplace. A well conceived acquisition should produce wondrous results. These dynamics are not reserved exclusively for Public Companies. Private and family businesses can and should take advantage of the opportunities presented by growth through acquisitions. We will now apply these principles to smaller businesses and analyze the results. Value Building Strategies for Small and Middle Market Businesses Private companies can employ the same three strategies used in the above Public Company example given an understanding of a few basic principles. General Principles: Financial Small companies generally have small P/E ratios. P/E ratios increase as companies grow and develop structure. P/E ratios increase as dependency upon owner decrease. Valuation Principles Two major value determiners are:

Perception of risk and

Expectation of future profit Businesses with essentially identical earnings, therefore, can have widely diverse values "Round Ball" Principle - Non Financial None of us are equally talented in all directions. We are not round balls, footballs or Frisbees perhaps, but no one can "do it all" well. Company strengths and weaknesses will therefore generally mirror those of its owner. Armed with a basic understanding of the ground rules we can begin to formulate a strategic plan to grow and build wealth through acquisitions. Table A summarizes P/E ratios, level of earnings, definition of earnings and management style by company size. We can use Table A as reference as we develop our plan.

Table A

P/E Ratio Usual level of Earnings and Definition of Earnings Type of Management Wall Street 15X to OMG* Typically measured in millions Definition of Earnings: After Tax * Oh My God

Professional management with many levels of responsibility. - Management's objective is to maximize profits and value to satisfy stockholder demands. Middle Market 3 to 15X $500.000 to small millions Definition of Earnings: Pre/after tax and various EBITs unless the company represents a unique opportunity, (proprietary product, technology, channels of distribution, talent base etc.), the all cash, high multiple Wall Street price is unattainable. Otherwise, dynamics found when selling Upper Main Street apply. Segmentation of responsibilities and management structure well defined. Owner may or may not be involved in operations to a significant degree. Upper Main Street 3 to 7X More than $100,000 but less than $500,000 Definition of Earnings: Adjusted EBIT ~ Earnings Before Interest, Taxes plus Depreciation and Adjustments (less an Appropriate Manager's salary)

Owner still major element of company