# Buying growth *Facing into M&A* --- Acquisitions get a bad rep. Value-destroying, dangerous, distracting for management, bad for shareholders: the charge sheet is long, and the research behind it is real. I've bought a few, so I've read that research with some interest, and the striking thing is what it actually studied. Nearly all of it is one kind of deal - Fortune 500 buyers, transformative mergers that take years to digest and sometimes never do. The finding is sound. The advice drawn from it travels a great deal further than the evidence does, and almost none of it is about a £100m business buying a £10m one. Below a certain size the sceptics are simply right. A business without the scale and maturity to absorb another one's complexity will find a deal massively distracting and overwhelming, whatever the strategic logic said. Organic growth really is the better route for most companies most of the time. Somewhere north of £50m of revenue, the arithmetic starts to change. Revenue is a proxy for two harder questions, and it's the questions that actually bind: could you lose a senior person to an integration for a year without the core suffering, and could you write the whole cheque off without breaching anything. Around that size, the core lines are at a reasonable level of maturity, and maturity is a polite word for the fact that they won't carry the next leg on their own. Getting to the next level means going somewhere you aren't already: new channels, new markets, new geographies - provided the destination is somewhere you could actually come to own, rather than open water. You can build your way in, which is slower and often right. You can stop growing, run the core for cash and hand it back to whoever owns you, which is a perfectly respectable answer that most writing on this pretends doesn't exist. Or, in a lot of instances, it's a genuine build-versus-buy decision, and a sensibly sized bet gets you into a new area faster than building. ## Why growth is worth paying for The arithmetic here surprises people who haven't run it. Take a business earning a 16% return on its capital against investors who'd settle for 10%. Its board has two proposals in front of it. The COO wants a cost programme that pushes returns to 18%; the commercial director wants an expansion that lifts growth from 5% to 8%. Which one creates more value? Run both through a simple valuation and the cost programme creates real money. The growth option creates roughly five times as much. A point of margin is worth the same at any level of return; the growth option wins because every pound reinvested earns six points more than investors require, and growth multiplies that spread across a larger and larger base. Below the hurdle the same maths runs in reverse, which is why growth at a business earning cost-of-capital returns creates nothing at all. > [!note]- For those so inclined > The working: value ≈ free cash flow ÷ (required return − growth). Free cash flow is operating profit less the reinvestment growth demands, and the reinvestment rate is growth ÷ return on capital. At 16% return and 5% growth, a £10m-profit business is worth about £138m on a 10% hurdle; push returns to 18% and it's worth £162m; push growth to 8% instead and it's £250m. Mind the sensitivity: that last number moves violently with small misses, because the denominator is now two points wide. Deliver 7% instead of 8% and the £112m of value created becomes £50m; at 6% the cost programme was the better call all along. One caution before this justifies any deal. The number that decides the case is the return on the *new* capital, and it's easy to assume the new market pays what the old one does. It usually doesn't, at least at first. If the expansion earns 12% where the core earns 16%, the growth advantage shrinks from five times to under two; below about 11% the cost programme wins outright. So the case for buying growth is really a case for buying access to returns above your hurdle, in a market you couldn't reach organically at a sensible cost. ## Which deal is this? Every small acquisition is one of two deals, and most of what goes wrong comes from pricing one and running the other. A leave-alone deal is roughly what the case says it is. You inherit the customers, the operations, the team and the working pattern, you collect the cash flow, and the integration work is paperwork: bank accounts, group reporting, audit harmonisation, a few weeks of finance time and you're done. The upside is bounded by what the business already does. So is the risk. A change-the-business deal is different, and it's where the strategic logic usually lives at mid-market scale. The reason the bolt-on in the adjacent vertical is interesting is rarely the cash flow at the asking price. It's that you can put your sales team into a market they couldn't reach on their own, or run the acquired customers through your operating processes, or put your channel behind a product you already understand. The upside is real and bigger than the leave-alone case, and so is the work: a change-the-business deal is a turnaround you have gone out and bought. Both can work. Being honest about which one this is matters because the price and the terms are very different. If the leave-alone version is worth £25m, the change version is rarely worth more, because the extra upside is created by your work after close, and you shouldn't pay the seller for value you're going to have to build yourself. ## Price the deal you'll actually run A business that's been prepared for sale has had its costs trimmed, its working capital pulled in and its capex deferred, all perfectly legal and routine. Where the founder has been paying themselves below market for a couple of years to dress the business, the profit you're buying is smaller than the profit in the information memorandum. Against a broker's glorified estimates, the number can very easily move twenty-five to fifty per cent once more realistic assumptions are embedded, which is usually enough to change the answer rather than merely adjust it. The board pack will typically handle all this with a single risk haircut on the headline price. That's the wrong instrument. A percentage off the top is a gesture at uncertainty; what you want is the case rebuilt on normalised earnings, with the founder's real cost of employment in it, the working capital where it will actually sit, and the deferred capex back on the line. A haircut lets everyone keep the number they arrived with. Then price in what the deal does to you. Senior management spent on integration is senior management not spent on the core, and if the model assumes the core grows at trend through the transition, the model is wrong. Build the version where the core flatlines for eighteen months and see whether the deal still clears. Write the post-close plan before close, with names and dates: *integrate sales by Q3, harmonise the operating processes by Q4, hold pricing through the transition* is a plan; *explore opportunities to leverage the platform* is not. The plan will be wrong by week six. Writing it down is how you notice quickly which parts are wrong, which is most of what a plan is for. And structure the terms to hold the seller to the business you intend to own rather than the one they've spent two years preparing to sell: deferred consideration, earn-outs tied to retained customers, rollover where the relationship matters. Warranties help less than you'd hope. I've won a claim under them: it took two years, we got some of the money back, and we were still stuck with a business that wasn't what we thought it was. ## Size it so being wrong is survivable The last condition is sizing, and the usual argument for it is the wrong one. The bets have to be much smaller than the core: small enough that a bad one gets absorbed and the business carries on. The standard defence is portfolio logic: do a lot of them and some failing is part of the plan. That works for a serial acquirer like Halma, which has done small deals for decades, keeps every one below a threshold, and turns down anything that would force a new operating model on it. It doesn't work for you. A mid-sized business does two or three deals in a decade, which isn't a portfolio, and the averaging that makes the portfolio argument work never happens. Each deal has to clear on its own merits. Small enough to survive stops being a portfolio argument and becomes a condition on every deal you do. > [!note]- For those so inclined > The underlying point is about single runs versus averages. A bet that's positive on expected value across a thousand parallel worlds can still ruin the one player who takes it repeatedly in sequence, because a big enough loss removes your ability to keep playing. When you only get one run, the size of the downside matters separately from whether the odds are good. Turning down positive-expected-value bets that could end the game is the correct arithmetic for someone with one timeline. ## What the capability is for If those conditions hold, deal literacy is part of the operating job rather than something the corporate-finance people do. Being able to look at a business and form a view on what it's worth, and being comfortable enough with a process to know when it's going badly, is a genuinely attractive thing to be good at. Be clear what the capability is for, though: pricing properly, and saying no quickly. Most of the times you use it, that's what it will be doing. ---