Business Owners: Know Your Buyer!
Business owners! Do you know your buyer?
Most business owners who read this are probably not thinking of selling their business – at least at the moment. But the time will come because, as we say around here, “Every business that doesn’t fail will eventually change hands!”
But there are different types of buyers of businesses and if business owners don’t give some thought to which might be the best fit, the process of selling could be a lot more painful, time consuming and less remunerative than it otherwise could be.
Now, the best way to approach a sale is to enlist the help and guidance of the right group of advisors, including an experienced professional business broker, of course, but business owners should be reasonably well-versed in the process so that, if nothing else, they’re familiar with the language brokers use and how the process will eventually unfold.
So, this post is essentially an overview of the types of buyers, what they look for and how they approach the process.
Types of Buyers
Aside from an intergenerational transfer in which the owner’s children or other next generation members inherit or buy the business – or one or more employees buy it – there are two primary types of buyers in the mergers and acquisitions (M&A) marketplace: strategic and financial.
Strategic buyers are generally other businesses that operate in the same or a related industry. This might be a competitor, a supplier, or even a customer of the business being sold.
The second type, financial buyers, typically are private equity firms, family offices, or high net-worth individuals and families, some of whom may have amassed significant capital from selling a business in the past. They can also be a group of investors who collectively pooled their resources to acquire one or more companies.
As a general rule, strategic buyers acquire businesses because of the potential the combined companies have to realize synergistic growth both in the short term and, more importantly, in the long term. A transfer to a strategic buyer is often more complex insofar as the strategic buyer has more than just the immediate financial return in mind. But finding the right strategic buyer will usually maximize the enterprise value of the selling company.
On the other hand, financial buyers, especially private equity firms whose main goal is to buy a company and sell it for profit over a three- to seven-year horizon, are more interested in the immediate and short-term cash flow and potential for rapid growth. They generally move more quickly and the deal will probably be less complex.
Key differences between these two types of buyers exist, and understanding these differences will help owners understand, and eventually make a quicker decision, which buyers to pursue.
Let’s examine some of the differences between these two types of buyers.
Strategic buyers believe that the combined performance of both companies is greater than the sum of their performance as separate entities – thereby creating more value over time. Strategic buyers are driven by many different reasons for buying a business including expanding the types of products and services they offer, entering new geographic markets and cross-selling into the customer roster of each company.
In addition, the combination of the two companies will result in a larger entity that will have a stronger presence in its market and greater leverage with suppliers.
In addition, if the acquired company is integrated into a larger company with better systems and processes, it will almost certainly increase the efficiency of the acquired business, a condition that should lead to better margins and greater profitability.
Financial buyers include a couple of subsets. Private equity firms (PEGs) are generally much less interested in synergies. They focus on whether the acquired company can be grown significantly in the short term because most PEGs have to return their investor’s money – including a generous return – within a defined period of time, usually no more than 10 years – and often more quickly than that.
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Family offices and high net worth individuals, on the other hand, are generally interested in the revenue stream of the acquisition and the likelihood that such revenue stream will continue and grow over a longer period of time. Unlike PEGs, they are usually – but not always – less interested in synergies. Family offices and high net worth individuals are, in our experience, more conservative than are PEGs
Strategic buyers typically pay more for the business because they look at how bringing the target company into the fold can improve performance and generate efficiencies. Significantly, by combining the companies’ operations, they can eliminate many administrative costs in one or the other entities in areas such as HR, finance, accounting, sales and IT functions thus reducing operating expenses.
Except in situations where a private equity firm already has a company in their portfolio that is similar to the target company, financial buyers do not usually gain synergies as a result of the acquisition. Their only motivation is the ROI from a single company, so they are therefore reluctant to pay a premium based on future earnings.
When calculating value of a target company, financial buyers rely on the company’s historical earnings or EBITDA. Assuming the targeted business is not in a declining industry, financial buyers will use an earnings multiple prevalent in the target company’s industry and the company’s past growth rate, as well as the buyer’s target rate of return to calculate the company’s value before tendering an offer.
Strategic buyers need to consider future synergies and several possible scenarios after the target company is acquired.
For example, cultural integration, retention of the management team, the mix of products and services, accounting, tax, and legal matters can be very challenging to ascertain. All are important considerations that will determine if the acquisition will be successful or end up being a massive failure.
This takes time and the dance between buyers and sellers will likely be a slow one.
The M&A process for financial buyers, however, is less complicated because they are dealing with only one company and uncertainties about the outcome are minimal. Executing the process from the time the owner accepts the offer can take anywhere from two to four months, whereas M&A with a strategic buyer can easily take six to 12 months or longer depending on the size of the company.
The Bottom Line
From the standpoint of the sellers, attaining the best outcome when selling a business requires the business owner(s) to determine what that specific outcome is. Does the exit strategy call for a certain amount of money as proceeds from the sale? Because the sale of a business is often a retirement event, sellers must have some idea of the amount of money they’ll need in retirement. If the sellers plans to spend their retirement years carving model boats in the garage, that’s one thing. On the other hand, if the sellers plans to travel around the world competing with The Big Dog, that requires an entirely different size bank account.
There are other issues. Does the seller’s specific outcome call for a specific time table by which to close the deal? Does the owner want a sudden and clean break – to walk away after closing – or will the owner entertain staying on with the business for a couple of years?
These are among the many questions that an owner must answer before being able to describe the type of buyer that would be most likely to allow the sellers to reach their goal.
Like anything else, if you know what you’re looking for, you’ll be much more likely to find it.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week!