Whether to sell your business or not, that was the question. You and your team labored long and hard, building a successful middle-market business and now you’re at the point in your career when you’ve decided that you want to sell it. Should you sell to a strategic, financial or an industry buyer? Lions and tigers and bears, oh my! Not quite, but the choices could be overwhelming.
Simply stated, a strategic buyer is an operating company from another industry that acquires a company to expand its services and/or client base. A financial buyer, also known as a buyout firm, typically acquires majority control a business in an industry they are not currently invested into with the goal of increasing shareholder value and reselling their stake at some point in the future. An industry buyer is a company from a particular industry that acquires another business from the same industry, typically for expansion purposes.
All three types of buyers bring different attributes with them to a selling company and each will approach value and deal structure differently. Sellers will perceive these attributes as positive or negative depending upon their individual desires and the performance of their company. Over the course of 3 blogs, I will compare and contrast these buyer types over three critical elements of a sale: pricing, growth and the role of the owner post sale. Today we will examine how a strategic, financial and industry buyer approach pricing.
The pricing of the deal
Pricing is arguably the most critical element of any transaction. In most cases for middle-market service businesses, the price falls in the broad range of three to eight times EBITDA which the buyer will adjust either up or down to reflect the true economic benefit of ownership to them.
|Size of Acquired Company ($ Revenues)|
|Multiples||2-3X SDE||3-6X Adj. EBITDA||4-6X Adj. EBITDA||5-8X Adj. EBITDA|
|Structure||25%-100% cash||50%-100% cash||50%-100% cash||50%-100% cash|
|* SDE = Seller’s Discretionary Earnings (Seller compensation + expenses combined with EBITDA)|
|** Adj. EBITDA = Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation + Amortization adjusted for non-recurring expenses that would not exist post-transaction)|
Typically, a buyer will incorporate excess or one-time operating expenses that will not continue under their ownership post-closing into their pricing model, such as a high level of owner compensation or the costs of a lawsuit settlement. Any such non-recurring or non-operational expenses are added back to EBITDA, thus increasing the base for the purchase price calculation. The buyer may also subtract any replacement costs needed to operate the business under their ownership. Many times, what appears to be a marginally profitable company can, after appropriate adjustments, be a very profitable one on that basis.
Beauty is in the eye of the beholder
All buyers, regardless of type, will evaluate key attributes of the selling company differently when pricing a transaction. They will closely scrutinize the selling company’s industry dynamics, its historical financial performance, its client base, growth potential, management team, and the overall size of their investment. How these elements impact pricing will depend upon the type of buyer that you are dealing with.
There are no hard-and-fast rules about whether you’ll get a better price from a financial, industry or a strategic buyer. In some cases, a financial buyer may be prepared to pay a higher price because they incorporate the seller’s total enterprise when arriving at their pricing level. Remember, financial buyers by definition do not have an investment to leverage in that particular industry so they have to approach the acquisition on a stand-alone basis. A competitor, by contrast, may be only interested in one aspect of the selling company such as its customer base. If so, the competitor will pay according to that aspect’s value to him, ignoring the business’s overall worth.
Availability of financing may also play a critical role in determining the pricing of an acquisition. In a market where financing is readily available like pre 2008’s financial meltdown, pricing tends to be higher overall than in a market like today where lenders are more conservative. Availability of financing mostly impacts a financial buyers’ pricing capability when compared to an industry or a strategic buyer.
The role you play with the company post sale may also impact pricing. If you leave the company upon its sale or after a short transaction, a buyer may be more inclined to cash you out. However, if you continue to run the business after it’s sold, you may have a chance to take a “second bite of the apple” if the company is later resold. Generally, the original owner sells his remaining interest when the buyer cashes out. This is most common among financial buyers; however it also occurs among industry and strategic buyers that are positioning for a sale of their own at some point down the road.
Like beauty, the attractiveness of business buyers varies greatly depending upon your particular desires as a seller. Knowing your options allows you to make an informed decision when it comes time for your big event.