You decided that you want to sell your business but you’re not sure whether a strategic, financial or industry buyer will present you with the best option. In the first part of this 3-part blog series, “To Sell to a Strategic, Financial or an Industry Buyer? That is the Question,” I examined how different types of buyers approach the critical element of pricing when approaching a transaction. Today, I will focus on the importance of growth in a transaction. In Part 3, I will investigate the critical role of the owner post sale.
To restate definitions, 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 that acquires another business from the same industry, typically for expansion purposes. All three types of buyers will approach value and deal structure differently based upon the seller’s attributes. Sellers will perceive a buyer’s features positively or negatively depending upon their own individual needs and the performance of their company.
The seller’s performance will make an impact
When it comes time to sell a business, the selling company’s historical financial performance and projected growth rate will have a direct effect on how certain types of buyers will approach pricing and deal structure. Let’s assume that your business’s revenue and profitability have consistently grown, year over year, at an annual rate of, say 20%, and you’re forecasting the same rate for the next 3 years based upon market conditions and your company’s sales pipeline. This is an attractive growth rate for each of the 3 types of buyers listed above. If a consistent growth rate is achieved over time then a buyer will feel comfortable that management understands the business dynamics and the expectation will be that the company will achieve the same rate in the future regardless of the buyer’s contribution. The buyer will approach pricing with that growth rate in mind.
Let’s suppose, however, that the selling business did not grow 2 years ago, grew at a 50% rate last year and is on course to grow 34% this year. A buyer will have a difficult time arriving at a baseline growth rate that they can utilize when determining pricing of this erratically performing business. A financial buyer may apply a lower multiple to determine their purchase price for such unpredictable performance and/or they might utilize an earn-out component to share the risk with the seller.
What if the business has flat-lined and hasn’t grown in recent years or worse, is forecasting a downturn? Most financial buyers won’t pursue that transaction unless the selling business is viewed as an add-on to an existing platform business they already own or has an exception growth story that the buyer can “buy” into. Industry buyers might still be interested if the selling company provides them with an attractive client base, complementary services or other attributes such as technological advancement or geographic coverage they perceive as valuable to their existing operation.
A few years back, Kaulkin Ginsberg advised the owners of a large, multi-national business in a sale. The company was perceived as a market leader in its industry for years. During the sale process, the selling company lost its largest client. Most buyers ran for the hills but one industry buyer was not placing value on retaining that particular client and was able to complete the transaction at the original pricing level that it placed on the business prior to the client loss.
What growth attributes will the buyer bring to the table?
In addition to the performance of the selling company, what contributions will the buyer make toward to company’s performance when the dust settles after the transaction closes? If the selling company is a growth business, perhaps the best course of action is to let it operate on a stand-alone basis. A financial buyer might be the best buyer type in this scenario if they buy into the existing management team’s business plan. But what if the selling business is not performing well and could use financial or operational support?
An industry buyer may be able to value non-recurring or duplicative expenses more aggressively than a financial buyer because they already have an existing platform to leverage. A strategic buyer may have an existing platform plus access to a different client base that can utilize the seller’s service offerings. A strategic buyer may also have more extensive technological capabilities, international reach or complementary service offerings to leverage, for example. Sometimes these buyers will value the seller on a stand-alone basis while other times they may incorporate these attributes into their valuation and be able to justify a higher price than a financial or industry buyer.
The bottom line may be purchase price, but knowing the intangible assets that a buyer may bring to the transaction might impact your decision which buyer candidate to choose when it comes time to sell your business.
A special thanks to two terrific conference hosts who invited me to speak recently at their industry events, Julie Dienes and the National Collections & Credit Risk Source Media team and Dawn M. Wierzbicki and the TRMA team. I appreciate all of their support.