Selling Your Company: Which Buyer Is Best?

Vistage expert Alan Scharfstein, President and founder of The DAK Group, describes what you need to know about:

• The differences between a financial buyer and a strategic buyer
• A new kind of corporate buyer: the hybrid
• Criteria for deciding which kind of buyer is best fit for you
• 2015 outlook for mid-market sellers

When business owners decide to sell their company, the needs of the owner and the motivations of the buyer combine to determine who will make the best transaction partner — financial, strategic or hybrid. Here’s an overview of each of these types of buyers, as well as a rundown of key considerations to factor in when deciding to whom to sell.

Financial buyers

Financial buyers are primarily PE (Private Equity) funds, venture capital firms, hedge funds, family investment offices and high net worth individuals. They’re in the business of buying companies and selling them at a profit within a certain period of time (approximately five years).

Financial buyers typically fund acquisitions with a combination of equity and debt, then work with the company’s management to improve the underlying performance. When it comes time to liquefy their investment, they do so by either selling the company again, or, if the company is big enough, by putting it up for an IPO (initial public offering).

The key motivation for financial buyers is the return on investment (ROI). These buyers are looking to maximize ROI through performance improvements and the use of leverage, hence the term leveraged buyout. Their goal is to quickly increase the value of the company beyond the initial purchase price to ensure an acceptable ROI.

Financial buyers will fund a buyout with as little as 20 to maybe 40 percent equity. They’ll finance the remainder with a combination of bank debt and, in some cases, seller notes. Typically, financial buyers like to keep the CEO/owner and other key management on board, and even have them maintain an equity stake in the business. This can be advantageous to sellers who want to stay involved in the business and get a second bite at the apple, while taking some money off the table at the initial sale. It also works well for the financial buyer who’ll be dependent on the management team to execute the operating improvements required to improve company performance.

Strategic Buyers

Strategic buyers are typically larger operating companies who make acquisitions for strategic reasons. They look for businesses that can be integrated in and complement their core business to support a long-term business plan. In strategic acquisitions, buyers are primarily looking for synergies from combining companies that will reduce costs, increase sales and ultimately improve profitability. It’s a long-term buy-and-hold strategy.

A strategic buyer can be a competitor but is equally as likely to be in a complementary business. The acquirer will always be seeking sales and earnings growth, but also may be looking for product, customer or geographic diversification or to upgrade some of its own weaknesses in such areas as technology, equipment, distribution, research & development, personnel, or internal processes.

Mike Richmond shares an example:

“One of our sell-side clients was a U.S. company, with only two products — white and yellow road paint. We approached the ‘standard’ strategic buyers; other paint companies that wanted to expand their product offering or open a new market.

“By adding our client’s products to their inventory, those potential buyers would have had an opportunity to increase total sales, but only marginally. As such, the ‘value’ of our client to them was also marginal, so they offered a purchase price of between 4-5 times EBITDA, a valuation acceptable to our client.

“We thought our client could do better. Using an ‘out-of-the-box’ approach, we identified a strategic buyer that ended up paying nine times the EBITDA!

“How, you ask? That potential buyer was a French concrete manufacturer, responsible for paving most of the highways in Europe. The company was looking to break into the U.S. market. Our client sold its products to the Department of Transportation in all 52 states. By acquiring a US road paint manufacturer, the acquirer would have a fast track to gain entrance to the U.S., enjoy a new, immediate revenue stream, and have access to a new customer base to sell its paving products and services.

“This is a perfect example of strategic transaction with the right buyer that is a home run for both the buyer and seller.”

Paul Sukel shares another example:

“Sometimes there are strategic reasons to make an acquisition unrelated to synergies. Recently, the owner of a popular Mexican food brand was ready to sell his company. He had two options: sell to a larger food company looking to expand by taking over existing customer relationships in a geography it didn’t currently have, and integrate the products under the known brand.

“The other option was a food company that was willing to pay a premium to get rid of the seller as an annoying competitor. In this case, it wasn’t the combination that improved the acquirer’s sales and profitability, but the closing down of the seller’s company that resulted in performance improvements.

“While financial buyers are primarily focused on the financial metrics, sellers have the opportunity to maximize the value of a transaction by getting buyers focused on things beyond the numbers to the total value the company can bring to the acquirer both short term and long term.

“As a result, usually a strategic buyer can and will pay more for a business than a financial buyer. Over the last five years, about 80 percent of our transactions have been sales to strategic buyers, while financial buyers were also often in the mix, during the process, the highest valuations and the least risks were in strategic sales.”

It’s clear, then, that there are certainly times where selling to a financial buyer would make more sense. For example, it’s a great strategy for a seller that wants to: 1) take some money off the table, 2) reduce personal risk 3) take the company to the next level with a financial partner, and who believes there is significant upside from a second liquidity event not to far into the future.

The Strategic/Financial Hybrid Buyer: A New Type

As the M & A market continues to mature, we’ve recently seen a “hybrid” buyer emerge. Hybrids buyers are similar to private equity firms in that they’re buying companies based on financial metrics with the goal of making a profit on its sale, yet they don’t have the same five-to-seven year horizon. Instead, they tend to hold the companies for a much long period. In this way, they can afford to be strategic and financial at the same time.

A leader in this hybrid category is that of the “Family Office,” who will own or buy a platform company in a certain space. As a financial buyer, the goal is to grow the business, improve the profitability, and yes, ultimately sell it. But these buyers do that by making strategic add-on acquisitions to the platform company.

Hybrids will generally pay a premium compared to the financial buyer “purist,” if they are bidding on a company in the same space as their platform that will bring synergies and improve the platform’s performance through the acquisition.

The Key to Getting TOP Valuation

To achieve key valuation, it’s essential to fully understand the buyer’s motivation. Is the buyer strategic, financial, or a buyer? The answer to that question will go a long way to increasing your negotiating power.

An important point for sellers to keep in mind is that the variance in valuations from competing buyers always depends on the motivation of each buyer. Your company may look the same to you as you meet with each buyer, but it looks very different to them, based on their different needs and wants. Ascertaining each buyer’s motivation is an art that comes with years of experience and, if done successfully, will make a huge difference in optimizing the purchase price.

Mid-Market Outlook for 2015 and Beyond: Why Now is The Right Time to Sell

The past few years have been a gearing up period for mid-market companies to sell. Sellers have been reluctant and cautious, wanting to wait for a stronger economy improved earnings. We’re now seeing better earnings performance, improved confidence in the economy, and a pickup in our M & A business, consistent with the overall industry.

The years to come could be the banner for mid-market M&A. Why? Strong key market indicators!

• Baby-boomer owners are looking to retire now
• Low interest rates
• Strategic buyers have record levels of cash they need to use
• The need for private equity firms to start spending money to close their funds

Buyers are ready to buy, and they have the funds to do so. This is a positive sign, but it comes with a word of caution: Buyers have seen tough years in the past decade, and they don’t want to repeat past mistakes. As a result, we’re seeing much more due diligence; buyers are kicking the tires much more carefully to ensure that their investments are really worth the value they appear to have.

As a seller, don’t be discouraged by the amount of due diligence a buyer is doing. As long as your “house is in order,” you should be able to earn the multiple you deserve, and the extended due diligence shows the buyer is very interested.

Whether a strategic, financial or hybrid buyer is knocking on your door, take the time to entertain the conversation.

Alan Scharfstein is President and founder of The DAK Group, an investment banking consultancy serving mid-market firms. Visit The Dak Group’s website here.

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