Choosing an Acquirer: Hot Date or Lifelong Partner?
Selling your business can be a lot like dating. Are you looking for a one-night stand or for that perfect girl to take home to the family? Knowing the difference is crucial to finding the right person, or group, to buy your company.
At some point every business owner needs to exit. Some want to travel, spend more time with loved ones, or just step out of the pressure cooker. Others have health issues, are underfinanced and underequipped, or feel they could benefit from a strategic partner. But when it comes time to transition, many owners have little idea what they’re looking for. Like dating, every prospective buyer has upsides and downsides, and your job is to understand them.
Here’s a framework to help:
Sexiness: The sexy part of any deal is the valuation and, all things being equal, more is obviously better. But like most things in life, the number always comes with strings attached. What adjustments are the buyers making for deal fees, working capital, or transaction expenses? In some cases those can add up to 15 percent, or more, of the total transaction.
Values: What’s important to you and do you share those core values with the buyer? Do you care how your company will be run? Do you want your firm to maintain independence? Is it important to maintain the company culture? It’s crucial to find clarity and understand how the buyer’s intentions overlap.
History: Talk is cheap. Actions speak louder than words. A tiger can’t change his stripes. How’s that for a barrage of platitudes? But they’re true. How has the buyer treated past partners? What are the results after they take over a company? How long do they plan to own the company? Doing your homework will save considerable heartache.
Interests: We’re all good at some things and inexperienced at others. Does it matter who makes decisions at your company? Of course it does. The buyer’s background is crucial and there are opportunity costs to every skill set. A buyer with deep industry expertise will have better intuition, but won’t bring a fresh perspective to the table. Conversely, a marketing expert is unlikely to see the nuance of the industry-at least, in the beginning. What you need is situation-specific, and you certainly need to understand the situation.
Finances: The leading cause of divorce is money problems, and business partnerships are no different. If you’re a conservative operator, you probably don’t want to marry a spendthrift who’s happy to go deep into debt. You should understand what type of debt the buyer plans to put on the business, how they plan to re-invest, and they’re capacity to fund the company if potholes are hit.
Adversity: Relationships are messy and take work. Your ability to successfully transition the company will depend on developing trust with the buyer. A key piece to the puzzle is how the buyer handles conflict. What are mountains, and what are molehills? Is the buyer a screamer, or a stoic? Do they have patience, or tend to be trigger-happy?
DATING POOL
After you’ve thought about what you’re looking for, it’s important to understand the dating pool. What are the types of fish in the sea?
Private Equity Group (PEG): These come in two distinct flavors, funded and unfunded. The funded groups have raised committed capital they need to deploy, while unfunded groups are waiting until they find a deal to seek equity investors. Both plan to buy the firm using considerable leverage (2 to 7X earnings before interest, taxes, depreciation, and amortization), use free cash flow to pay down debt, and flip the company to another buyer within four to seven years who will reload it with debt.
Searchers: Search funds are led by one or two individuals, likely recent MBA grads, who are backed by a group of equity investors. They are looking for companies to buy and run, assuming the top management positions. Some (but not all) rely heavily on debt to finance the transaction. They typically plan to operate the company for five to ten years and then sell.
Family Offices: These are organizations built around the wealth of a few individuals and come in all flavors. Some act like traditional PEGs, while others function with long time horizons and commitments. It’s vital to understand the attributes of each group.
Strategics: These are the players in your industry and you likely know them well. Does it make sense to sell to your competitor? It all depends on your values. Strategics frequently fold the acquired company into the mothership and extract considerable “synergies” out of company structure.
ADVISORS
Remember all that advice you got when you started dating? There was no shortage of opinions from friends, family, and co-workers, and exiting your company is no different. You’ll hear plenty of feedback, and like dating, remember that everyone comes with various biases and interests. Here’s a quick roundup:
Financial Advisors: When you exit, financial advisors get a big raise based on the assets you deploy with them. They’ve seen many of their other clients exit and know some horror stories. They’ll likely advise you to “get all the money up front,” because “there are lots of ways you won’t get paid out.” Plus, they’ll get more money to manage that way.
Lawyers: As the adage goes, the devil is in the details. Every lawyer’s background is different, but most general practice lawyers don’t make excellent transaction advisors. They frequently miss big issues and send up red flags on inconsequential matters. And depending on your future plans, they’ll also be worried about losing your business. It’s highly advisable to find specialized counsel for the transaction.
Intermediaries: Warren Buffett said, “Never ask your barber if you need a haircut.” Understand that much of your intermediary’s advice will be based on how fees are structured. If fees are based on a transaction, you will be pushed to do something quickly. If it’s a retained search, you run the danger of the intermediary stringing out the process. There are many types of intermediaries out there, so be sure to interview a wide variety before settling on one.
Bankers: If you have loans with the bank, they’re not likely thrilled with a transaction. You’ll pay off your notes and they’ll likely lose the company’s business. This might be offset if the bank has a wealth management division, of which they’ll be quick to remind you.
Accountants: Like bankers and lawyers, accountants will be worried about losing business. Make sure they’re readily available to help explain the company’s financials and are capable of interacting directly with the buyer. They should be able to help field questions or concerns.
Your Execs: It’s not unusual to bring your senior executives into the “know.” A normal, immediate response is fear. Change is scary and few things are more nerve-wracking for employees than an ownership transition. Understand that in most cases, a majority of their advice will come from a position of insecurity and concern.
Regardless of who is advising you, don’t outsource your judgement. You didn’t build a successful company by blindly relying on the advice of others, and your exit isn’t an exception. Understand what you want; establish a process that will likely deliver the right buyer; and think critically about the dynamics.
PLANNING A WEDDING AND MARRIAGE
After dating, it’s time to settle down. But before you get married and live happily ever after, you get to go through a grueling engagement called due diligence. This process stress tests you and your company to verify the valuation. Results from these examinations may result in adjustments to the purchase price. Here are the main components:
Quality of Earnings: Most buyers will perform a quality of earnings assessment that tests where profits originate. The more profits that flow from higher sales or lower costs, the better. Profits from anomalies like inflation, one-time events, or changes to inventory are considered negative.
Capital Structure: Buyers will want proof of ownership and a list of all shareholders, options, notes, debt instruments, and any off-balance sheet transactions or liabilities.
Operations: Everything critical to the operations of the company will be shared and analyzed, including major customer files, strategic relationships, suppliers, competitor, and distribution information, and the research and development pipeline.
Personnel: You’ll share historical and projected head count by function, the current organization chart, and compensation arrangements and expectations. Personnel turnover and all employee files will be scrutinized.
Legal: Any lawsuits against, or initiated by the company will be reviewed. You’ll supply lists of patents, trademarks, copyrights, and licenses as well as environmental and safety records.
After this review is completed, the buyer will supply the final paperwork necessary to complete the transaction, and you’ll be on your way. But depending on the nature of the transaction, your partnership may just be starting. Many sellers “roll forward” equity and maintain a considerable stake in the new entity-making a long-term commitment to the new ownership group.
If you continue with a stake, the marriage analogy is quite apt. Each stakeholder brings a different set of baggage into the relationship, including personal reputations, routines, outside interests, and timelines. Relationships are messy and require work. Choose wisely.
This post was originally published in Forbes.
