Selling Your Business in a Merger & Acquisition Transaction - Part 2
By Jack Lyons, Mergers & Acquisitions Advisor and Certified Exit Planning Advisor (CEPA)
The next thing you need to know in a M&A transaction is your strategy regarding what type of buyer you want to sell your company to. Your buyer could be a family member, your management team, employees, an entrepreneur, a professional investor or private equity group, an industry or strategic buyer or the public via a public offering. In mergers & acquisitions no one type of buyer is right for everyone. There are plusses and minuses inherent in the sale to each type of buyer who may be available. Many of the plusses or minuses end up being in the risk associated with the sale price and payment structure each type of buyer is in a position to offer.
A Family Member, Your Management Team, Employees, An Entrepreneur
We’ve categorized these types of merger & acquisition buyers together because they share a number of characteristics. They are either looking to buy a job or run the company following the acquisition and will need to leverage the purchase, so obtaining financing is an important factor in closing the sale.
In the case of a family member, that person may be running the company already in the best of situations or may need to be trained. If the family member already runs the company, this makes the mergers and acquisitions sale a less risky alternative than if the family member is not currently running the company. In some cases, a family member may need many years of training before being ready to take over the business or may not have the talent to take over the business no matter how much training is received. In either case, it is up to the owner to make sure that a successor family member is properly prepared and able to run the business. Although passing a business over to a family member is the dream of many owners, in actuality, it may not be realistic due to the financial and/or post sale management risks involved.
A mergers & acquisitions sale of the business to the management team or the employees is something that is often considered. If the sale is accomplished via an employee stock ownership plan (ESOP), the merger and acquisition transaction needs to be structured over a long period of time in order to be legal. However, in many cases the financing required to fund the ESOP is more easily available than the financing required to fund a management buy-out (MBO). In either scenario, the company tends to become highly leveraged following the merger & acquisition transaction. The mergers & acquisitions sale of a company to an entrepreneur is usually both a financing risk and a management risk. Many very small companies are sold to entrepreneurs and the merger & acquisition sales process tends to be very emotional since the entrepreneur is frequently risking his or her life savings to buy a company. Many M&A sales to entrepreneurs fall apart because the entrepreneur can’t pull the trigger or obtain adequate outside financing. If an entrepreneur has owned another prior business, that person will probably feel capable of running your company and will probably have a few ideas about what will be done after the business is taken over. You can expect this buyer to be aggressive in finding faults with your company because they are looking to minimize their risk, many times at your expense.
Professional Investor or Private Equity Group
Professional investors include both private equity groups and venture capitalists. As such, in a merger and acquisition they are looking to buy an equity interest, with either complete or a significant degree of voting control in a business with good management in place. Sometimes they will acquire a company to merge with or round-out another of its operating companies. The professional investor adds value primarily through making a capital infusion and/or by providing industry knowledge, contacts, marketing channels or management know-how. They are almost always concerned about a company’s potential for rapid growth because they are looking to exit their investment over some short to intermediate time horizon and growth is usually more important to a venture capitalist than near-term profits. Private equity firms on the other hand are very concerned with near-term profitability and tend to invest in profitable operations with good growth potential. Professional investors tend to be attracted to industries they know well and usually have well developed formulas for valuing and pricing a M&A investment opportunity. Unless management is extremely solid and has an uninvolved owner, selling to a professional investor is not usually a viable option if the owner is looking to exit the business in the near future. Among the risks of selling to a professional investor is the risk that the company will not be able to pass stringent due diligence, the risk of getting the deal financed in a way that makes sense to the owner and the risk of what will be paid for the percentage of owner’s equity not initially acquired.
Industry or Strategic Buyers
Industry buyers in a merger & acquisition transaction are your competitors or similar businesses in a different geographical market. They look to acquire similar businesses in the same or in different geographical markets in order to to add to their customer base and realize economies of scale from becoming a bigger operation. They value strong customer relationships and will sometimes pay a premium for them. They don’t value systems as they will be replaced shortly after a company is acquired.
Strategic M&A buyers are generally publicly traded companies or very large privately held companies. They seek to acquire a specific technology or process owned by the business being sold. They also seek to acquire a presence or customer base in a geographical market and to acquire the skills of the personnel working for the company. When dealing with a strategic M&A buyer you must have good information as to their reasons for acquiring, understand how they priced and paid for previous transactions as well as, understand if they have other potential merger and acquisition transactions they are evaluating in your industry or market area. A risk of dealing with either an industry buyer or strategic buyer is the information they will gain from your company if the mergers & acquisitions transaction doesn’t happen.
A public offering is just that, a sale of a portion of a company’s stock to the public. It is a viable M&A alternative for large companies having $250,000,000 or more in revenue. When a large company goes public, the offering often includes a portion of management’s stock holdings which can provide a partial liquidity event for owners. In addition to large companies that become public, there are a number of smaller companies that go public every year. The major reason these smaller companies choose a public offering as a merger & acquisition alternative is the opportunity to raise growth capital at a valuation that would not be possible in a sale to a strategic or financial investor. Seldom does the owner of a small company sell shares in the initial public offering because the money needed by the company is all that is available. The cost of going public is very high and the cost associated with public reporting is significantly higher than is required by a private company. Often times, going public does not turn out to be a home run. That requires the company doing well over a long period of time so that the stock price remains high and then the owners are able to offer a portion of their stock to the public in what is called a secondary offering.
Once you understand the most likely kinds of M&A buyers for your company, you can make decisions about how to approach the market. We’ll address this topic in Part 3 of this article next month.
Jack Lyons is a Mergers & Acquisitions Advisor, a Certified Exit Planning Advisor (CEPA) and president of Lyons Solutions, LLC. He can be reached at 203-642-4141 or at email@example.com.
Copyright 2010 Jack Lyons. All Rights Reserved.