Who will buy my business?
A. Whom You Target Determines Whether, and for How Much, You Sell – Focus Your Effort Where it Will Do the Most Good
Classify Your Prospective Buyers by Their Rationale for Buying Your CompanyIn my 27-plus years advising sellers and buyers of public and private companies, I have found it most practical and simple to classify prospective buyers by their rationales for buying what I am selling. Looking at your company through your prospective buyers’ eyes, what do you bring to the table for them and what is that worth to them? You can best answer those questions by taking a carefully ob-jective look at prospective acquirers, focusing on what they do and how they make their money. When you do, you will start to see patterns that permit you to group companies into categories based on how attractive they find your company.
The first step is to brainstorm about the categories. The second step is to study each of the companies within the categories to determine whether individual differences at a more detailed level make you worth more to some than to others. You will use the answers to create and prioritize your prospect list. Recognizing the buyer’s view of every action, you take will: 1. determine whether, and to what extent, to spend time, effort, and money to repair, im-prove, or transform your business before putting it up for sale;2. frame and construct your marketing materials; and3. prioritize the buyers you approach.
Exercise DisciplineUntil you mention that you are thinking about selling your company, you have no idea of the depth of genius in your business and social circles. Almost everyone will immediately proclaim: “You should sell to __________!” Most of these suggestions will display a blinding grasp of the obvious, some will be off the wall, and too many will be naïve. For example, a billion-dollar public company is unlikely to buy a Company worth $20 million because an acquisition of that relative size doesn’t move the value con-tribution needle at the bigger player. It happens, but it’s the exception – the most frequent being when you are selling a truly disruptive innovation. You may find it easier to start with blank index cards, or an electronic equivalent, listing every company that you have ever thought might be a good candidate acquirer, and those suggested by others that you thought at least plausible. Now stare at the compa-nies arrayed before you. It’s time to create a disciplined framework for your prospects for a successful sale.
Intelligently Generalize Buyer Categories – Fortunately It’s Common SenseThere are many ways to categorize potential buyers, and for creativity and brilliance you will get the kind of points you care about, but it all starts with the basics; for most sellers, it never has to go further to enjoy success. First, consider what other operating companies – not private equity firms -- will think, because as a practical matter “strategic buyers” are leaders and “financial buyers” are followers. Venture capitalists investing in start-ups -- if they are not, as is frequently the case, in search of the already stylish among their rarified social circles -- may be exercising original thought about identifying innovative, disruptive economic value. However, even for them, when it comes to exiting an invest-ment via a sale of the company, it is what strategic buyers value that will determine the return on in-vestment. Whatever strategic buyers like, financial buyers will also like. Build a Simple Framework for Arraying Prospective BuyersAnalytic frameworks are most useful when we harness them to an organizing principle that cuts to the heart of the primary goal and enjoys the tremendous advantage of being tested over time. The key concept to organize your thinking about constructing your pool of prospective buyers is based on common sense. A seller can realize the highest price for a business with the buyer to whom the sell-er offers the most that the buyer desires but does not already possess: the more alike, the less the relative price; the less alike, the higher the relative price. Consider first companies in your industry most like you, then move further afield to find buyers with more incentive to pay up because you of-fer something they don’t already have. You reach the outer limit where prospective buyers become afraid that they do not understand, or in any case, do not know how to mitigate and manage, the risks inherent to your business – or are at fundamental philosophical odds with the way you solve for busi-ness challenges.
CompetitorsAs you examine which rivals may be interested in buying your company, understand that some differ-ences, like those fundamental to your business model or mode, may be significant (as in: “We just don’t do business that way.”), while others are minute and inconsequential. A competitor’s assess-ment of your value will vary depending on whether your business approach is more or less efficient if your processes are superior or inferior, your brand stronger or weaker, your staff more or less produc-tive, your locations more or less cost-effective. If on balance, your business is the same or weaker on all or most of the dimensions relevant for comparison in your industry and market, then incremental business is all you bring to the table and what your competitor/prospective buyer will value. Sales vol-ume could be very large compared to your competitor’s book of business, or it could be fractional, but either way, the metric your competitor will use to determine the worth of your business will be largely determined by substitution cost. Your competitor will determine what it would cost to attract your customers by other means: advertising, sales, promotion, time, and money. Then, it is rational for the prospective buyer to pay a price that pivots on the easily determinable value of the work you have done to attract your customers. To the extent you have any competitive advantage that your compet-itor cannot, without buying you, build, or soon acquire by some other cheaper means, they will pay more, because of the economic advantage you bring to the table. Competitors -- whether through prejudice, or accurately -- often do not see much value in a rival’s business, other than the incremental value of getting access to your customer base. They will retain only so much of your facilities, systems, and people as necessary to serve the incre-mental customers they obtain by buying your company, meaning they will value everything you have built only at the margin of what they can’t serve or maintain with their existing infrastructure. Com-petitors can be a viable acquirer, but all too frequently they are the source of the lowest bids when your buyer prospect pool includes other classes of potential acquirers. On ABC’s “Modern Family,” Jay Pritchett of Pritchett’s Closets & Blinds gleefully related that when he saw that Closets, Closets, Clos-ets, Closets! was up for sale, he simply waited and then picked up his competitor’s assets for 10 cents on the dollar. A fictional case, perhaps extreme, but illustrative nonetheless. Companies in Your Value ChainThe next place to look for prospective buyers is in your value chain, the companies from whom you buy goods and services and those to whom you sell. These acquirers tend to pay more because the buyer is not simply adding more business at the same profit margin but also increasing their profit margin. That is, for every dollar of sales, if a competitor buys your business the profit margin is roughly the same, adjusted for some savings from economies of scale. If its profit was 15 cents of every dollar before the deal, the profit after the deal for every dollar of sales on average is still 15 cents, or maybe with economies of scale factored in 17 cents. However, if a supplier or customer buys your business, a beginning profit margin of 15 cents on the sales dollar before the deal can turn into 30 cents. Of two businesses with $30 million in sales serving the same product or service market, the one with the 30 percent profit margin is worth significantly more than the business with the 17 percent profit margin. What your business brings to the table for an acquirer above or below you in your value chain is much more than what you bring to a competitor, and for that reason, all other things being equal, you will usually command a higher price from a supplier or customer than from a competitor. Suppliers as AcquirersFrom the acquirer’s point of view, acquisitions by suppliers are downstream acquisitions. Your suppli-er, upstream from you in the value chain, buys you to capture profit margin earned closer to the cus-tomer. We are not talking about suppliers of generic goods and services like office supplies or legal services. Your business is not special to the companies that supply your staples and legal advice; they do not value your business other than for commercial transactions ancillary to your main line of busi-ness. Such suppliers have no economic incentive to consider acquiring you because you are one of many customers in your line of business to whom they sell products or services. Moreover, if you are one of several or many customers in your line of business, then to buy you would put your supplier in direct competition with its other customers like you, which is likely a self-defeating acquisition strategy because generally, customers don’t like to buy from their competition.The type of supplier that would value you is one for which you are one that is, or among the few that are, the most critical to the supplier’s value chain to the customer. If you are, then what the would-be buyer picks up by acquiring your company is an economically streamlined pipeline to your customer. At a minimum, your profit becomes your supplier-acquirer’s profit. When the businesses are com-bined, profit improves because the enterprise will be able to eliminate the expense of duplication. Electronic and Computer component manufacturers sometimes acquire their customers selling brand-ed consumer products at retail, or customers adding proprietary innovations in an industrial value chain, to gain direct entry into downstream markets, and to capture the typically bigger profit margin of the product or service sale further down the sales pipe, at retail or wholesale. Media companies who own content libraries are making a downstream acquisition when they acquire a company that streams content directly to consumers. Example:• A large independent national radio network acquired its only independent advertising sales agency. A customer became a subsidiary. The radio network absorbed the advertising sales people, and their relationships, pared back-office duplication and the agency share of the gross commissions, money that then dropped straight to the bottom line of the acquirer. A business with a 20 percent profit margin became a business with a 35 percent profit margin. Customers as AcquirersFrom the acquirer’s point of view, acquisitions by customers of a supplier are upstream acquisitions. We are not talking about customers who are the end-users of your product or service, rather custom-ers incorporating your company’s product or service into its own offering and selling further down-stream. Example:• An optical electronics product company, selling primarily to government clients, acquired an innovative lithium niobate (LiNbO3) modulator component manufacturer whose product pro-vides a competitive advantage. The acquirer captured the advantage. It could offer the modulator in its product and deny it to others. It also captured as profit what it paid to the target company. Other Ships in the River of CommerceNow it’s time to be creative, to go farther afield. If you can sell to one of the companies in this catego-ry you are likely to sell for more. This type of buyer will value you higher because you are offering cus-tomers something different, and you are not above or below the buyer in the value chain. You are bringing new and different value, frequently the opportunity to realize sales synergies where 1 + 1 = 3. This is not to say that the buyer’s operations are unrelated. The interested buyer knows enough to:1. understand your value proposition;2. be comfortable with the risks inherent in your business;3. foresee how to exploit your capabilities;4. not be at fundamental odds, philosophical or otherwise, with how you conduct your busi-ness.
Different Product or Service, Same Customer Profile, Similar or Dissimilar ProcessesHere’s the idea-generating question: Is there a product or service that is, or could be, co-marketed with your product or service because they are in some way linked or contextually relevant to the same customer at roughly the same time he or she purchases either of your products or services? For ex-ample, taxpayers who purchase do-it-yourself online tax preparation services to prepare income tax filings are presented, somewhere in the e-commerce checkout stream, with the opportunity to pur-chase a prepaid tax audit defense membership plan entitling the purchaser to professional represen-tation by a licensed tax professional in the event the income tax authority challenges the tax filing. The products are different: one is automated and do-it-yourself, the other is manual, or semi-automated, and do-it-for-you. They are contextually relevant because it is precisely at the time tax-payers fill out the myriad details of an income tax return that they are probably most likely to consider the possibility of having any of those entries questioned by the IRS or State income tax authority. Cus-tomers ponder the risk of drawing an inquiry, and the cost, both real cost and opportunity cost, of dealing with the prospect of a tax notice in the mailbox. This is a logical time to present do-it-yourself customers with the opportunity to pur-chase a product that provides forward-looking, expert help to stand in their shoes and deal with the tax authorities.
Strong contextual relevance to, and during, the customer’s purchase decision for two different prod-ucts by two different companies suggests that there are excellent prospects for a match. The custom-er sets are identical or very nearly so. It is no, or extremely little, incremental cost to the buyer to market the seller’s product. It will market the seller’s product the same way at the same time as it markets and sells its own products. You might think that the different processes by which each deliv-ers their services to the customer might dampen enthusiasm. The fact is you can’t tell until you pitch the idea to the prospective buyer. Some prospective buyers will be uncomfortable because they are unfamiliar with how to operate a different type of process and don’t understand how to manage the risks of doing so; others will heartily embrace the difference and explore for further ways to integrate and exploit the new capabilities. In the case of the online tax preparation companies, while they com-pete with plenty of code-based innovation, they also compete, (seek to distinguish themselves) by developing and fielding networks of humans to assure and hold the hand of tax filers. The software company does have something to learn from the high-volume, professional services company, and each can exploit the convergence of their processes.
Here's a well-known example: Beats’ sale to Apple. Apple didn’t make headphones; Beats didn’t make computers and phones. The customer for one, however, was exactly the target market for the other, in the same or a closely related purchase category. If we torture the logic, it doesn’t work. At one time, banks gave toasters to their customers, but it doesn’t make sense for a bank to buy a toast-er company. To work best, this idea needs persistent customer-centric contextual purchase rele-vance.
B. Use Filters to Evaluate the Chances of Selling to Companies in Your Categories
Filter #2: Financial QualificationOne of the first questions we are greeted with when we step onto a new car lot is: “May I ask what you do?” This question is among the first car salespersons typically ask because they want to know: “How much can you afford to pay for a car?” They are probing your financial qualification to buy what they are selling. When selling your business, you also need to probe accordingly as early as possible, albeit at a superficial level.Probing is easy enough if your prospect is a public company – and you must do it because “publicly traded” doesn’t mean the company can pay you full value for your business. Being publicly traded is not always tantamount to having access to an endless wellspring of equity or debt financing. For some it is. For others, being public is an obstacle; their stock value could be in the basement, and they could be tapped out on their borrowing capacity. While you might accept the stock of a healthy public com-pany in full or partial payment for your business, you would accept stock-based consideration from a public company in trouble only if you did not need it other than to change out the paper on the bot-tom of the parakeet cage.If your buyer prospect is a private company, you can perform a credit check, like for any prospective customer to whom you are considering extending credit. If your prospect is a financial buyer, there is less concern because a financial buyer inherently has access to capital; here the best indication of fi-nancial wherewithal is to peruse the buyer’s existing portfolio of companies. In any case, financial buyers frequently syndicate their deals among other financial buyers to mitigate their risk, so there is financial strength in numbers. If they were not strong enough to create a syndicate or to increase ef-fective investment returns with borrowed money, they wouldn’t have any companies in their portfo-lio. At this early exploratory stage, investigate the financial qualification of candidate buyers at a rea-sonably prudent level to determine whether it is worth your time and effort to at least solicit a bid from them. At the time you receive and evaluate bids, you will get another chance to gauge financial qualification, and this time you will not have to rely on third-party information sources; you will be able to require bidders to present evidence of their financial qualification not otherwise available to the public. Filter #3: ScaleYou might be able to make a sound, logical case for why another company might want to buy your company, but it’s always a good idea to be mindful of disparities of scale that will bear on the ultimate probability of getting a deal done. A business smaller than yours may or may not be financially quali-fied. In the annals of mergers and acquisitions, minnows have swallowed whales, but not very often; that is why they are notable when they occur. What also requires a dose of realism is the other side of the scale disparity. Multibillion-dollar, market capitalized public companies do not as a rule buy companies that do not “move the needle” in whatever part of the company your business would fit. Unless your tiny (in comparison) company has developed an innovation that will revolutionize an industry segment, your business’s incremental value will hardly get the attention of the leaders of the business unit into which you would logically fit. If you do manage to get their attention, you will have to probe continually to assure that you are getting the engagement at all the necessary executive decision levels to get a deal done. The bigger the disparity of scale, the more likely that, even if you do get someone to accept your marketing materials, you will expend a great deal of energy and end up with nothing to show for it except dashed hopes. Of course, there are exceptions. Illinois Tool Works, with a public market cap-italization of $40 billion at the time of this writing, became Illinois Tool Works by buying large, medium, AND tiny (by comparison) manufacturing businesses. However, Illinois Tool Works made it a point to publicize to small manufacturing companies that it was interested in them and made it relatively easy to evaluate their intake criteria. Filter #4: Interoperability of Business ModelsThis filter is all about asking yourself: How much would I have to change my processes to fit into the business of a prospective buyer before it might be interested? If you provide something unique to the buyer, your way of doing business may be foreign, and yet, you won’t have to change a thing. The closer you are to the substance of your prospective buyer’s product or service the more method may matter. Thinking about how businesses may or may not “fit” has as much variation as there are di-mensions to business models. The following simple example explains the general utility of this filter: Uber™ is in the business of providing transportation, but (until autonomous cars arrive) it is not a “car” company; it is an information company. It provides the platform by which customers request rides from independent drivers – what is the “order-taking” and “dispatch” function of a taxi company. It handles, among other things, all payment arrangements between rider and driver. It offers drivers preferred routes, and it offers customers the ability to rate every ride with every driver every time. Until it deploys autonomous vehicles, it does everything except own, maintain, insure, and bear liabil-ity risk on the cars. You will not sell your taxi company to Uber, no matter how profitable you are. The conventional taxi industry model is not interoperable with the Uber™ model. Nothing about the way Uber does business fits with the way any conventional taxi company does business – even though your taxi business and Uber™ both offer and deliver rides. Filter #5: LocationIf you run a small to medium-sized service business drawing your customers from a city or region, the buyer of your business is overwhelmingly likely to be based in the same, or an immediately adjacent, city or region. The exception is where a larger company has decided to grow by acquiring and rolling up many similarly focused small businesses to create a super-regional enterprise, as Coach USA did with local and regional bus companies. Otherwise, if your customers are geographically dispersed, then your buyer could be from anywhere.
Filter #6: Prospective Buyer’s “Strategic Direction”If a large, multi-product or service prospective buyer is on your list, even though what your company does would fit “somewhere” in the mix, it’s a very good idea to try to figure out as quickly as possible what is on this year’s strategic business development “wish list.” Large companies with permanent business development staff every year establish a set of strategic and tactical priorities. This is the team’s “go get” list, and meaningful progress against it is the stuff of excellent middle management performance reviews. If your business is sitting on the proverbial train tracks, you are in luck if you can frame your opportunity within that context as clearly as possible. You may even get faster “uptake” and more ea-ger evaluation attention than at any other time. This is not “normal.” This is because, as luck would have it, you have the right thing at the right time. It does happen. Regrettably, the opposite is also true. Your business, by type, focus, market or some other category identifying it as not a priority, may attract no attention no matter how great a combination theoretically it “could be.” If you are not a waypoint on the charted annual strategic development path, then it will be a challenge to get your prospect to return any communication. Sellers that succeed swimming against the current do so with persistence and heavy and early reliance for their pitch on quantifying tactical, realistic, profit ad-vantages that will be forever lost to the prospect. Filter #7: Qualitative AttributesThere are some attributes you know will matter; however, they are tough to quantify. For example, companies put a great deal of effort into creating, communicating and reinforcing their brands. If a company says: “Our brand stands for this, and (either directly or by implication) not for that,” then two companies in the same industry can lack brand affinity. It will be tough for the company that stands for “this” to acquire the company that stands for “that,” until one or the other decides to change their brand story to rationalize a transaction. The best incentive is greater growth and profitability in a com-bined entity – or put another way, at a high enough price to the seller, and benefit to the buyer, any deal can happen.
C. Financial Buyers: Determining Which Ones to Approach
4. Business Model and Competitive PositioningWithin industries and at any size, some companies will be in more demand than others by private equity, and they will command higher prices than others, even if a snapshot of their sales and profit are equal because some business models are more efficient than others from a financial operating point of view. That is why Chapter 1 advises, well before you intend to sell your business, to (i) consider whether there are better ways to operate your business, and (ii) determine how much time, money, and effort it would take to adjust your business model, so it’s more efficient and highly valued in the capital markets. These are the type of questions you can ask yourself: • To get customers, does your business require you to spend money in up-front advertising for volatile revenues, or can you work with a strategic partner to send you a stable, reliable flow of business for a lower average price per customer?• Once you get a customer, is every interaction a “one-off,” or can you figure out a way to earn recurring revenue from the customer that does not require you to spend money to get every additional sale and makes your income more predictable?• Can you automate your customer interactions so that your business becomes highly “scala-ble”?• Is your business one of a few in some desired category, or one of many?• Does your business have some sustainable competitive advantage compared to others in your industry? Generally, private equity greatly values business models that feature a high component of stable, re-curring revenue, are scalable, are in the top three in their relevant market, and have some sustainable competitive advantage in the same industry and at the same size. Chapter __, Migrating the Multiple, delves more deeply into the characteristics of businesses that command more value in a sale.