Not All Business Buyers are Created Equal – Part Two

In my last article, I covered the various types of business buyers and what financial buyers tend to look for in a business. In this article, I’ll cover what strategic buyers tend to want in a business.

Strategic Buyers

Strategic buyers are often a larger company in the same industry or vertical. They are looking for the following criteria in a potential business purchase:

• Growth potential, or, as one buyer told me, “If we pay seven times EBITDA and grow the business like we want to, it’s a great deal. If we pay four times EBITDA and it doesn’t grow, it’s a bad deal.”
• A good management structure in place. Strategic buyers and private equity groups usually don’t want to come in and run the company on a day-to-day basis. They want a proven team in place. This carries down to the non-management employees also. They are really buying people (as are all buyers).
• Correspondingly, the business can’t be highly dependent on the seller, whether the seller is staying on as an employee or exiting after the transition. A situation like this is often referred to as “personal goodwill” and does not provide the value, or price, associated with “company goodwill.” (In simple terms, goodwill is the difference between the value of the assets of the company and the company’s value based on profit.)
• While profits are important, gross margin may be more important. These buyers can control and reduce the overhead. They don’t want customers accustomed to paying so low a price they can’t make an acceptable margin.
• Assimilating overhead is often the key component to a deal, even if it’s a small or midsized business buying another small business. Combining facilities, reducing administrative staff, or getting increased buying power can all affect the price.

Strategic buyers may or may not know what they’re doing (regarding an acquisition). In many cases they are as naïve as the corporate executive making his first foray into entrepreneurship. If it’s a small to mid-sized company making the acquisition, they are still, in many ways, also a financial buyer. After all, it’s the owner’s money, not some group of shareholder’s money. They will be as careful as any individual.

If it’s a larger company, expect a more organized process, but also a lot more detailed process, especially during due diligence. What’s the main reason for this? To me, it’s the fact no person climbing the corporate ladder wants to be responsible for a bad deal (they’ll let those already on top make the bad deals). So, they’ll be hyper-diligent and ask every possible question, looking for complete answers. Don’t let this scare you unless you have something to hide.

I can’t give you an exact size range of companies that are strategic targets. It could be as small as $1-2 million in sales if there’s a desired product, IP, or employee talent pool. Or, a buyer’s minimum could be $10 million or more. What there must be are some synergies (I consider more customers and revenue a synergy). But a warning, don’t expect a smart strategic buyer to calculate all the possible synergies and pay you based on all that estimated profit. Because I doubt if in the history of the planet there have been more than a handful of deals where all synergies were achieved as planned. You may get more than from a purely financial buyer, or, you may not (being frugal with the company’s money also can lead to career advancement).

Examples

A seller told me he didn’t know why he should waste his time with an individual financial buyer and the accompanying due diligence when all he had to do was tell firms in his industry he wanted to sell and they would pay him a high price based only on his sales volume. My reply was, “That could happen but probably won’t. While they won’t have to verify the market demand, the industry, or other things of this nature, they will know all the weak spots your business could have and will pick apart those areas much more deeply than an outside buyer. They know where the secrets can be hidden and how to expose them.” He ended up selling to the financial buyer.

When it comes together it’s great! Fred grew his mid-sized company by acquisition. The first one was the definition of synergy.

• The second firm was far enough away to have a different customer base and close enough to commute between the two locations.
• A Venn diagram of the customer mix would have very little overlap. Same industry, different service niche.
• Given some of the service peculiarities, he could shuttle jobs between the facilities instead of reprogramming equipment.
• He was now large enough to hire a controller instead of a bookkeeper and a higher-level manager with experience growing similar businesses.

They’re not all like Fred’s but then again, a buyer doesn’t need all the boxes checked, only the ones they feel are important.

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