Which is Better, a Financial Buyer or Strategic Buyer?

If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial and a strategic buyer—understanding the different motivations of these two buyers can be the key to getting a good price for your business.

A financial buyer is acquiring your future profit stream, so they will evaluate your business based on how much profit it is likely to make and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business.

But there is a limit to how much they will pay, because financial buyers are playing the buy-low, sell-high game. They do not have a strategic rationale for buying your business. They don’t have an army of sales reps to sell your product or a network of retailers where your product could be merchandised. They are simply trying to get a return on their investors’ money, so they tend to buy small and mid-sized businesses using a combination of this investment layered on top of a pile of debt, and they want to buy your business as cheaply as possible with the hope of flipping it five or ten years down the road.

Because financial buyers are usually investors and not operators, they want you and your team to stick around, so they rarely buy all of a business. Instead, they buy a chunk and ask you to hold on to a tranche of equity to keep you committed.

A strategic buyer is a different cat—usually a larger company in your industry, they are evaluating your business based on what it is worth in their hands. They will try and estimate how much of their product or service they can sell if they added you into the mix. Because of their size, this can often lead to buyers who are willing and able to pay much more for your business.

Tom Franceski and his two partners had built DocStar up to 45 employees when they decided to shop the business to some Private Equity (PE) investors. The PE guys offered four to six times Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), which Franceski deemed low for a fast-growing software company.

Franceski was then approached by a strategic acquirer called Epicor, which is a global software business with a lot of customers who could use what DocStar had built. Epicor offered DocStar around two times revenue—a much fatter multiple than the PE firms were offering.

Selling In A Buyer's Market

The demographics of the Boomer transition are not very encouraging for business sellers. We are rapidly approaching the worst imbalance between small business sellers and buyers in history, and it will continue for the next 20 years.

The most generous estimate of the population born in the twenty years following the Boomers is that they are 9 million fewer (69 million vs. 78 million.) More importantly, the bulk of that group was born in the late 1970’s, when birthrates began to rise again following the “Baby Bust” of the late 60s and early 70s.

From 1953 through 1957, over 21 million children were born in the US.  From 1973 through 1977, there were only 16 million new births, 23% fewer. What happens to pricing and competition when there are four sellers for every three buyers?

If the problem was limited to the numbers alone it would still be dramatic. In addition, there are other factors that make the numerical shortfall even more pronounced. The profile of the buyers, and the values and the choices of Generation X, will exponentially increase the gap between Boomer sellers and the people to whom they expect to sell their businesses.

The value system of this buyer generation doesn’t fit the values that are predominant in Boomer entrepreneurship. The concept of devoting 50 or more hours a week to a business, and doing it for 20 years or more, is antithetical to most Gen Xers preferred lifestyles.

From 2018 to 2023 the boomers will be reaching age 65 at a rate of 10,000 a day. About 9% of those aging boomers are business owners. Even if the next generation had the same competitive instincts and work ethic as the Baby Boomers, the number of available buyers would be short by over 200 daily.

Based on the numbers alone, small business buyers will have ample choice in the marketplace. Having had little opportunity to build up savings, they won’t have much cash to put down for a successful Boomer business. This will create a large number of sellers who will be forced to finance an acquisition themselves, rather than walk away from the business with nothing.

Of course, the best Baby Boomer businesses will still find qualified buyers. In order to successfully sell in a competitive market, they will need profitability, systems, and a track record that is better than that of their competitors. If you would like to assess the status of your business and its chances for successful transition, please give us a call.


© 2014, MPN Inc.

What Is An Exit Plan?

Exit planning has become a new buzzword for those who consult to Baby Boomer business owners. Business brokers, wealth managers and other professionals are adding “exit planning” to their marketing messages.  It’s a logical reaction when over 5,000,000 Baby Boomers are preparing to leave their businesses.

Not surprisingly, when a business broker creates an “exit plan,” it usually involves listing the business for sale to a third party. An attorney’s planning focuses on the legal documents that allow the transition of the assets of a company to new ownership. An accountant or financial planner will look closely at tax and inheritance issues, and an insurance broker offers products that reduce the risk of interruption or disaster.

All these are important to the successful implementation of a plan, but each professional focuses on his or her specific skill set. If your shoulder hurts, you could go to an orthopedic surgeon, a neurologist, a general internist, a chiropractor or a physical therapist. Each will have a treatment approach for a painful shoulder. Each will be different, based upon his or her specialty. Each will reduce the pain at least somewhat, although some of them may or may not address the underlying cause.

Similarly, there are many professionals who claim competence in exit planning. Each has a different area of expertise, and what they term as exit planning tends to focus on those areas. A comprehensive exit strategy encompasses legal, tax and risk management issues, but it also examines the operational issues of the company whose value is the underlying driver for everything else.

Before the first document is drafted, or embarking on a plan for spending the money from a sale, the business must first realize the proceeds of a transaction. That means it has to find a buyer who will pay for it. That buyer could be a third party, but it might also be an employee, an employee group, or family members.

Any third party considering the purchase of a business will do extensive due diligence. Their willingness to pay a premium for a company will depend on its track record of revenue growth, the stability of its margins, and how well-established its systems and customers are. If the company is larger than about ten employees, they will look for supervisory and management talent who will stay after the sale.

Regardless of size, a business that is highly dependent on the owner for revenue or for making all key decisions will be deeply discounted or even impossible to sell. An exit plan should look at these factors, and help to make the adjustments needed to realize full value.

Selling to employees or family is often an attractive option, because it allows the owner to choose a retirement date, and price is less of an issue than financing terms. Unless you are willing to accept a promissory note for most of the price, and feel secure that your successors can maintain payments over a long period, a plan for this kind of exit should begin at least three, and preferable five to eight years before the planned transfer date.

An exit plan needs legal, tax, risk and wealth management expertise to be successful, but it also requires a practical examination of the operational strengths of your business. Selecting one professional to manage the efforts of everyone, and to help keep you on track, is a wise investment.

In America, the average small business owner has nearly 75% of his or her net worth in the company. The single biggest financial transaction of your life deserves special attention. Call us to discuss your options. 

© 2014, MPN Inc.

"The Owner's Trap"

Entrepreneurs can have many reasons for wanting to launch and own a business, but typically "freedom" is a key motivating factor.  And, when your business is sellable, not only do you enjoy increased freedom today, but also in the future when you realize more options for your eventual exit.  You might decide to scale up and become an absentee owner, transfer the business to children or insiders, or sell to a third-party or ESOP.  If you have a sellable business, you have tremendous freedom as an owner, both now and at exit.

John Warrillow, author of Built to Sell and The Automatic Customer, often describes what he refers to as "The Owner's Trap" and how so many business owners today "are stuck"  in the trap with businesses that are not sellable.  Basically, these owners have businesses that are far too dependent on them and they are not experiencing the freedom they signed up for.  You can discover whether or not you're in "the owner's trap" by answering these questions:

  1. Does the business slow down when you're not there?

  2. Do customers come to you when something goes wrong?

  3. Has your revenue plateaued?

If you've answered "yes" to one or more of these questions, and you want to plan to escape the owner's trap, take steps now to implement the following strategy:  First, assess the sellability and value drivers of your business, and then, once you've exposed reality, implement a plan to accelerate the value and sellability of your company.   With increased sellability, you will enjoy much more freedom today and when you're ready to exit.

"I Want To Sell My Business In 1-2 Years..."

Many baby boomer business owners are thinking they "are ready" to leave their business in next 1-2 years and begin their retirement or third act in life.  With the economy growing and the number of investors seeking quality businesses to buy, many are thinking it could be an opportunity to "sell high" and accomplish their financial goals.

If indeed there is a desire is to sell within 2 years, and minimal or no exit planning and pre-sale due diligence has been achieved to this point, following are a number of the key planning issues that should be addressed in the first 60 days:

  • Establish owner-based exit goals (desired buyer, sale-price, values-based goals, etc.) and do whatever possible to prepare for life after the sale. Survey data indicates most business owners are not happy in life two years after the sale of their business.

  • Select a transaction intermediary (Investment Banker or Business Broker).

  • Get an estimate of business marketability and value.

  • Begin tax planning and pre-sale due diligence.

  • Assess and, if possible, enhance business value drivers.

  • Take steps to protect the value of the business during transfer (i.e., employee incentive plans/stay bonus).

  • Select the remaining needed members of your Deal Team (i.e., CPA, M&A Attorney).

  • Review your estate plan and business continuity arrangements.

  • Make decisions pertaining to a plan for communicating your plans to employees.

This is not an exhaustive list and only represents what should happen in the first 60 days.  There is much more to do throughout the 2-year period to give yourself the best chance at a successful exit.  So, an immediate priority should be the selection of a trained and experienced Exit Planner to assist with the management of the exit planning project.  Typically someone is going to engage a knowledgeable project manager or general contractor to manage the process for building their "dream house".  In selling a business, there is much more at stake than building a dream house.