News of a strategic buyer acquiring a string of Colorado businesses spurred me to end this blog’s summer break
and to help human-owned businesses understand the distinctions among
possible buyers of such companies. Business buyers are often described
as “strategic,” “financial,” or “entrepreneurial,” and the differences
between the three result in important implications for prospective
sellers. This four-part series will explore these three profiles and
one more, the related-party buyer. This series draws heavily on some
great thinking and advice my partner Ned Minor gives in his book
“Deciding to Sell Your Business.”
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| You will jump through many hoops when you sell your business. It helps to know which ones are important. |
A “strategic buyer” comes from the pool
of companies that conducts business, directly or indirectly, in your
industry. Any business that sells goods or services to your industry,
distributes your industry’s products, or provides financing to your
industry is a possible strategic buyer. Of course, your direct
competitors may be the most important group of strategic buyers.
The strategy that drives a strategic
buyer to acquire a particular business changes from buyer to buyer, deal
to deal. Here’s a list of some of the most common strategies:
- Increase revenues;
- Diversify revenues;
- Reduce competition by acquiring a competitor;
- Reduce competition by acquiring a business before a competitor can;
- Increase market share;
- Economies of scale;
- Expand into a particular market segment;
- Expand into a new geographic market;
- Secure a specific location;
- Open up strategic alliances;
- Protect or enhance a supply chain; and
- Enhance growth opportunities for employees.
Strategic buyers have dominated mergers
and acquisitions, lately, since they often use their own cash to make
acquisitions. Financial and entrepreneurial buyers typically rely on
the leverage of credit to make their deals happen. With the credit
markets yet to recover fully from the Great Recession, in some markets,
those buyers have been sidelined or put at a significant disadvantage
relative to strategic buyers.
More often than not, a strategic buyer
will pay a higher purchase price than a financial or entrepreneurial
buyer. There are several reasons for this. Strategic buyers compare
the cost of purchasing your business to the cost of starting a business
in your area and competing head to head against you. The strategic buyer
knows your industry and may be willing to pay a premium because it
understands the opportunities, dangers, pitfalls, market conditions, and
trends in the industry. Because strategic buyers understand the risks,
they can also be more flexible when it comes to negotiating
indemnifications in the sale transaction.
The potential for financial and
operational synergies is another strong motivator for strategic buyers
to pay more for your business than financial buyers, entrepreneurial
buyers, or related parties. Strategic buyers can cut costs, eliminating
areas of duplication. For example, once the post-closing transition
phase is complete, your controller may be looking for a new job. Most
strategic buyers already have strong accounting/financial departments in
their home offices. The strategic buyer may consolidate multiple
locations, thus saving significant rental expense. Some strategic buyers
may stop doing business with smaller, lower margin customers in order
to improve their profits.
You need to think carefully before
talking about a deal with a competitor. Antitrust laws may make add
challenges and costs to closing the deal. Confidentiality will be key,
especially since industry rumor mills wreak havoc on employees,
customers and suppliers by spreading premature, or downright false,
information about negotiations. But most critical of all, if the
transaction fails to close, the competitor will know everything there is
to know about you, giving it an unfair advantage. A good transaction
attorney can help minimize this risk with a well-crafted nondisclosure
agreement, as well as carefully timed, and structured, responses to the
buyer’s due diligence requests.
One fundamental principle applies to
all buyers, but especially to the strategic buyer. No matter how
successful you are, your strategic buyer believes he is smarter than
you, knows your industry better than you do, and can make more money
running your business than you can. The challenge for you, and for your
transaction attorney negotiating the sale, is to make that strategic
buyer pay a premium for the opportunity to prove just how smart he
really is.
