Constructing the Buyer List

The first step in constructing a buyer list is having a conversation with the divestiture principal. He/she will know the immediate competitors they face every day and why or why not they will not be "good" buyers. They will also know the reputation of these companies in the marketplace and may not want their legacy in such a company’s hands.

It is important to understand all of the objectives/considerations of the seller. Realizing the most money possible is the obvious goal, but is it also to leave a legacy? provide continuation and opportunity to the staff? retain the brand? ...the local employment base?

An acceptable acquisition structure and transaction time frame are also important considerations in constructing a buyer list. Does the seller want to exit as soon as practical (usually a minimum of six months post close) or does he/she want to continue to lead the company as a division of a larger, perhaps public entity, and in this circumstance, he/she may be more comfortable with an earnout or accepting shares of the purchaser as consideration.

M&A advisors will use many resources to prepare a buyer list, including proprietary in-house databases, existing relationships in industry and the private equity and fund sectors, business networks, associations, and commercial company databases, some containing as many as 15 million companies worldwide. These databases allow for searching by revenue/profit size, geography, key words, business description, NAICS codes (a government approach to classifying industries) and also by number of funding transaction and M&A transactions.

The buyer list is an evolving document. While an advisor has tremendous resources and many relationships at his/her disposal, they will never identify all potential buyers before engaging in the process. Once the teaser is in play, recipients (particularly private equity groups) will sometimes suggest other interested parties. Sometimes, private equity groups will have investments in companies (or relationships with companies) that are not obvious. These days, companies can evolve from an idea to a funded and strategically aligned early stage company in a matter of six months. Databases and M&A personnel have a hard time keeping up with this level of activity.

Entrepreneurs often exclude direct competitors from a buyer list for the obvious concern that the competitor will use the information that the seller is for sale as a sales tool against them OR they may wish to feign purchase interest only for reasons of gaining competitive intelligence. Excluding direct competitors may or may not be an issue from the perspective of realizing full value in the sale process. I have found that rarely does the obvious buyer turn out to be the actual buyer. Direct competitors may be under capitalized or they may have very similar products where very little synergies are realized in the acquisition. For example, they may just want the customer base and then lay off staff and replace the solution. This may not be a desired outcome.

What Makes a Good Buyer?

Now that we have constructed the buyer list, what really went into the thinking of who to include? What are the buyer list criteria? I have outlined several considerations above, but another way to look at it is as follows: identify companies with an ability to pay and an interest in paying a premium.

Assessing the ability to pay in the private market space is difficult. While for public companies you can peruse their financial filings, private company information is usually based on voluntary disclosure and may be out of date. The other area where ability to pay is difficult to assess is if the company has a relationship with a private equity group. The company may appear small and unable to acquire, but the private equity group may have access to hundreds of millions of dollars.

With respect to paying a premium, the rationale for doing so may be:

  • Economies of scale - The combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  • Economy of scope and cross-selling opportunities - Economies of scope are attained when, for example, efficiencies are gained by increasing the scope of marketing and distribution to additional products (sometimes creating product bundles as seen in the Telecom sector).
  • Unlocking underutilized assets - In some cases, proprietary resources such as R&D, patents, proprietary processes and technologies and even personnel are underutilized because of limited access to capital or other constraints. An acquisition by a well resourced company can unlock these assets.
  • Access to proprietary technology - In some cases, start-up or R&D focused companies have developed technologies that can have an immediate and broad impact on the operations of leading incumbents and substantially improve their competitiveness.
  • Increased market power - Acquiring a close competitor can increase market power (by capturing increased market share) to set prices.
  • Shoring up weaknesses in key business areas - When talent is hard to attract, acquiring businesses that perform functions that are under-performing can be an efficient way to fill gaps.
  • Synergy - An example of synergy includes increased purchasing power as a result of bulk-buying discounts.
  • Geographical or other diversification - Acquisitions can achieve immediate access to new geographic or product markets. In some cases, this can also serve to reduce earnings volatility.
  • Providing an opportunistic work environment for key talent - Growth through acquisitions provides managers with new opportunities for career growth and advancement.
  • To reach critical mass for an IPO or achieve post-IPO full value - Larger companies typically have more financing options, thereby reducing capital risk. Once public, companies need sufficient trading in their shares to realize full value.
  • Vertical integration - Vertical integration occurs when a company acquires its supplier and can result in significant savings if the supplier has substantial market power.

Ultimately, it All Boils Down to Fit

Determining beforehand whether a private company has these goals or can potentially achieve these results is nearly impossible. The best way to find the company that will pay the most is to approach all possible buyers, talk to them, and discuss the possible fit.