When you are constructing a buyer list, what really goes into the thinking of who to include? What are the buyer list criteria? I have outlined several considerations in "Constructing a Buyer List and Finding the Right Buyer for Your Company," but another way to look at it is as follows: identify companies with an an ability to pay a valuation premium AND an interest in paying such premium.

Is the Buyer Able to Pay?

Assessing the ability to pay in the private market space is difficult. For public companies, you can peruse their financial filings. However, for private company information, this review is usually based on voluntary disclosure and may be out of date. The other area where the 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.

The Top 11 Reasons a Buyer will Pay a Valuation Premium

Reason # 1: 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.

Reason # 2: Economies 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).

Reason # 3: 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 more well resourced company can unlock these assets.

Reason # 4: Access to proprietary technology

In some cases, startup 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.

Reason # 5: Increased market power

Acquiring a close competitor can increase market power (by capturing increased market share) to set prices.

Reason # 6: 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.

Reason # 7: Synergy

An example of synergy is the increased purchasing power that results from bulk buying discounts.

Reason # 8: 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.

Reason # 9: Provide an opportunistic work environment for key talent

Growth through acquisitions provides managers with new opportunities for career growth and advancement.

Reason # 10: 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.

Reason # 11: Vertical integration

Vertical integration occurs when a company acquires its supplier and can result in significant savings if the supplier has substantial market power.

In Conclusion

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.