The Sale Process - From Preparation to Closing

Summary of Prospective Buyer Types - Preparation Phase

Perhaps the most crucial facet of a business sale is understanding the range of different types of prospective buyers. The following factors would have an impact on selecting the most appropriate buyer type:

  • Importance to the seller of maximizing purchase price vs. ease of transition;
  • Attributes of the business (size, industry, attractiveness, strengthen of management team, etc.);
  • Transaction structure (full vs. partial sale)
Different buyer types will approach the acquisition process differently, have varying objectives and level of experience. The options of buyer type available to owners of mid-market businesses that have chosen a sale to an arms-length party include; strategic buyers, financial buyers, existing management and individual investors.

Strategic Buyers

Strategic buyer would be any corporation pursuing an acquisition to achieve one of the following strategies:
  • Remove a competitor;
  • Expand horizontally into new geographies or product/service lines;
  • Expand vertically toward the customer or supplier; or
  • Enhance the operations of the acquirer by gain the assets (technology, products, distribution channels, workforce, etc.) of the target.
Strategic buyers tend to pay higher multiples for a business, because they are willing to pay both a control and a synergy premium. In most cases, these buyers expect to realize synergies with the acquired asset which makes the asset more valuable to the acquirer than to previous shareholders. Cultural fit is also an important consideration with regard to strategic buyers as clashing values and philosophies often result in unrealized synergies and hence, failed acquisitions.

A strategic buyer is better suited for a seller who wishes to exit quickly and maximize the dollar value on the sale. It is not suited for a seller who wishes to remain in the business, or wants to retain some autonomy. A strategic buyer has sufficient resources to absorb the seller, and will usually move quickly on realizing some of the synergies from acquisition. This usually entails the elimination of redundant overhead and assets, which may be difficult for a seller to adapt to.

Financial Buyers

Private equity (PE) groups are financial buyers that invests in private companies of all sizes. Private equity firms will acquire various levels of equity (from minority to control) of companies with the goal of selling this equity - three to five years later to achieve an investment return. Hence, PE firms are primarily driven to maximize their IRRs on exit.

The funding for these investments comes primarily from a group of investors known as limited partners (LPs). Typical LPs include endowments, pension funds, sovereign wealth funds, wealthy individuals, and large corporations. Funding pledged by these LPs is pooled into individual PE funds which are managed by general partners who are co-owners of a PE firm.

These PE firms use the money in their respective funds to make investments in a broad range of public and private companies with the hope of selling them some day for large profits.

There are typically a wide mix of pros and cons of selling your business to a PE buyer. Private equity are usually pursued by sellers that want a partial exit or are looking for a partner that can provide either financial or strategic resources to facilitate accelerated growth. Shareholders of a company looking for a more immediate exit should heavy weight their prospective buyer list with strategic buyers more so than private equity firms.

Post-acquisition, PE firms usually take on a more active role in company oversight, for instance, putting Managing Directors and even more junior investment partners on the portfolio company’s board. They may also recruit new or supplemental company management they believe can add value to the business by helping the company set strategic direction. Active involvement in company management by PE firms can be beneficial as it presents existing management with new perspectives but on the flipside, it can lead to clashes if the two parties fail to agree. Having a PE firm on board can also allow a company to leverage its financial expertise for add-on acquisitions as well as better management of the company’s capital structure.

Existing Management

Existing company management could also emerge as a key buyer for businesses. This purchase is known as a management buyout (MBO). In an MBO, the purchase of the exit shareholder’s equity can be funded by a combination of senior or subordinated debt (called a leveraged buyout), vendor financing or by an equity injection from a private equity group. The interest burden tied to the additional debt taken on by the company could presents a key risk with this type of transaction.

A challenge in an MBO is that during the selling process the balance of negotiating power could shift towards the management team since they are insiders and should be well versed in positives or negatives to the potential valuation of the business. The transfer of ownership to management can also be gradually phased out to facilitate smoother transition since this represents an internal sale. However, the MBO may restrict the buyer field to just one party resulting in sellers becoming highly sensitive to concerns that they are not getting the best value for the deal.

Individual Investors

Individual investors differ from larger, institutional buyer types as they invest on their own behalf. They generally consist of high net worth individuals or family investment offices looking for a business that is financially healthy with a sound return on an investment. Like financial buyers, individual investors seek private companies with potential for future growth and existing competitive advantages.

These buyers will invest capital in their operations, and realize a return on investment upon exit via a direct sale. The individual investor typically focuses on managing wealth at hand to ensure sustainability for current and future generations. There is also a great deal of emphasis on portfolio diversification to minimize concentration risk in accordance with the individual or family’s goals and objectives. In many cases, individual investors may drive a hard bargain when it comes to price due to the fewer financing options available and may even expect the seller to finance a portion of the purchase.

Additionally, deal negotiations may be needlessly prolonged due to inexperience on the buyer's part. They are however less aggressive with their business strategy, seeking to make fewer and far less drastic changes, ensuring the stability of business operations. Individual investors are also usually more involved in the day to day operations and have a direct stake in the business, resulting in better aligned management and shareholder goals.

Decision Tree on Selection of Most Appropriate Buyer

The following decision tree can be used when assessing which buyer types might be most appropriate.

The ultimate decision does not preclude involving all types of buyers in the process, but it does demonstrate which parties would best fit the sales process, give the objectives of the seller and the attributes of the business.

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Written by Divestopedia Team
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Divestopedia is a resource for entrepreneurs who want to sell their business for the best price and terms. Whether you are thinking of selling, have started a sales process, or are post-deal, we aim to arm you with the knowledge required to maximize value and limit your downside risk. Full Bio