Business Buyers are
Savvy Shoppers
The business sale
process is a complex battle for leverage. A seller wants to invite many
qualified buyers to the table and position his company to produce strategic
value. The experienced professional business buyer has his own arsenal of tools
to move the balance of power in his favor. This article examines how Private
Equity Groups approach the process and try to stack the odds in their favor.
We preach to our
business seller clients the benefits of testing the markets and inviting many
qualified buyers to participate in the process. The ultimate goal is to get two
or more buyers that recognize the tremendous synergies that the combined
companies could realize and produce offers that are not based on a financial
multiple, but on a strategic value premium. A financial multiple would be a
purchase value something like 4 X EBITDA (basically cash flow) or 70% of annual
revenue.
What would produce
strategic value? The good news is that this can be created in a number of
different ways. The evil "Wall Street stereotype" is to
eliminate duplicate functions and save a tremendous amount in payroll expenses.
I am not a big fan of this as the reason for doing an M&A deal. Somehow
tearing something apart does not represent any particular management
imagination or skill. Identifying ways to build value by creating the sum of
the parts that far exceeds the inputs is real visionary management.
This strategic value
can be created by acquiring a complementary product line that can be added to a
strong sales and distribution network. Acquisition targets can provide
superior systems, business models, product technology, and management
talent that can be leveraged by the new combined company to produce revenues
and profits that far exceed the two separate companies.
This sounds easy on
paper and makes a lot of sense, but the truth is that most acquisitions fall
short of expectations because, integrating all the systems, personnel, culture,
locations, customers, etc. is complex. This makes buyers cautious. When buyers
get cautious, they revert back to the conservative financial multiple which
basically provides a safety net to their investment if the post acquisition
synergies are not realized.
We subscribe to a
private equity group database which helps us identify likely buyers of our
sellers based on searching their investing criteria and identifying their
portfolio companies. A surprising discovery I made is that in this particular
universe of the largest 3500 private equity groups, they owned a combined
46,000 companies. If you wanted to draw any conclusions about business buyer
behavior, this would be your group of target subjects.
First conclusion is
these guys want to win. Sure it's money, but it is the game and the competition
and thrill of the conquest that also drives these serial business acquirers.
They think they are the smartest guys in the room (hey check their educational,
and job history background) and on paper they may just be. But you only
need to have one failed $20 million acquisition to instill some real rigor and
financial conservatism into your process. They want to stack the deck to
put as much as they can in their favor to make these investments winners.
The first thing they
do is look for Warren Buffet type businesses. You know the ones that have a
durable competitive advantage, positive cash flow, steady growth rate, loyal
customers…… They want to draft Payton Manning coming out of Tennessee - Great
start.
The next tenant of their success formula is to take advantage of the large company valuation premium. This is how it works. Their first acquisition into a market space is generally a bigger company, say $25 million in revenue. Let's say that this valve and pump company sells for a 6.1 X EBITDA multiple. They then attempt to make a series of tuck-in acquisitions of a $5 million valve company here and a $4 million pump company there. These smaller companies command a smaller valuation multiple than the large company, say 4 X EBITDA. The day the acquisition is completed, the PEG has already won because the acquired company is now valued at the higher EBITDA multiple of its new parent. They make a series of these investments, grow the company organically as well for 7 years and then sell their $150 million in revenue company to a strategic buyer at an EBITDA multiple of 7.8 X.
The next tenant of their success formula is to take advantage of the large company valuation premium. This is how it works. Their first acquisition into a market space is generally a bigger company, say $25 million in revenue. Let's say that this valve and pump company sells for a 6.1 X EBITDA multiple. They then attempt to make a series of tuck-in acquisitions of a $5 million valve company here and a $4 million pump company there. These smaller companies command a smaller valuation multiple than the large company, say 4 X EBITDA. The day the acquisition is completed, the PEG has already won because the acquired company is now valued at the higher EBITDA multiple of its new parent. They make a series of these investments, grow the company organically as well for 7 years and then sell their $150 million in revenue company to a strategic buyer at an EBITDA multiple of 7.8 X.
These sophisticated
buyers are very disciplined in their acquisition process and very seldom stray
from the strict EBITDA multiple offer. In order to stick to that
discipline, they have to look at a lot of deals. We normally ask our buyers
that have signed NDA's and looked at our client, and then withdrew, why they
dropped out. We get a lot of different answers, but the top answer is that they
were in another deal and would not be able to process both at the same time.
Most of these firms invite 50 - 100 potential acquisitions into the top of the
funnel for each one that they complete.
So, what they are
doing is creating the counterbalance of the leverage we are trying to create by
getting lots of potential buyers involved. They have multiple options, so
if the price gets too high, they go for easier prey. If the sellers are
difficult, they move on. If the financial reporting is shaky and unclear they
find a company where it is transparent.
Please don't let me
give you the impression that this process is totally by the numbers. There are
great companies that will command a premium, but just like buying a luxury
automobile, they are still shopping.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
