Know the Differences Among Buyers
A critical part of the deal making process is creating a Buyer List to whom an anonymous teaser document will be sent to gauge initial interest. This list often will number into the hundreds and there are several good data bases one can use to research buyers in order to make this list as effective as possible. There are some basics, however, that sellers should know about buyers before creating such a list.
Buyers can be divided into three general categories – Individuals, Strategic and Financial Buyers. Let’s look into all three of these:
Many Individual Buyers have never bought a business before so, by definition, they are less sophisticated than either Strategic or Financial Buyers. Hopefully, the ones Sellers encounter have money but it is often not the case. Individual Buyers’ naiveté goes so far as to assume that all they have to do is go to a bank where they can surely borrow what they need. They will soon find out that there is only a remote chance that this will happen seamlessly. Individuals can be very successful in buying companies – typically very small companies. Very often what they really want is to buy themselves a job. The down payment money will come from friends and family and often the Seller ends up being the biggest financing source after that. The terms of this loan, also called “Seller take-back”, will most always include a personal guarantee but it is rare that the Individual Buyer will have a personal balance sheet to fully support this loan. The only real collateral to a “Seller Loan “often ends up being the business itself. But the Seller doesn’t want the business back in case of default – he wants to sell the business for good reasons. So it ends up being a risk that the Seller will get paid on his loan. Despite these dire possibilities, many people sell their companies to Individuals and everything turns out fine – especially when the business being sold is a solid business and the Buyer is a solid Individual. Sellers just need to go into these types of transactions with their eyes wide open and an understanding of the downside risks.
An old mentor once told me that “Buyers seldom buy what Sellers think they are selling.” Strategic Buyers are just what they sound like – corporate buyers who buy companies for strategic purposes. Strategic Buyers want to expand horizontally – buying companies with similar or competitive products or services – or vertically, by buying businesses that will provide component parts to their existing product line or provide other ways to generate cost savings. Nobody wants to use their own money so, even if these companies have strong balance sheets, typically they will want to finance the transaction. However, in contrast to Individual Buyers, this is usually not a problem for corporate buyers. Strategic buyers present both problems and opportunities. One of the biggest problems they present is that there usually has to be agreement to do a deal up and down the corporate ladder. If even one person doesn’t like the deal it could blow up the whole transaction. The great opportunity to Sellers is that there are often reasons for Strategic Buyers to pay more than any other class of buyer. They can really be so synergistic so as to make two plus two equal five or six. On the other hand, Strategic Buyers will often feel that they shouldn’t pay the full purchase price because the potential returns of the deal will result from synergies the Buyers bring to the table, not the Seller.
Sellers may argue, “Maybe so. But if it weren’t for us you wouldn’t have the opport unity to apply the leverage that will create these returns.” Both arguments make sense, the parties enter into negotiations and, with skillful deal teams on both sides, agreement on price is reached – or not.
Financial Buyers, otherwise known as Buyout Groups and Private Equity Groups, are firms that buy companies typically to own for a defined period but not to directly manage them. They acquire for investment purposes and plan to sell or “flip” them later for substantial gains. Either they will have money, commitments from others to provide capital or no money at all. The latter group are usually called “Fundless Sponsors”. Either existing management come with the purchased company or be provided by the Buyout Group. Management will often end up owning an equity interest in the ongoing company after acquisition. The Buyout Group wants those individuals to have “skin in the game.” Financial Buyers most often will use a model in which they borrow as much as is reasonable and thereby invest as little as possible of their own money to comprise the entire purchase price. The debt is serviced with the cash flows generated by the acquired company. The plan is to grow the company over the same period and sell it for enough to retire the remaining debt, if there is any, and end up with a handsome return on their relatively small out-of-pocket investment. The Sellers of the purchased company most often end up with an equity interest in their now “old” company and profit along with the Financial Buyer when they exit the company. In other words, Sellers can get two paydays – upon the original sale of their company and again when it is flipped by the Financial Buyer. If the company qualifies, this can be a very profitable way to sell but it does not come without its challenges. Once the Financial Buyers decide to buy the company they have to convince a lender to supply the debt. Financial Buyers often have a small stable of lenders they have worked with successfully in the past but this convincing does become a second “sale” in which the original owner usually participates. Also, doing your deal is important to these Financial Buyers but if things don’t work out they will quickly go to the next deal they are working on. Their emotional investment is often not as strong as that of a Strategic Buyer.
There is much more to be said about this subject. I would be pleased to spend time with you discussing it in more detail if you so wish. Just let me know.