In the first two parts of this series we have covered making the decision to buy or keep your business as well as how to value your business and how to find buyers.
At this point you may be feeling that you can really do this! You can take the process step by step and eventually sell your business and feel good about the entire process!
The next step in the process is to compare and contrast types of buyers who could potentially purchase your business.
The first thing you should do is determine the type of buyer(s) you want. There are five basic types of buyers:
- Consolidators
- Investors
- New entrants
- Horizontal and vertical acquirers
- In-firm buyouts
The type of buyer(s) that you will want to work with will be determined by what sort of exit strategy makes you feel most comfortable.
Do you want the highest price and then be able to walk away entirely?
Do you want to continue to have control over business direction and continue to work?
Do you need cash immediately?
The answers to these questions will help determine what sort of buyer(s) make the most sense. There are pros and cons to each structure which should help direct you down the right path.
Consolidators
In Keep or Sell Your Business, Mike Cohn describes our first type of buyer as a consolidator.
He says consolidators are large companies with a regional domination in their industry or a prosperous national or multinational business. They are looking to expand into new geographical areas or to gobble up their smaller competitors to eat up market share and spread capital costs, allowing for more competitive negotiation.
This may be typical of a manufacturing firm looking to make entry from Canada into the United States. Let’s say they have a manufacturing facility in Canada and are planning on aggressively expanding further into the U.S. If you sell to them, this acquisition would be one of the many in the past or the future.
Cohn states that consolidators will typically pay a large premium over other buyers and you’ll likely receive many stock options or shares of stock and limited cash payment, although some companies will pay a large sum of cash given the right situation. However, after the purchase, your participation as an employee/partner/director will likely be limited as their main goals are usually to cut costs.
Cohn puts forth that consolidators are experienced acquirers. They usually have a team of lawyers and negotiators who do this on a daily basis and have closed many transactions. More than likely, you are probably on the opposite end of the spectrum and this is the first time or perhaps only the second time you have explored selling your business.
Make sure you have an experienced mentorship team around you who can offer years of wisdom on mistakes they have seen other people make or have even experienced themselves. We usually suggest having an attorney or two, a CPA, a business broker or intermediary, a financial advisor, and trusted business friends on your team. This will be especially vital for negotiating with consolidators.
Investors
Cohn describes our second class of buyers as investors. He wrote that investors are generally viewing your company as a source of financial gain. They usually have great access to capital (whether debt or cash). The investors may be a group or may just be an individual. They are looking to add value to the company and sell it down the road. They may be entirely new entrants to the industry or are looking to reduce expenses or to create economies of scale by placing several small businesses together. More than likely, they will be the latter and will have many years of industry experience.
Cash flow and exit opportunities are most important to them. They often are heavily reliant on financing – possibly bank financing or direct financing from the seller. Their prices will generally be lower than consolidators, but they will usually pay a large down-payment in cash. There will often be opportunities for the owner to stay on as a consultant or as a partner and thus will allow for future cash flow whether through earn-out provisions or as a salaried employee or a combination.
However, this can be a risky proposition due to often heavy debt financing. Do these buyers have the necessary capital and reserves for bad times as well as good times? This is no small issue. You need to do your due diligence not limited to calling their bank, asking for audited financial statements, and talking to references of customers and suppliers.
Additionally, many of these newly formed partnerships may sound good on paper, but as the rubber hits the road some sellers regret the transaction due to a partner who may be making ethically unsound decisions, is overly pushy or aggressive to their inherited customers, or there is simply a personality mismatch.
In order to identify these issues ahead of time, we have developed an extensive testing system for new partners as well as employees. We suggest as negotiations start to become serious with an investor to interview your potential partner as though it is a quasi-job interview. Is this somebody you would hire as an executive in your company? If not, the money they are offering will not be worth the headaches that could be coming down the road.
New Entrants
New entrants are our third class of buyers. Some people may consider them a subset of the investor class, but we treat them separately because they have their own set of issues. New entrants are individuals with limited experience (10 years or less) or are people who have been in the industry but stepped away for a few years. Buyers in this group are usually qualified, although you sometimes run into many un-qualified buyers who think they can buy a business with little to no money down.
Most new entrants are qualified because they have a lot of cash on hand and they have the ability to put up the necessary capital. They will not be as highly leveraged as most consolidators or investors.
New entrants often have the long-term in mind for the business. They plan on staying with the business for the unforeseen future. Usually, the changes will be relatively minor compared with investors or consolidators. They are not looking to change the business model or to cut costs.
New entrants will desire to have you on board, even more so than investors, possibly for two to three years or as long as you have the drive to work. There will be many opportunities for you to be involved working with the people who you have built relationships with for a lifetime as well as to continue to earn money on top of the sale of their business.
New entrants have many of the same pitfalls as investors. They will pay a lower amount on the business relative to consolidators. They often will seek some bank or seller financing so you are subject to their credit risk until they complete paying for the transaction. Additionally, there may be the same partnership issues discussed for investors. We strongly suggest having a quasi-interview and testing thoroughly all new entrant candidates.
Make sure to scrutinize their financial situation as carefully as possible. Do they really have the financial depth to make this deal swing? Talk to their bank, check their credit history, and get verified financial statements. This is one of the biggest events in your life – do your due diligence and don’t just rely on others.
In-Firm Buyouts
The last class of buyers is in-firm buyouts. The entrenched staff or your board of directors may also be a potential buyer. Unlike all of the other buyers, you know them and their abilities intimately. They have relationships with your suppliers and customers and will often continue the business down the same direction you started. Due to the knowledge they have, they may be willing to offer a strong price. However, they may not be able to put down a significant down payment or afford debt financing.
If this is the case, you could look at several options. First, you could plan to stay on longer than any of the other scenarios as you groom your successor. You could look at various partnership structures like a limited partnership to have them slowly come into the practice as limited partners. As their income and savings rise, they now have skin in the game. They are partial owners of the business.
As income grows, they could put more into the company to buy you out. You should be able to identify a minimum of two to three people within your organization who have the financial wherewithal to swing this deal. Additionally, you could explore an employee stock purchase plan either as a single event or over a number of years. This will allow you to maintain control over a majority over the organization while gauging interest and ability of the employees/potential partners.
There are some potential problems. When you share the organization you also share power and this may hamper a complete sale of the company to another qualified buyer who could purchase the organization outright. This type of deal may also create accounting headaches and will take significant time to track and distribute profits. It may also create Napoleonic complex within members of the organization as small residual owners of the company think they should have greater say and sway than their ownership percentage actually dictates.
Do Your Homework
Overall, no matter which buyer would be the best fit, make sure to do your homework. Due diligence is vital to determine how well the deal will succeed. Is this partner really a good match? What are they bringing to the table? Can they talk the talk as well walk the walk?
There will be issues that come up even in the smoothest deal. There will be issues that were not discussed because they were not thought of by the buyer and the seller. You need to make sure your potential partner is willing to negotiate as well as to compromise and make sure you have that spirit and attitude as well.
So, now that you have an idea of what type of buyer you wish to pursue, how are you going to attract them and close the deal?
Stay tuned for part 4 of our series where we will provide tips on how to do just that!
What type of buyer did you decide is best for you? Shoot me a message and let me know which type you chose and why @dave@daviddenniston.com!
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Please consult with your accountant or tax advisor for specific guidance.