I had a call from a business owner this week who wanted to know how the M&A market was doing given the current economic environment.
“All good. There is an abundance of capital still available and activity is running high. The three Cs—Capital, Credit, Confidence are still in our favor.”
Next question: “Who do you think could be my buyer? Do you think I could attract a private equity group?”
“I don’t know without first completing your Master Exit Plan and having a thorough understanding of your business, financial, and personal objectives.”
In regard to financial buyers, like a private equity group, they certainly may be interested. There are different types of private equity groups. For example, growth PEGs bolt companies together onto a platform to meet their growth goals. Many financial buyers have a required minimum EBITDA of $2MM plus, however, we were involved in a deal recently in which the target company’s EBITDA was under $1MM.
So, you never know. If your business can fulfill and investor’s strategy you may attract a financial buyer willing to pay a nice premium for your business.
Who Are the Third-Party Buyers?
Not every buyer has the same motivations or comes to the table with the same opportunities. There are three different types of third-party buyers: financial, strategic and individual.
These investors are looking for a return on their investment via cash flow and a future exit for their holding. PEGs and family offices are the most common financial buyers in the middle market. These buyers actively pursue well-positioned businesses in which they can invest capital and expertise to grow value through increased cash flow and margin improvement. They’ll often bolt smaller companies onto a larger platform or entity with the goal of doubling, tripling or even quadrupling the size of the group, and then either sell the company down the road to a larger financial investor or take the entity public.
Buyers of this type are primarily looking at how consistent your earnings have been and the anticipated future growth potential. They typically are not eager to invest a great deal of capital to realize future earnings or to run your business themselves. Thus, they’ll rely heavily on your employees (and perhaps you in an ongoing management or consulting role) to drive the ROI they’re seeking. If you’re concerned about preserving your employees’ jobs or you want to continue working for a few more years, this is an ideal buyer to meet those goals.
Also, if you’ve built your business to the highest level possible and still see future growth opportunities but lack the expertise or capital to fund the growth, a financial buyer can provide the resources needed to realize your business’s optimal potential.
The deal may also be structured as a recapitalization in which the seller rolls equity into the new entity at the close. So, instead of cashing out 100 percent, the seller buys back an equity position at close, keeping them invested in the future success of their former company. This benefits the buyer and the seller with another liquidity opportunity when the new entity sells in the future—the proverbial “second bite of the apple.” It should be a win-win for both sides of the deal.
There are two different types of PEGs that rule the roost: efficiency and growth. Efficiency PEGs focus on running the organization lean to boost the bottom line as quickly as possible. Growth PEGs operate more like strategic buyers in that their strategy is to grow by bolting companies onto a platform to achieve economies of scale and improved margins. Therefore, if your buyer pool includes a PEG, it’s important to evaluate risk by understanding their motivation and will be used to grow the platform.
Strategic buyers are looking for businesses that offer a synergistic fit to their existing operations, making the whole greater than the sum of the parts. They may be larger competitors, customers or vendors. They’re motivated by the opportunity to expand quickly either into new geographic regions or product lines. They may be searching for customer expansion or supply chain depth. Perhaps they need to shore up a weakness in one of their core functions (for example, in technology or distribution). It always comes down to the basics—the opportunity for cost savings, increased revenue, market expansion, economies of scale, or diversification, resulting in a reduction of risk.
These buyers are long-term investors and pay high premiums for strong synergies. Because the free cash flow is adjusted for cost efficiencies as a result of this synergistic fit, the valuations are often higher than a financial buyer.
The third type of buyer is an individual investor. They may be wealthy individuals searching to invest in a business or people who have left the corporate world and now aim to try their hand at owning a business. Typically, they’ll be related to your industry in some capacity.
Such investors will rely on your team without hesitation, and they’ll be geographically sensitive, so there usually won’t be any concern about them moving the business or eliminating employees. They may or may not have access to capital, so the terms for payment will be important. The biggest question is whether they have the capabilities needed to run your business. You don’t want to accept a note as payment and have the business fail because the new owner didn’t have the skills to be successful.
At Legacy Partners, we work with our clients to gain in-depth knowledge about their organization, business goals and personal objectives to determine the best type of buyer for their needs. By focusing on the right buyer, our clients can position themselves to attract the most lucrative deal possible.