Creating a Competitive Sale Process

By: David M. Jennings, Investment Banking Analyst

It’s an old adage among M&A professionals: “one buyer is no buyer.” This saying, of course, refers to the tendency of acquirors to take full advantage of their inherent leverage when singularly engaged in M&A negotiations. Despite this frequent (and frankly, predictable) tendency, business owners with limited M&A experience will all-too-often limit the potential buyer pool to a single, well-timed solicitor without realizing the potential impact on proceeds from the sale of their most valuable asset.

Business owners seeking a liquidity event should interpret unsolicited inquiries of interest as a signal for a potentially broader market demand and seek to create a more competitive bidding environment. By including additional buyers to create competition, owners can deleverage the buyers’ position and extract more compelling initial bids from interested parties.

The first step in creating competition is to conduct an exhaustive search for the most promising potential buyers. The key to the process, however, is identifying a strong group of potential buyers prior to marketing the business. While this may seem like an intricate task at first, there are a few essential concepts to understand that help to delineate this process.

Recognize the Value Components

In order to determine which buyers may have an interest, it is essential to first identify the attractive components of the company. By taking inventory of the qualities that make your business stand out, you will be better prepared to identify the most likely candidates. Attributes to consider include:

  • Customer Base

  • Product Mix

  • Regional Footprint

  • Market Share

  • Cash Flow Stability

  • Intellectual Property

  • Revenue Model

  • Operational Controls

  • Brand Reputation

  • Management Team

  • Sales Force
  • Revenue Visibility

Cast a Broad Net

A common mistake among selling business owners is to limit the list of potential buyers to competitors in the company’s direct market. Although competitors are often a good start, they are just the beginning of the search for potential buyers.  

Business buyers can generally be categorized into two groups: strategic and financial. Strategic buyers are other operating companies in a similar line of business who engage in acquisitions to grow and/or realize synergies from the acquired company. This category encompasses a range of companies up and down the supply-chain which may include competitors, suppliers and even customers. On the other hand, financial buyers are interested in the annual cash flow generated by the business and future exit opportunities that are available. As this article will explore, there are variations to the norm in both categories and it is typically best to include all types in order to maximize value for the seller.

Strategic Buyers

Sellers often first look to strategic buyers because they are the most familiar with this group. Strategic buyers primarily operate in a similar line of business as the selling company and they will quite often have a strong understanding of their business and operations. Strategic buyers engage in acquisitions to accomplish a myriad of growth strategies. In these challenging economic times, strategic buyers are turning to acquisitions to supplement their organic growth. Accordingly, the search for buyers should include competitors as well as other strategic parties in the business’s value chain.

Horizontal Integration - Buyers seek to acquire companies that are in direct competition with their primary line of business. In this case, the customer base is most desired in addition to the reduced competition they’ll face post-merger.

Vertical Integration - This type of strategy occurs when buyers seek to cut costs by integrating with companies up and down the supply chain.

Product Extension – Companies seeking to leverage their own customer base will use a product extension strategy to buy a product line that is complementary to their own portfolio.

Market Extension – The market extension transactions involve the acquisition of another company that sells the same or similar products in new markets. This allows the acquiring company to immediately gain visibility in new regions and reduce their dependence on any single market.

 Through a comprehensive analysis of potential buyers in each of these categories, the list becomes far more compelling than just the close competitors. This extended list features a range of potential candidates including suppliers, customers and a number of similar companies selling complimentary products or in tangential geographical markets. Strategic buyers are a great option for many sellers. More often than not, strategic buyers can realize synergies from the acquired company and have the ability to pay a higher price to the seller.

Financial Buyers

Financial buyers are an increasingly viable exit option to lower and middle market businesses. The realm of financial buyers includes an abundant list of private equity firms, family offices and high net worth individuals. Most common are private equity firms, which are privately managed pools of capital created to acquire privately-owned companies. The prevalence of private equity firms has burgeoned in recent years and now includes over 1,500 firms with approximately $400 billion of uncommitted capital. 

The private equity world has evolved significantly since its inception when it was commonly known for its financial engineering tactics. Today, these firms incorporate various growth strategies, industry expertise and degrees of executive engagement in order to drive value post-transaction. Additionally, many private equity firms implement “buy and build” strategies and commit additional funds to finance future acquisitions. The ultimate goal of these firms is to sell a much larger company down the road and generate substantial returns for their investors.

A preliminary analysis of potential private equity buyers can yield literally hundreds of results. As this segment of buyers has grown exponentially, many firms have refined their focus to target specific companies by industry, size and/or geography. To assess a potential fit, it is necessary to consider the fund’s stated investment criteria as well as previous investments and portfolio holdings.

Another important consideration that business owners often underappreciate is the significance of the private equity community in the strategic buyer category. Currently, private equity firms own or have an interest in over 6,000 companies; many of which are ideal buyer candidates. Moreover, these portfolio companies have the financial capability and strategic interest to aggressively pursue add-on acquisitions. 

Qualifying Prospects

With a comprehensive list of strategic and financial buyers, the list needs to be enhanced to prioritize the most likely buyers. By doing this, the seller is able to limit the exposure of sensitive information and ensure that all interested parties have the requisite resources to consummate a transaction. First, look to estimate the company's size by gathering information relating to revenue, number of employees, number of locations and so on. Then, look for any known or stated strategic relationships that the company has with a capital source. Many of these companies may be wholly owned subsidiaries of a much larger strategic parent, have received investments from a financial sponsor, or are the platform investment of a private equity group seeking to grow through acquisition. Finally, look to see if the company has made any recent acquisitions. These companies in "acquisition mode" are fantastic prospects because they understand the sale process and have the ability to quickly communicate their interest to the seller.

Creating Competition

The ultimate goal in approaching numerous candidates is to promote competition among potential buyers. To do this, sellers must first engage buyers through a well-orchestrated and confidential marketing effort. In any auction process, the seller should invest the time and effort to prepare a comprehensive marketing document that highlights the company’s strengths and offers a compelling value proposition to the buyer. There are a number of different auction strategies to choose from and all have different applications. In a limited auction, a select number of likely prospects are contacted and provided marketing materials pursuant to a confidentiality agreement. From this information and typically a follow-up discussion, the group of buyers will have enough information to submit a preliminary bid. 

As the process reaches the bidding stages, the seller should see the full benefits of a competitive environment. Through this process of conducting an exhaustive search for buyers and a coordinated marketing effort, the seller creates a competitive environment where potential buyers put forth their best effort. Ultimately, this achieves the seller’s goals of maximizing value and receiving optimal terms.

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