Identifying a Strategic Buyer
Q. My ultimate exit strategy is to sell to a strategic buyer. Are there things that you would recommend we do prior to the sale?
A. Typically, there are two types of buyers for a small business. The first is a strategic buyer (e.g., one that owns a business that has synergies with yours so that the two businesses are worth more together than the sum of what they are worth separately). The second is a financial buyer (e.g., a person who wants to purchase a business, but doesn’t bring anything to the table that is synergistic with your business). You are right to look for a strategic buyer because your business will likely be worth more to that type of purchaser. To get ready for the sale, we suggest four steps.
First, increase the number of prospective buyers. If your business isn’t already there, grow it into a fully evolved midsize structure. This means having a competent set of managers in place with well-documented processes and an appropriate set of metrics to let you know what is going on in bowels of the business without your having to be there personally. Then, delegate day-to-day decision-making authority to these managers and hold them accountable for results.
The acid test for a fully evolved midsize business is that the principal can leave for a couple of months and not much changes. Obviously, strategic decisions won’t be made in your absence, but the normal work of the business will go on without a glitch.
This will also underscore the fact that the business is more than you. Many small businesses are worth little without the owner because the business cannot run on a day-to-day basis without him or her—in effect, the owner is the business. You need to demonstrate that this is not the case with your business.
This structure will also make your business attractive to buyers who are not able or willing to make all of the day-to-day tactical decisions, because your managers are capable of doing that. Therefore, it will greatly increase the number of prospective buyers. The competition to buy your company will both increase the probability of a successful sale and the price your company will garner.
Second, determine the type of strategic buyer for which you are looking. Strategic buyers will be interested in how your company will fit into their long-term business plans. Typically, a strategic buyer will be planning:
• A vertical expansion (e.g., a customer planning backward integration or a supplier planning forward integration)
• A horizontal expansion (e.g., into new geographic markets or complementary product lines)
• The elimination of competition
• The strengthening of its own functional areas of weakness (e.g., technology, marketing, distribution, research and development, etc.)
For which type of strategic buyer will your business create the most value? Once you have answered this question, you will know where to market your business.
Make sure your business operates as profitably as possible for at least a couple of years prior to the sale. Your business will be worth more if it is generating a healthy profit. We suggest making sure that it is.
This may mean making tough decisions that you have known you need to make for a while, like cutting loyal employees who are no longer worth to the business what they are being paid. By the way, the new owner will likely let them go shortly after the sale anyway. At least this way, you can offer a fair severance arrangement.
This also means that you will stop making investments in the business that are unlikely to pay out until after the sale. You are probably not going to get credit for these investments in the sale price and will almost certainly be better off showing more profit.
You’ll also want to manage discretionary expenses tightly. Typically, this isn’t the time for a blowout holiday party, purchasing new office furniture, or upgrading all of your software. We’re not suggesting that you make stupid decisions that will hurt the business in the long run. We are suggesting that this isn’t the time for a spending spree.
Finally, we would advise that you seek the help of a competent investment banker who specializes in the sale of companies of your size and type. There are two reasons. First, an experienced advisor can give you a good idea of the price you are likely to get for your business. Get this assessment while there is time to make changes that will increase the value of your business. Many entrepreneurs make the mistake of believing that they can sell their businesses for much more than they actually can. It is best to face this reality while you can still do something about it.
Second, you will face a myriad of questions as you negotiate the sale of your business. Will this be an asset sale or a stock sale? Will you accept stock or debt from the acquirer or will this be a purely cash transaction? Will you give the buyer a note for a portion of the purchase price? Will there be an earn out provision? Will you have any role in the business after the sale? If so, what will your role be and for how long? The answers to these questions are not necessarily simple and getting what is right for you is paramount. A competent advisor can be invaluable.
Selling your business is a big step. The three suggestions above will help ensure that you maximize the price you are able to get for it.