When your shareholders have decided that it is the right time to put your business up for sale, it is very easy to say “great, let’s sell it to the buyer with the highest valuation”. But that would be a mistake. There are several other factors that go into finding the “right” buyer for your business and your specific situation. This post will help you think through those various consideration points and provide some warnings for things you need to look out for to avoid known potential pitfalls when it comes to picking the right buyer for your business.
A Normal Sale Process
When companies are put up for sale, that is often done with a business broker that is marketing your company to many prospective buyers at the same time. Let’s say in a normal process they could reach out to 200 target buyers, get 20 of them to engage in some sort of dialog or preliminary due diligence and get 5 of them to submit a letter of intent to purchase your business. The question of this post is: which of the five buyers is the one you should pick? Spoiler alert, it may not be one with the highest price.
The Different Types of Buyers
Most buyers can be classified into one of three categories: (i) strategic buyers that are companies looking to get into your industry or increase their current market share in your space; (ii) financial buyers that are often private equity firms or family offices looking to buy cash-flowing businesses as an investment strategy; and (iii) individual executives or entrepreneurs that are looking for a business for them to own and operate themselves (these can be individual executives or fund-less sponsors backed by private equity funds creating new executive roles for themselves). Let’s talk about the typical advantages and disadvantages of these three different types of buyers.
Strategic Buyers
Advantages: Strategic buyers are often the most reliable to get to closing. They are talking to you because they see something in your business that can help them with their business. Because of that, they are often the most willing to pay the highest valuations. And they are often cash-rich, which means many do not need outside loans to get a deal done, depending on the deal size. They don’t necessarily need your management team, if they have other executives able to step in and run the business.
Disadvantages: Strategic buyers are often the slowest moving with the longest timeline to get to closing, with lots of different decision makers involved. So, if speed is important to you, think twice about going down this path, as the due diligence and document drafting process could be the most cumbersome.
Financial Buyers
Advantages: Financial buyers can move pretty quickly, as they are typically sitting on a big pile of cash that they are looking to invest.
Disadvantages: They will often want to raise bank debt for up to 50% of the purchase price to better spread their equity investing potential into other companies. And banks like to invest in companies with over $3MM in EBITDA, which may not be you. They will want to back executives, as opposed to run the business themselves, so make sure you have a management team plan for them, which may include hiring and training your replacement prior to selling. They tend to be the most aggressive in terms of negotiating the best price possible for themselves in order to maximize ROIs for their investors.
Individual Buyers
Advantages: These tend to be the least sophisticated buyers and can require the least due diligence or least “hoops for you to run through” to get to closing.
Disadvantages: They often require bank financing for a large portion of the transaction (up to 90% with SBA-backed loans), so the process can get slowed down by them having to secure the needed capital. Since those bank loans often require personal guarantees of the buyer, they are often the most nervous about “making a mistake” and can easily talk themselves out of a transaction if they don’t want to take the additional personal risks.
Other Topics to Consider When Picking a Buyer
In addition to the type of buyer, you have to assess these additional considerations to determine if they are the right buyer for your business or not.
Their Reputation. If you are interested in protecting your legacy, you don’t want to hand your business off to a buyer that will hurt the company’s reputation in the future.
Their Plan for Your Business. If you care about how the business is going to be run post-sale, you don’t want to sell to anyone that doesn’t share that vision.
Their Plan for Your Employee Team. If you care about your staff being treated fairly post-sale, you don’t want to sell to someone who is going to layoff your team.
Their Odds of Closing. Selling to a buyer with a 75% chance to get to the finish line is a lot better than selling to someone with a 25% chance of getting to the finish line. Even if it means a lower price.
Their Speed to Closing. Selling to an experienced buyer that knows how to get through the process quickly is preferred to selling to an inexperienced buyer that could have the process drag out for months, and still not get to the finish line.
Their Personal Fit for Your Culture. Make sure there will not be any personality or other issues with the buyer, in terms of how they will mesh with your current culture and team.
How is It Financed. An all-cash offer is a lot better than an offer requiring any seller notes, earn-outs or third-party bank financing. Duh!
How Secure is Their Financing. If they do require outside bank debt or equity investors to fund the transaction, have those commitments been secured already, or is there risk they will lose their financing. Even committed financings can fall apart, so be careful here.
Market Conditions. If the economy or financial markets are perceived to be on unsteady footing, that will make buyers, banks and equity investors nervous, which will hurt your odds of getting the business sold. Find buyers with a long term vision that are comfortable in all market conditions.
Closing Thoughts
So, as you can see, there are a lot more things to consider than maximizing valuation when picking the right buyer for your business. Don’t be so focused on getting the highest sale price, that you potentially “topple your apple cart” by not fully thinking through all of the above issues. Good luck!!
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George Deeb is a Partner at Red Rocket Ventures and author of 101 Startup Lessons-An Entrepreneur’s Handbook.
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