Most Acquisitions are Small Business Acquisitions
The term “mergers and acquisitions” tends to conjure thoughts of headline-making deal announcements spurred by large strategic and private equity acquirers. Exhibit A, Capital One’s announced acquisition of Discover Financial Services, a $35 billion transaction that if approved by regulators would position Capital One as the largest credit card issuer in the United States.
Although multi-billion dollar, headline grabbing deals capture the public’s attention, the reality is these deals represent a small fraction of total merger and acquisition activity. According to data provider PitchBook, about 1% of global M&A deals in a given year are valued at $1 billion or more. The most active deal segment includes businesses worth $100 million or less, which represent about 75% of deals in a given year and are far from the front page of business journals, but near and dear to the entrepreneurs involved in the transactions.
Buyer Types Shift As Deal Sizes Move Lower
As deal sizes move below $100 million, the universe of buyers shifts from one that is dominated by large corporations and institutional financial buyers to one that includes individual buyers. Individual buyer activity is especially pronounced below $50 million. According to a recent survey of business brokers and investment bankers, among deals completed in 2023 and valued between $2 million and $50 million, 36% of buyers were individuals. Strategic acquirers generated 39% of deal activity, while private equity buyers represented 23% of 2023 transactions.
In the context of the survey, individuals are defined as first time individual buyers and serial entrepreneurs. Generally, these individuals are looking for a business to operate and have either raised capital from investors, or in some cases may have sufficient personal wealth to fund a transaction.
2023 was not an Anomaly for Individual Buyer Activity
Historically, individual buyers have been active participants in acquisitions valued between $2 million and $50 million. During the five years from 2018 to 2022, individual buyers represented anywhere from 31% of transactions (2019) to 40% of transactions (2020). COVID likely created volatility during the 2019-2020 period, but excluding these years results in a consistent range of 34% to 36% of deal activity driven by individual acquirers.
Five Things Sellers Should Know About Individual Buyers
37th & Moss is an individual buyer. Although we raised capital to fund an acquisition, we are not a traditional private equity fund because we intend to acquire one business and step into the operations of the business, versus building and overseeing a portfolio of acquired companies.
Despite individual buyers representing one-third of middle market transactions, many sellers are not familiar with this option but may be a great fit to consider a sale to an individual buyer. During the course of our conversations with business owners we regularly encounter a short list of questions about individual buyers. Below we address some of these questions in an attempt to help sellers better understand the individual buyer approach.
1. Where do individual buyers get funding?
Sources of capital vary depending on deal size. Anecdotally, as transactions move above $10 million, individual buyers will increasingly lean on equity capital raised from investors, such as high net worth individuals, institutional investors, or family offices. Individual buyers often secure capital commitments prior to approaching business owners to discuss an acquisition, as is the case with us at 37th & Moss. In addition to equity, individual buyers will raise debt to fund the portion of the acquisition not covered by equity.
Just as a home buyer will put down 20% of the purchase price and fund the remaining 80% with a mortgage, business buyers rely on a combination of equity and debt to finance transactions. Unlike the 80%/20% ratio of debt to equity used to purchase a home, business acquisitions in the lower-middle-market typically support debt financing equal to 40% or less of the value of the business, a 40%/60% debt to equity ratio.
One exception to this leverage ratio is for business sales between $2 million and $10 million. Individual buyers in this segment are eligible for SBA financing for upwards of 80% of the purchase price. SBA loans are guaranteed by the US Government and most SBA loans are capped at $5 million, hence the applicability to transactions below $10 million.
2. What are the benefits of selling to an individual buyer?
Sellers seeking liquidity and succession often find it challenging to identify a buyer that can fund a transaction and allow for the seller to transition out of the business. Per the US Census Bureau, over half of businesses in the US are owned by people 55 or older and succession needs are high. Individual buyers bring capital and operating resources to the acquisition table, and are therefore a strong option for owners who desire to step away from the day-to-day operations while also receiving a fair value for the business.
Individual buyers frequently do not have a predefined investment holding period, which can be an advantage over competing acquirers. Most individual buyers are looking for a long term operating opportunity versus a quick exit, which gives sellers comfort knowing that the company may not undergo significant short term change to position the business for a sale a couple of years after acquisition.
Other benefits, including flexible acquisition structures and a smooth transition for the team, are covered below. For more information on buyer types, owners can navigate to our post dedicated to this topic.
3. How is the acquisition structured?
Individual buyers tend to have more transaction structure flexibility than other buyer types and can work with a seller to meet their unique needs. Although strategic and private equity buyers are not rigidly locked into a specific structure, they generally underwrite deals within a defined parameter of risk set by an underwriting group and designed to manage exposure across a portfolio. This can limit flexibility and lead to challenges for the acquirer to meet the goals of the seller.
Cash at close is also favorable for sellers in the individual buyer scenario. Because individuals want to run the company, they will often target an acquisition of 70% or more of the seller’s equity. This translates to a competitive level of cash at close relative to acquirers who seek to purchase a smaller portion of the target company, or that desire to use stock to fund a purchase.
When sellers are paid with stock in an acquiring entity, known as rolled equity, questions abound related to when that stock can be realized as cash. Strategic acquirers are especially inclined to structure an acquisition as a combination of cash and stock. Private company stock is illiquid and sellers have very limited visibility into when stock can be turned to cash. In the individual buyer scenario, sellers may have the opportunity to roll equity but can do so with a smaller portion of equity than required in a transaction with a strategic acquirer.
The seller’s business also remains a standalone entity when acquired by an individual, which means the seller retains equity in their business. When a strategic acquirer completes a transaction, the seller’s company is often tucked into the larger entity, sometimes eliminating the seller’s brand. The seller then receives stock in the parent company, which may not have the same growth prospects and return generating potential as the seller’s business (hence the appeal of the seller’s business as an acquisition target).
4. Why does an individual buyer think they can run the seller’s company?
In short, good teams. For anyone that’s worked with a high functioning business, strength of team is a leading attribute to the success of the organization. Individual buyers will often assess the depth of the team and like to see operating leaders who are aware of and comfortable with the transaction. Relationships with customers and vendors are also important, and if relationships aren’t transferable then an individual buyer may be challenged to facilitate a smooth transition. But most importantly, with the presence of strong operational leadership, the odds of a smooth transition increase.
Trends in the business are also a useful indication of whether an individual buyer can step in and facilitate an orderly transition. Newton, the famed physicist, observed that an object in motion stays in motion. While Newton wasn’t necessarily offering an opinion on economics with his First Law of Motion, we believe the concept transfers well to businesses. If a business is showing positive trends in growth or margins, then the odds of transition success increase given the business is likely to stay in motion.
Lastly, many individual buyers have experience as entrepreneurs or operators. Experience facilitating operations allows for familiarity with many of the patterns that an individual buyer will face during the course of operations at the acquired company. Each business is unique and it can take six plus months to learn a team, operations, customers, etc. But individual buyers with prior operating experience are often well positioned to build on prior roles to learn the seller’s business. Individual buyers will also often rely on the guidance of advisors, such as a board of directors.
5. What will happen to the seller’s team?
Attempting to maintain team cohesion through a transition is one of the individual buyer’s greatest benefits. To the point made above, an individual buyer relies on the team to navigate the seller’s transition. In most cases an individual buyer has no intent to disrupt the team or to make immediate changes to the employee base.
Sellers who prioritize culture and want to ensure that a team is taken care of through a transition will likely find the individual buyer to be an attractive option for succession. Because individual buyers have a long-term horizon there is rarely a need to make sudden changes to the team in an attempt to optimize expenses. And unlike strategic acquirers that may have duplicate functions as a result of the acquisition, for instance duplicate sales, marketing, and administrative team members, an individual buyer does not bring a full operation and won’t face a duplicate resource planning scenario.
Is an Individual Buyer Right For Every Seller?
Each owner faces a unique selling journey and will have distinct transaction goals. Preparation before taking a business to market is key and will help sellers form priorities. Depending on the seller’s goals, an individual buyer may be a good option for acquisition. Strategic acquirers and private equity acquirers are also suitable for some sellers, again depending on the desires of the seller. Individual buyers are a great option for sellers who desire to transition out of the operations, who value transaction flexibility, who want to minimize change to for the team, and who want to receive fair value for the business.
Although transactions among individual buyers, most of which are below $50 million, grab fewer headlines than prominent strategic or private equity transactions, individual buyers are responsible for nearly one-third of the liquidity in the lower-middle-market ($2 million to $50 million purchases). For this reason, we hope sellers can walk away with knowledge of this option and will consider individual buyers when setting goals and planning for succession.
