Transaction Goals Are Important For Seller and Buyer Alignment
All buyers are not created equal. Selecting the best partner for your business sale is not only important for increasing the odds that a deal is completed, it’s an important consideration for the expectation of the owner’s post-transaction involvement in the acquired entity.
A lack of alignment with a prospective buyer regarding an owner’s post-close obligation can be the catalyst for conversations between a buyer and seller to wind down. Or worse, a seller may end up in a post-transaction role that is materially different from the role the seller assumed they would fill. Depending on the owner’s transaction goals, the types of buyers that are best suited for a sale process will vary. Owners should reflect on their goals and carefully consider which type of buyer is best to approach during the sale process.
Below we cover three common buyer types, including search funds, private equity funds, and strategic acquirers.
01. Search Funds
Who are they? Commonly referred to as entrepreneurship through acquisition, or ETA, search funds are typically composed of one or two entrepreneurs who desire to buy a single business and step in to operate the business. Importantly, once a search fund acquires a business the search for additional acquisitions stops and the entrepreneurs become employees of the acquired business. The number of active searchers has grown consistently over the past twenty years, and between funded and self-funded searches there have been thousands of businesses acquired via this model. You can read more about the distinction between funded and self-funded search in this article. Search fund entrepreneurs often have backgrounds in business operations, although many also come from industries like consulting, banking and private equity. Companies that are targets for search fund acquisitions are typically below $50 million in enterprise value (total company value). Institutional investors who back search funds have a strong track record for acquiring and growing businesses in the $10 million to $50 million range, and the asset class continues to grow in both number of funds and total value of capital deployed via the search fund model.
What are the post-acquisition expectations? The search fund model allows an owner to step away from day-to-day operations. The individual(s) leading the search fund will step in and run the operations of the business. Transition periods for the outgoing owner are flexible and can range from a few months, to a year plus. For owners seeking minimal disruption to operations and a smooth transition for employees, search funds are an attractive option. Search fund investments are typically directed to businesses with low asset-intensity, such as technology business, services business or other models with low capital expenditure requirements.
Depending on the search fund principal’s background and desired post-close cadence, owners may have the opportunity to continue as an advisor or board member, and can often roll a minority equity interest into the post-acquisition company (typically 20% equity or less). Owners who roll equity into the acquired entity and who find strong search fund partners to take over the business may realize attractive returns on the portion of their equity that remains with the business post-acquisition.
Where does capital come from? Search funds raise capital from institutional investors, serial entrepreneurs, and high net worth individuals.
02. Private Equity Funds
Who are they? Professional investors that oversee a portfolio of investments in private businesses. Private equity firms raise pools of capital, called funds, that typically have a 10 year life, meaning that the fund will target a full return of capital to investors after 10 years. Once a fund is raised, the firm will seek to deploy capital early in the 10 year fund life by making investments in private companies. Once capital has been deployed, the fund will shift to a harvest period, during which investments are managed or exited so the fund can prepare for a return of capital to investors. Although a fund life may be 10 years, the holding period for investments is typically 3 to 5 years.
Private equity investments on the lower end of the size spectrum are targeted at companies as small as $20 million of enterprise value (total company value). On the upper end of the spectrum, large private equity funds target transactions in the many billions of dollars. According to data from Pitchbook, the majority of deal activity takes place among companies valued at less than $100 million.
What are the post acquisition expectations? Private equity funds generally invest in companies with management teams that intend to stay with the business post-transaction. If a business owner does not intend to stay with the company after a sale, the owner should have a deep management team that allows for the operation of the business without the involvement of the owner. Or, if the owner is a key person in the deal, the owner should be comfortable remaining with the business post-acquisition. To align incentives, a private equity buyer may also request an owner to roll a sizable portion of their equity into the post-acquisition company.
If depth of management is a perceived risk, a private equity fund may not be a good candidate for acquisition or investment. Although in some cases private equity seeks to improve operations, the preference is not to facilitate the management of the day-to-day operations, but instead to acquire a business that has a strong team and advise that team on strategy and capital deployment. One exception to this would be the acquisition of a platform company that is used to consolidate similar businesses within an industry. Private equity firms conducting what’s known as a roll-up strategy may buy a company in an industry and use that company as a platform to acquire smaller competitors and tuck those business into the platform company operations. If a platform company acquires a seller’s business, then the platform’s management team is likely to continue leading the operation, reducing the importance of an owner staying with the company post acquisition.
Where does capital come from? Institutional investors, endowments, pension funds, sovereign wealth funds, family offices.
03. Strategic Acquirers
Who are they? Strategic buyers are operating entities that provide goods or services in a specific sector and industry. These buyers may be direct competitors, suppliers, customers, or companies in adjacent industries. Strategic buyers may pursue acquisitions for a variety of reasons, including to expand into new business lines, to reduce a competitive threat, to gain access to a new geography, to gain access to new distribution channels, to obtain an attractive customer list, or to bring in a talented group of employees.
When contemplating strategic buyers as a deal partner, consider the risks associated with divulging your financials, customer list or operating strategy to companies that may use that information to your disadvantage. A failed deal process that entails sharing your company's full financial, operating and strategic picture represents a sizable risk to your business. Sellers should diligently qualify a strategic buyer to discern whether a serious level of interest exists, or whether the buyer is merely looking to gather information about your company. Can the strategic acquirer produce the funds required to complete the acquisition? Where will these funds come from? Why is the strategic acquirer interested in growth through acquisition? Is the management team of the acquiring company strong enough to lead the combined organization?
What are the post-acquisition expectations? Once a strategic buyer has completed an acquisition, the operations of the acquired company (the seller) are folded into the operations of the acquiring company (the buyer). Business owners should be clear that selling to a strategic company in many cases will require the owner to fulfill a post-acquisition employment obligation, meaning the owner has to be comfortable with the idea of going to work for someone else for an extended period. Strategic buyers may also find some functions of the target company to be duplicative. Sellers should contemplate how their team will be impacted by a strategic acquisition. The term “synergies” is thrown around as a buzzy corporate expression related to expense savings and revenue opportunities, but as an acquisition strategy it is an important driver of value for many strategic acquirers.
Sellers should also consider whether the elimination of their company’s name or brand is important to the legacy of the business. Strategic acquirers that fold a business into a larger operation may not retain the brand of the acquired company. This varies from deal to deal but should be considered when evaluating preferred buyer types.
Where does capital come from? Acquiring company’s cash, equity investors (public and private), debt investors.
Let The Seller Beware
Selling a business is a significant milestone for an entrepreneur and should be a point of celebration, not consternation. By forming an opinion on transaction goals and educating yourself about buyer types you will be positioned favorably for sale conversations with prospective buyers who are best suited to shape an outcome that matches your goals.
For more information on preparing for a small business sale, including more detail on buyer types, check out our comprehensive sale guide here.
