Know Your Audience in a Company Sale Process
By Brian Lobo, Managing Director, GulfStar Group
Written for HBJ's 2017 Texas Capital Connection insert
No merger or acquisition can successfully be completed without a willing buyer, willing seller and stable debt market to finance the transaction. It is important to recognize that each of these groups approaches the opportunity from their own unique perspective. In the middle of a well-orchestrated transaction should be an investment banker, who pieces it together in a way that best satisfies client objectives. Investment bankers communicate daily with each type of buyer group, gathering valuable insights into ever-changing appetites for certain business models and industries.
Corporate buyers, commonly referred to as “strategic” buyers, evaluate how transactions align with their own strategic initiatives and objectives. They consider whether it is worth paying a multiple of earnings for a business rather than investing capital and other resources to do it themselves in the classic “Buy vs. Build” analysis. They consider how an acquisition may enhance their growth; expand or complement existing products, services or geographic footprint; provide entry to new end markets; add new customer or vendor relationships; or contribute valuable intellectual property. The more of these boxes a potential acquisition checks, the more valuable it will be to the buyer. Thus, communication with each strategic buyer should emphasize the unique value the acquisition would contribute to that specific buyer.
Private Equity Buyers and Lenders
Conversely, a private equity buyer evaluates a transaction on a stand-alone basis with a focus on the potential return on the equity capital deployed. The investment will serve as a platform for future growth through a combination of organic growth and “bolt on” acquisitions. The strength of the seller’s management team is a critical element to a private equity buyer in the same way that location is paramount to a real estate investor. Since a private equity group does not intend to run the business, it is imperative to invest in a strong and committed team.
Given its focus on returns, a private equity buyer approaches an acquisition quite differently than a strategic buyer. In order to validate its investment thesis, private equity buyers focus on the growth potential of the company, its ability to finance a portion of the transaction with debt, downside protection and potentially available options to eventually sell the business for materially greater value.
Most private equity groups specify growth as the most important driver of investment returns. They will therefore closely study the size and company’s current share of the addressable market and how much room remains for future growth. They also gauge the competitive environment in which the company operates, the basis on which it competes, its value proposition and its “reason to exist”. In an effort to assess the potential for growth, perhaps the most important consideration is its perceived ability to scale. Often this means providing complementary products or services to existing customers, entering new markets and extending geographic reach to expand its customer base. A frequent strategy of private equity groups is to invest in fragmented industries, thus providing an opportunity for growth through acquisition and consolidation (often referred to as a “Buy and Build” approach).
Downside Protection and Ability to Finance the Transaction
Both private equity groups and lenders focus on downside protection and their ability to finance a portion of the transaction with debt. To evaluate this, they will assess industry cyclicality and the company’s performance during cyclical downturns, placing a premium on a history of stable and predictable revenue in such environments. Other important considerations are the duration and diversity of customer relationships and the company’s free cash flow characteristics, including capital expenditure and working capital needed to grow or sustain the business. Each of these items is carefully analyzed to determine the company’s transactional debt capacity and, in turn, the value that private equity buyers can afford to pay.
Private equity buyers do not have an indefinite hold period for an investment and usually seek an exit within three to seven years. Private equity groups must therefore have comfort with not only the business’ current profile, but also with how the market will perceive it in future years. The same assessment of the company’s strengths and weaknesses will be made by buyers in that future transaction. Private equity buyers often view certain weaknesses of the company at the time of investment as opportunities to implement improvements and enhance future value. Sellers should therefore be thoughtful about where possible weaknesses exist and position them constructively.
Whether dealing with a strategic or private equity buyer, the objective is ultimately the same: to present the company in a way that leads each potential party to develop its own enthusiastic assessment of the opportunity for valuation creation. To do so effectively, it is critical to know your audience.