14 Feb, 2018
Why Successful Business Owners Sell Out
In the world of mergers and acquisitions, there are typically several hundred transactions per week and there are a variety of reasons why those owners sell their companies or explore strategic and capital raising alternatives.
The macroeconomic environment can be an impetus to sell. The vast pool of capital available could push up acquisition prices. As such, owners often look to take advantage of a «seller's market» and hire advisors to market their businesses for higher multiples. With vast amounts of cash competing for acquisitions, acquirers have become flexible in structuring deals in order to accommodate existing shareholders' preferences and objectives.
There is a clever decision to sell out the company in case of forecast of future drop of investors' interest. It could happen due to significant slowing of the market, when the majority of the companies suffer; market consolidation, when the well-entrenched competition attack under performers or companies with limited recourses; big changes in the customers behavior, what can make more difficult and more expensive outperforming the company.
Owners may be tired of running the business and seek either a full or partial exit. Indeed if an owner wants to liquidate 100% of the equity, acquiring investors will usually offer a lower acquisition price. This is partly a result of the greater difficulties that are anticipated in running the business after the transaction if the owner is not available to help with the integration process. A recapitalization, where the exiting owner retains a minority equity stake in the business (typically 10−40%), is a more common structure. In this case, the exiting owner has incentive to help increase the value of the business (normally through part-time effort). The exiting owner will still benefit from a gradually diminishing role in the operation and the freedom to enjoy more leisurely pursuits. Once the owner is out of the picture, the combined entity will have a go-forward plan in place to continue to grow the business, both internally and through acquisitions. In addition, the exiting majority owner will see the value of his or her equity increase if performance benchmarks are reached. It is important to remember that large companies receive higher valuation multiples from the market compared to smaller companies, partly due to lower enterprise risk.
An exiting owner may also wish to convert the equity into cash. This is because many business owners have considerable net worth, but a lot of this value is often value tied up in the business. Unlocking this equity through a liquidity event may reduce the seller’s risk by diversifying portfolio and allowing the seller to free up more cash.
Another common exit scenario involves an elderly owner who is experiencing material health problems, or an owner who may be getting too old to effectively run the business. Such situations often necessitate the need to quickly find an acquirer. While business development officers of strategic companies can move the M&A process rapidly, large companies often do not respond quickly enough because they are hindered by a number of bureaucratic processes that cause delays (ex. managerial and board approvals).
Family disputes are also a common driver for an acquisition. A spouse or close relative may be abusing company assets for personal gain, resulting in poor company performance. Incoming investors can get rid of dysfunctional individuals and restore good management practices in the business, as well as provide peace of mind to the seller.
Operational or strategic purposes
Gain market share. A larger acquiring company has complementary distribution and marketing channels or a recognizable brand and goodwill that the target entity can leverage.
Finance an expansion. The acquiring entity has the cash to fund new equipment, advertising, or additional geographic reach, increasing the operational footprint of the target.
Raise capital for an acquisition. The acquiring entity has the capital or debt capacity to execute an accumulation play. In other words, it can acquire a series of smaller competitors and help to consolidate an industry. The target operates with fewer competitors in an industry, and has access to its former competitors' resources (management talent, product expertise, etc.).
Place better management. If the parent company has superior management it can unlock value in the target business. The acquired business can then be professionalized (have better IT systems, accounting controls, equipment maintenance, etc.).
Diversify a relatively focused customer base. Small companies often have a large percentage of their revenue base coming from a single or a relatively small number of customers. Customer concentration significantly increases enterprise risk because the business can go bankrupt if it loses one or more of its key customers. A diversified customer base — presumably with a diversified revenue stream — lowers the volatility of its cash inflow, increasing the company’s value.
Diversify product and service offerings. The addition of complementary product and service offerings into the target business allow it to capture more customers and increase revenue.
Secure leadership succession. A business owner may not have invested time and effort into identifying and grooming a successor, necessitating the sale of the business in order to ensure that it continues to operate effectively.
Surviving: It’s never easy for a company to willingly give up its identity to another company, but sometimes it is the only option in order for the company to survive.
Some ideas about capital-raising strategies: Bringing Your Company Public, Exploring Alternative Capital-Raising Strategies, Refinancing and Minority Equity as Partial Exit Strategies, 5 Alternatives To IPOs, How to Raise Capital For a Company in Financial Troubles, 7 Private Equity Strategies