In the world of mergers and acquisitions, there are typically several hundred transactions per week. While many of the multibillion dollar, cross-border transactions attract most of the press coverage, a vast majority of deals involve micro- and middle-market companies. These transactions involve mergers, acquisitions, leveraged buyouts, management buyouts, or recapitalizations, and involve companies with enterprise values between two to several hundred million dollars.
There are a variety of reasons why owners sell their companies or explore strategic and capital raising alternatives. A vast amount of deal structure possibilities exist to accommodate varying objectives. The owner (normally with the advice of an experienced M & A advisor) will seek out a structure that best meets one or more of his or her objectives.
Read on as we explore the motives behind M&As from the seller's perspective. Understanding this process can be an important step for investors in researching a company they own or are considering buying into. What happens to a company once it's acquired is often determined in the details hashed out in the merger/acquisition process.(To learn about the other side of these transactions, see The Buy Side Of The M&A Process.)
Why Owners Sell
Owners who agree to sell their companies may be tired of running the business and seek either a full or partial exit. If an owner wants to liquidate 100% of his or her 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 his or her 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, and thus illiquid. Unlocking this equity through a liquidity event may reduce the seller's risk by diversifying his or her 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). (For related reading, see Owners Can Be Deal Killers In M&A and How The Big Boys Buy.)
In the acquisition marketplace, private equity appears to be better suited to quickly engage the owner, assess the business and complete the acquisition. A reasonably well run mid-market company can be acquired within three to six months if both parties are genuinely invested in the deal. This is especially true if the exiting shareholder's accountants readily provide yearly and monthly financial statements, and if the acquiring equity group already has the accounting and legal due diligence team ready to move in.
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 and low morale. 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.
A seller may seek to sell his or her company for operational or strategic purposes.
For example, the owner may wish to:
- 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. The parent company has superior management that can unlock value in the target business. The acquired business can then be professionalized (have better IT systems, accounting controls, equipment maintenance, etc.). (For more insight, see Evaluating A Company's Management.)
- 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. (For more, see How To Create A Business Succession Plan.)
The macroeconomic environment can also be an impetus to sell. The vast pool of capital available in the U.S. economy has pushed 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 (particularly private equity) have become flexible in structuring deals in order to accommodate existing shareholders' preferences and objectives. However, while a seller's market provides such perks and benefits, if owners get too carried away from reasonable and fair prices for their companies, they risk blowing up the deal and losing millions of dollars.