Ep. 18 - Do You Have A Good Buyer Or A Goodbye-Er?
Every business must allot a lot of time and put tons of things into consideration when vetting potential buyers. In this episode, we reveal the secrets to determining what a good business buyer is for you and your business, and how to separate legitimate prospective buyers from questionable ones. Tune in as we break down the four universal characteristic of an ideal buyer, the three biggest challenges you have to get through, and the four major components of a powerful success roadmap. We also discuss four categories of internal buyers and the two different types of recapitalization.
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Do You Have A Good Buyer Or A Goodbye-Er?
How To Create A Buyer Profile That Helps You Weed Out The Riff-Raff
In this episode, we are going to reveal how to determine what a good business buyer is for you and your business and how to separate legitimate prospective buyers from questionable ones. With me, as always, is the ever-luminous Jason Tuzinkewich, Blue Sky’s Chief Operation Officer. Take it away, Jason.
Let's get into this. As we're talking about what a good buyer is, we're thinking about an individual or an organization that has made an offer to acquire a business and the business owner is deciding, “Do I take this offer seriously? Is this somebody that I want to pay attention to or not?” For every different business owner, the question of a good buyer is going to depend a lot on their own individual goals and objectives.
There's a lot of subjectivity in there, but what we've found is that there are four characteristics that are universal. The very first one of those is wherewithal. Is that prospective buyer capable of closing a deal? That goes into if they have the money, but there's a lot more to it. Do they have the money in cash? Do they have the ability to obtain credit? Are they looking for a third party to back their acquisition?
Understanding that wherewithal and the picture of that will give you a good idea of how complex the process of working through a closing with them will be, even if it looks like they can come up with the money. We'll talk a little bit more about the different buyers and where that comes into play later. The first question you always have to be asking yourself if you're a business owner and you get an offer to purchase is, “Can they close the deal?”
If the answer to that is yes, then that leads to the second core characteristic that's universal in decision-making, which is dependability. Does the potential buyer have a track record of doing what they say they're going to do with businesses? Can you reasonably count on them to do what they say they're going to do? Are they in integrity? If you try to get in bed with a buyer who has ethics or integrity deficits, not only will the selling process be fraught with complications, but the chances that you're going to be happy with the outcome are low to none.
You would never not think about checking references or doing a background check on an employee. Treat a prospective buyer the same way. Don't hesitate to ask for references and do a background check. That's good and important stuff. The next thing is alignment. When we're facilitating a transaction, we always want to have a fair amount of time where the business owner, the executive team, the buyer, and their team break bread together and get to know one another in a non-negotiation setting.
You want to know if this person or a group will be good for your brand and your people when you are not there. It's so important. If you care about your people and the legacy of your business, you're going to want to know that not only do you get to ride off into the sunset with some cash in the bank and security for the rest of your life, but you can know that your team and your brand are in good hands. That speaks exactly to culture and integrity.
Very much aligned with that is legacy. Does the buyer's vision match? Is it compatible with your business's goals and your exit goals? Those aren't the same. They're hopefully compatible. They need to be compatible. It is the goals that your business has and that you have for your business continuing after you exit and your goals in your own exit in terms of things like how much does the business need to be sold for in order for you to meet your goals? Are there potential buyers that can pay that amount of money? What the buyer wants to do with your business must match what you want to be done with your business after you leave.
That leads us to three big challenges in identifying a good buyer. The first of those is to know what your business is worth and understand the market for your industry. What we see over and over again is that business owners are so close to their business and their view of how precious it is, is so magnified in a way that what they think their business is worth and what it's worth, there's a pretty big gap between those two things.
Coming out of denial and getting clear through doing an independent valuation so that you know what your business is worth is the first part of the first of three big challenges of identifying a good buyer. The second part of the first challenge is understanding how the market is performing in your industry. If you are wanting to sell during a down market, what that's going to mean in terms of price is going to be different than if you're wanting to sell during an upmarket. Not only that but if you're wanting to sell in a crowded market versus an uncrowded market, those are all going to influence what your business is worth.
If you want to sell in a crowded market versus an uncrowded market, it will influence what your business is worth.
The interesting thing about markets is like now, we are in a market that is volatile. We're frothy. There's not a lot of activity for mediocre businesses. There's a ton of action now where buyers are purchasing in the margins. Businesses that are best in class are getting a premium in value and businesses that are in some state of distress are getting purchased for steep discounts, but there's not a lot of activity in the middle of the market.
Also, understanding the market will help you define who's buying in the market. Are there big corporations or companies that are consolidating into themselves, or are there a lot of financial buyers, private equity groups, and the like that are coming in and trying to play in this market? Understanding who's buying in your market is going to be a big part of understanding who you can target and figuring out how that fits with your overall buyer avatar expectations.
What I want to footnote for our readers is that when you say right now, what you're referring to in terms of time is spring of 2023.
That's true. I'm not good at the greenfield verbiage yet, but I'll get there. Going into the second big challenge, this is where we start talking about understanding what these different types of buyers are and how that will impact the buyer profile and exit expectations that you can start to develop. There are two major categories of buyers that are external and internal buyers.
When it comes to external buyers, we've got financial buyers, which are predominantly private equity groups. They're buying 1 of 2 things. They're either buying a platform that they can start out strong and then build up to exit either through a placement offering, an IPO, or an exit upstream to a larger company, or they're looking for bolt-ons to their platform companies. One of the strategies that private equity groups use to grow their platform companies is to buy a bunch of smaller companies and tuck them in. It is understanding that those are the two types of purchases that private equity firms most commonly make and understanding, based on size, whether or not you are an appropriate candidate for a platform or if it's more appropriate that you're a bolt-on.
That size range usually breaks off at between $3 million and $5 million of EBITDA. If you're above $3 million, it's likely that you can be a platform acquisition. If you're above $5 million in EBITDA, you are a strong contender to be a platform company. What happens there is if you are a platform company, your brand carries on.
If legacy is important to you and you think that a private equity buyer is where you want to be, you can protect your legacy and the brand's durability by growing up into that $3 million to $5 million EBITDA space before you try to exit. If you're acquired as a bolt-on, it's a tossup as to whether or not they decide to keep your brand underneath the larger umbrella or if they make your brand go away and assimilate your people, your equipment, and your skills to service the larger brand.
That's private equity groups. The next one is unfunded sponsors. You'll also hear these called search funds. That is where an executive who may not have the wherewithal by themselves to purchase a business but doesn't want to work in Corporate America anymore goes and talks to a bunch of financial investors, usually family offices, and says, “I want to go run a business. Will you back me if I find a business to purchase?”
The good thing about unfunded sponsors is that they'll typically keep your business and your brand the way it was and use their skills and their experience to make it grow. The tricky thing with unfunded sponsors is that you've now got two masters in the purchasing negotiation. The operator who wants to buy the business will make you an offer, but then they have to go back to their funding partners and convince them to make that offer. We'll talk a little bit more about that later when we're getting into the pros and cons.
There is a synergistic buyer. A synergistic buyer is like a private equity group that is bolting companies into its platform. It's a large player in your space, a major company that is using the same strategy of growing through acquisition. Synergistic buyers will most commonly roll your equipment and people under their brand name. There are small exceptions to that. If you have a strong regional presence and brand reputation, they may do a DBA. They may keep that brand name and leave that alone. It's not very common in the larger synergistic companies because they're usually big enough that their brand name is stronger everywhere.
We've got high net-worth individuals. High net-worth individuals are very similar to unfunded sponsors, only they're using their own money. They are executives with a long history of running businesses who are tired of making wealth for a corporation and want to buy their next job and generate that wealth for themselves. The great thing about them is that they very frequently keep the business largely as is and use their skills and expertise to make it grow, but they're also working with their own money. It's a lot easier to close those deals. Doctor, do you want to tell us about internal buyers?
I will be happy to do that. There are four categories of internal buyers. The first is family succession where you have family members that you would like to see carry on your company and where they want to carry on your company. This often gets muddy because there are situations where you want family succession, but there's no one in your family that wants your company, or where you want family succession and there may be people in your family that want the company but don't have what it's going to take in order to keep the company flourishing. That's the family succession type of internal buyer.
The second type is a partner buyout. You may be in business with other partners, and your partners may want to stay with the business even though you want out of the business at a particular point in time. Your partners, if they're willing, will buy out your position in the company. The third option is a management buyout, where your top management and your top executives are so on fire about wanting to own the company themselves once you are wanting to exit that they'll buy the company from you. The final is ESOP. That's where you turn the company into an employee-owned company.
We should do an episode in the future about ESOPs because that's a great option that many business owners don't know enough about. We've done a good job as we're describing these buyers of explaining the pros and cons. There are a couple of other things that I want to make sure that we highlight as we're thinking about what type of buyer we like. Do we want to go external? Do we want to keep it internal? Can we keep it internal?
The first thing that I want to say is internal acquisitions are great because they are the most surefire way to maintain the continuity of your brand and legacy, but they're often trickier in terms of obtaining maximum value. If you think about selling a business to your child, they're going to want a deal, the family discount. You're almost obligated to give them a lower price than you could get in a competitive marketplace. You're never going to have competition if you keep it internal.
They'll also always take on all of the liabilities of the company's history. That's a challenge for the buyer. The good news is that these internal buyers already know the company. They already have a good idea of what those historical liabilities are. It's easier for them to make that decision. The due diligence process is much more simplistic when you're doing an internal transaction than if you're selling to a stranger entering the external market.
In terms of external sources of purchasing your company, your business's liabilities might or might not transfer to the new owner, stock sale, or asset value. Due diligence that you do or that they do even more often can lead to a retreading or reworking of the deal terms because of material findings that surface during the due diligence that hopefully you didn't intentionally withhold. That's a big problem in and of itself. It’s where things surface that you didn't think about or didn't take into account despite good intentions to be transparent.
Surprises in due diligence are a big issue. That's where having a good team and taking the time to prepare your business before you take it out to market is so important. Let's move on a little bit to point number three, which is understanding the type of transaction you're looking for. When we talk about exit planning and when most people think about selling their business, they think, “I've got to sell it all. This is an all-or-nothing thing. I'm not going to talk to any buyer until I'm ready to leave the business.”
That's an option, and that ultimately is what should be done. Before you're ready for that, there are other options. The most common options are recapitalizations. You can recapitalize for several reasons. You can recapitalize because your business doesn't have the cashflow that it needs to get to the next level, but you know in your heart that that next level is there.
You can recapitalize. You can sell a portion of the company and bring on a partner that brings on the resources that the company needs to get to the next level. What you retain in equity value will then grow. You get the opportunity to take some chips off the table, as they say, reduce some of your overall risks, and put some money in the bank, but also be there when the company realizes what you know is the next stage. You can exit fully at a much higher value.
There are two different types of recapitalizations. There's majority recapitalization, where you sell 51% or more of your company to a buyer that will bring expertise, professionalization, cash, or sometimes an executive team to the table to drive the business to the next level. If you think that you've got all the capabilities, the leadership team, the skillset, the wherewithal to get to that next level on your own and all you're missing is cash, then you could do a minority recapitalization, which is selling 49% or less of your business to take on a partner that has a checkbook. It is thinking about where your business is at, what your long-term objectives are, and understanding what makes the most sense as far as a sale goes now.
I'm stepping back to the 40,000-foot level as I'm listening to you and me and I'm realizing that what we're covering in this episode is an overview that, in my experience, is very rarely offered to business owners. I'm feeling a whole another wave of gratitude that we're doing this episode on this topic. With that, let's move into the success roadmap.
What we want to unpack is four key decision-making guidelines based on everything that we've covered. The first of those decision-making guidelines in selling a business and finding a good buyer is to determine what your business is worth and the state of the market that the business is in. We've already covered those, but it's a crucial decision-making guideline. Determine your business' actual value and the state of the market when you're wanting to sell.
For those of you who read our show regularly, you hear us beat this drum a lot. Start early because things change. If you don't like where your business value or where your market is now, then as long as you started early, you've got time to adjust. If you love it and the market is great, even if you weren't thinking about selling, you might realize that now's a great time.
If you don’t like where your business value is right now, you have time to adjust as long as you have started early.
The second piece to success is right along that same vein. That's figuring out what type of buyer you're looking for and what type of transaction you're looking for, and then creating a plan to figure out where they're at and how you can get your business in front of them where they're at so that you're setting yourself up to be most attractive to get their attention.
The next decision-making guideline is that as you're telling your story to the M&A firm that is assisting you and to prospective buyers, make sure you're extremely clear about the specific profile of a buyer that you're looking for so that you become maximally attractive to the right ones.
I love that you bring in that as you're explaining and telling your story to your advisory firm because your advisors are the ones who can help crystallize that for you. You can say, “These are the things that I want. I want somebody that's going to put my employees first. I want somebody that is going to be more concerned with integrity, quality, and legacy than in squeezing out every dime of profit.” Your advisors can translate that into, “This is the type of buyer you're looking for. I know 25 private equity groups that fit that, but we might want to think about these synergistic as well because they're extremely high integrity companies.” Your advisory team can help you out with all this work.
That leads us to the last piece, which is to be patient. A lot of business owners now are coming to us when they're tired or when they want to get out. They don't want to have to put in a year of transition time. They don't want to have to put in a couple of extra years to build their value and make sure that their executive team is there, and they're like, “I know that I'm going to take a discount, but I have to get out.” I can empathize with that, but I can tell you from experience the long-term implications of seller’s remorse and feeling like you made a bad decision because you were in a hurry are much worse than the few months or the year that it will take to wait for the right buyer and put together the best quality deal that you can.
The earlier you start, the less patience you have to exhibit when you pull the trigger on this. No matter when you start, this is a marathon process. It takes time, so have that mental mindset going into it that, “I'm going to be patient. I'm going to make sure that this is the right thing, the right buyer for my company, and the right deal for my future. Only then will I pull the trigger on executing a letter of intent.” That brings us to the final takeaways for this episode. My takeaway is if you don't know what you want in a buyer, you're certain that you won't get it.
I'll piggyback on that to say if you do know what you want in a buyer and you don't do the proper vetting, you're never sure to get it perfect either.
Make sure that you know what you want and that you don't settle for less. On that note, on behalf of Dr. Gruder and myself, we want to thank you so much for reading this episode. It's always fun to share thoughts and ideas with you. We invite you to click the subscribe button so that you can be notified immediately when we drop our next episode. Also, please throw your thoughts and feedback into the comments section so that you can help us shape the future of this show into something that is not only interesting but valuable for you and your peers.
Lastly, I'd love to invite you to take advantage of Blue Sky's free surveys for gauging your business health, your infrastructure, and your strategic planning capacity more accurately. We've got a series of small, very brief surveys that provide a whole host of meaningful, actionable information that you can take back to your business and start to strengthen and improve those things now. It's all free and you can find it at BlueSkyAdvisors.net. We hope you get started with that and enjoy growing value, and we look forward to seeing you on the next episode.