Chapter 5

At this point in the process we turn our attention outward to potential buyers in the marketplace. Having completed Steps One, Two and Three (the Sales Readiness Assessment, Pre-Sale Due Diligence and Identifying the Competitive Advantage) we know if the owner and company are prepared for sale and what makes the company tick.  It is now appropriate to identify those companies in the M&A marketplace that can use their significantly greater resources (such as access to capital, more efficient processes, deeper or wider distribution channels, or massive sales force) to make more money from the company for sale than can its current owner.

All investment bankers can provide sellers with lists of prospective buyers.  Most firms do a generic search using purchased databases to create those lists.  To succeed, both the Proactive Sale Strategy and Outrageous Price Process require a more refined approach.  We spend a great deal of time to conduct a huge amount of research into prospective buyers.  While we do have access to several databases, we have created and maintain or own with more than current names of firms actively seeking acquisitions.

We refine that list by determining if there’s a credible match between what our seller has to offer and what a buyer might seek.  In my experience, the effort we expend in identifying a greater number of qualified buyer is well worth the payoff: a significantly reduced risk of not closing. 

Types of Buyers

There are two primary types of buyers who purchase companies in the $10M to $250M range:  financial buyers and strategic buyers.

Financial buyers use a financial formula—usually based on a desired rate of return—to determine the price they pay for companies.   A Private Equity Group (PEG) pursuing an acquisition for any other reason than to add on to an existing platform is the classic example of a financial buyer.  Financial buyers often buy companies in industries they’ve not been in before so sellers spend more time (and effort) educating financial buyers.  These buyers typically also require more time to perform due diligence because they are learning about the industry as they learn about the seller’s company.

A strategic buyer bases its purchase offer on its perception of future value:  how well it expects the target company to perform under its management, or how successful the acquisition will be once it can take full advantage of the buyer’s better market distribution, name recognition or proprietary technology.

When a PEG makes an acquisition to add on to existing holdings, it behaves more like a strategic buyer.  It will pay a purchase price based on its perception of how the acquisition will develop or improve something it is already doing.

There are four types of strategic buyers: competitors, verticals, industry players and adjacencies.

The first, competitors, is obvious.  We look to see if one or more of a selling company’s competitors would benefit from acquiring the seller.  Competitors usually seek to increase market share and/or eliminate a competitor. Before we add a competitor to the Potential Buyer List, however, we calculate the risk associated with dealing with a competitor.  Not only do competitors know all about the seller’s industry, but they can be dangerous when armed with the knowledge that a competitor is for sale.

 We also look for potential buyers up and down a company’s supply chain.  Would one of its suppliers or one of its customers benefit from purchasing the company? If your company is a major customer of one of its suppliers, that supplier may be interested in securing the business of its major customer.  It may wish to tighten the link between itself and the ultimate consumer.  On the other hand, a seller’s major customer may wish to manage its costs by purchasing its source for a critical or costly component.

Industry players are businesses engaged in the same activity as a selling company, but are not in direct competition with it.  For example, an Information Technology consulting firm in Boston that wants to expand into Atlanta (the home of its most lucrative account) may be interested in acquiring an agency there.  Industry buyers are sometimes willing to pay a premium for synergies that include expanding geographic reach, acquiring additional customers or eliminating overhead.

Less obvious (and therefore requiring more extensive research) are adjacencies.  Adjacencies are those businesses that complement the selling company.  For example, an electrical supply company may be interested in acquiring a plumbing supply company to both expand its customer base and its product offerings.  Unlike competitors, adjacencies do not know as much about the seller’s industry nor are they as dangerous.

Identifying buyers is critically important whether you sell your company using the Outrageous Price Process or via a traditional sale.  If you hope to sell your company for an Outrageous Price, however, you will focus your efforts on attracting the attention of a strategic buyer and persuading it to pay handsomely for future value.  We talk more about attracting a buyer’s attention in Chapter Seven.

Gauge Buyer Activity

Most owners have some idea about how active the marketplace is for companies in their industries or of their size.  But because sales in the mid-size marketplace are not publicly disclosed, owners don’t know if the active buyers are strategic or financial, what the purchase prices are or what terms control the deals.  Your investment banker should be able to collect much of this data using public sources (such as a company’s K-1s, press releases and annual reports) and private sources.  Most investment bankers also subscribe to various databases that provide information about purchases of privately held companies.

Keep in mind, however, that even those databases do not reveal details about transactions between privately held companies.  The databases enable an investment banker better gauge activity levels, but he or she must gather competitive intelligence to find the most valuable nuggets of information.

Gather Intelligence

Once we have compiled a list of buyers that could benefit most from acquiring a company, we begin to gather competitive intelligence about each.  We are digging for details regarding:

• Past acquisitions;
• Prices paid;
• Changes in their strategic acquisition plans;
• Problems they may be encountering in their industries,
• Changes in their industry position or reputation,
• Personnel changes; and
• Changes in their regulatory environment.

To gather competitive intelligence we turn to a number of sources.  We already mentioned the public sources: a company’s website, its K-1s, annual reports, and press releases.  We scour trade journals for articles and analysis related to potential buyers.  Once we’ve identified the transactions that a buyer has completed in the past, we’ll dissect each to determine the motives for the acquisition.  What synergies was the buyer seeking or did it make the acquisition to solve a problem?

We also talk to the prospective buyer’s sales representatives about the company’s direction, challenges, opportunities, goals and problems.  We ask reps what they know about competitors’ actions or plans, and if applicable, we ask for their opinion regarding what their employer could do to enhance its profitability.  While not standard operating procedure, we have asked sales representatives if they think purchasing a company that could enhance profitability is an idea worth pursuing.  Sometimes planting just one seed yields a bountiful harvest when a sales rep makes a suggestion to the home office.

Next we ask similar questions of a buyer’s M&A representatives.  It is not at all unusual for us to talk to various M&A representatives several times each year in an effort to understand what kinds of companies they are looking to acquire.

 In short, we do everything we can—without disclosing a seller’s identity—to get as much information as possible about one or more prospective buyers before we position our sellers to enter the marketplace.  The information we gather helps us to highlight the compelling benefits that we will communicate when we take the company to market.

Buyer Engagement

Gathering information about buyer preferences and behavior is part of our marketability analysis for every company. Before we can predict whether a company is saleable or not or give a seller our best estimate of a purchase price, we must identify and understand potential buyers. If we determine that a company is a candidate for an Outrageous Price, however, we spend a great deal of time focusing on potential buyers.

Remember, that to seek the Outrageous Price, we need more than just a list of qualified, active buyers.  An Outrageous Price requires that:
1) The selling company has the ability to cause a strategic buyer pain or offer the buyer an opportunity for tremendous gain;
2) The targeted buyer must be highly motivated to relieve that pain or exploit that gain;
3) The seller has both the perseverance to ride the transaction rollercoaster and the acting ability to convincingly maintain an attitude of indifference regarding the consummation of the transaction; and
4) An investment banker who is able to craft a strategy that makes that buyer understand the value in the acquisition and can inject awareness of the seller’s company into the consciousness of the selected buyer;

All of these Pillars of An Outrageous Sale are discussed in Part II of this book.
Even before taking a company to market, an investment banker can actively, yet anonymously, engage a prospective buyer.  Through a series of contacts, a transaction intermediary can glean more specific details about what a particular buyer typically pays for companies in the seller’s industry, who its negotiators are, what attributes it looks for, and what problems it commonly encounters.  With all of that information in hand, when a seller announces its intent to sell, it does so with all its ducks in a row.

Let’s turn our attention to the behavior you can expect from buyers during acquisitions.

What to Expect from Buyers

Over the years in working both with buyers and across the table from them, I’ve observed several important characteristics that often control or influence their behavior.  I share those observations here because the more you know about buyers (and their motives) the better prepared you are to get from them what you want.

Buyerspeak

Buyer speak is the name I give to the devastatingly effective weapon that buyers use to undermine a seller’s confidence and thus reduce the seller’s resistance to a lower offer for the company.  To engage in it, a buyer will carefully choose a “front person” to connect with, impress and inflate the ego of the seller.  Before making any offer, the front person will deliberately say and do everything he or she can to deflate the seller’s opinion of his or her company’s value.  All sophisticated buyers are fluent in buyer speak but not all sellers know it when they hear it.  If you aren’t familiar with it, your investment banker should be able to recognize it for what it is and thus neutralize its affect on you.

With “Pay as little as possible” as their mantra, buyer representatives use this language because it works.  The words they use and their style of delivering those words are carefully designed to:

• Undermine sellers’ confidence in the value of their companies
• Undermine sellers’ confidence in their advisors—especially in the advisor negotiating the sale for them;
• Make sellers grateful for the offer a buyer ultimately makes.

Buyers pull tried-and-true favorites from their “Buyer Speak Phrasebooks” such as:  “Ultimately, we don’t care whether we do this deal or not” or “We always talk to employees before we make an offer” or “These are the standard documents that we use in every deal.”  Whenever a buyer says, “always” or “never” warning bells should sound in your head.

In addition to the phrases common to nearly every deal, some buyer speak is tailored to specific situations, such as:  “We only pay a four multiple for companies like yours” or “You don’t need an investment banker.  They cost you time and money.” Really?  Ask any buyer if it uses investment bankers and the answer is always, “Yes.”

There’s no way to alert you to every example of buyer speak because buyers spend hours in their conference rooms figuring out exactly what they can say or do to shake your confidence in your asking price.  Your best defense is to understand that buyers orchestrate the very first, the very last and every single contact with sellers to achieve one and only one goal:  to pay the least amount possible for a company.

In the buyer’s conference room bets are made on the spread:  how much of your purchase price can it chisel away by taking money back in post-closing adjustments or through claims against your representations and warranties. (See Chapter Three for a discussion of post-closing adjustments.)
If I’ve made it seem as if you are swimming in a sea of sharks, you are.  In Chapter Nine we’ll talk about all the characteristics you should look for in an investment banker, but this is a good time to suggest that you look for one who knows how sharks think and how they hunt.

Buyers Put the Cart Before the Horse

We’ve established how buyers think: they will say and do anything to lower a purchase price.  But how do they do it?  Buyer speak is one example.  Another is to make requests of a seller that, if granted, demonstrate weakness on the seller’s part.  For example, buyers may ask to visit the seller’s plant before they make an offer.  They may ask to meet with the seller’s employees or banker.  If a seller grants any one of these requests—any many naïve sellers do even before pre-qualifying the seller’s ability to pay—the buyer has drawn first blood, and it will thirst for more.

What’s The Rest of the Story?

Buyers are experts at collecting information, but they never share it.  For example, you will never hear a buyer tell a seller how it expects to eliminate half of the seller’s overhead or that its accountants have uncovered a fatal flaw in the seller’s financial records.  Keeping information like this from sellers has a profound (and costly) effect on a seller’s payday.

The investment banker you want to hire knows how to figure out what the buyer isn’t saying. I’ve already admitted that investment bankers can’t read minds, so how can they uncover what the buyer isn’t sharing?  First, the investment banker should spend time analyzing your company—inside and out—to find its competitive advantage (see Chapter Four).  Second, the investment banker must do a great deal of research to uncover any synergies between your company and the buyer’s.  Third, he or she must make a hypothesis about what the buyer has up its sleeve and then create ways to test that hypothesis.  Basically, I’m suggesting that the best way to uncover a buyer’s hidden agenda is to engage in the Proactive Sale Strategy whether or not you intend to go after the Outrageous Price.
           
The Proactive Sale Strategy reduces a seller’s risk of failing to close the deal, but it also increases the seller’s chances for getting the sale price he or she wants—even in a tough M&A market.  It does so by carefully preparing the seller’s company, aligning the seller’s assets to the buyer’s needs, and understanding and acting upon the buyer’s priorities and preferences.