Beginning in 1995, eBay single-handedly flipped the market for sale of miscellaneous household junk from a buyer’s market to a seller’s market. eBay is great for buyers too, allowing buyers interested in a particular trinket to locate that trinket worldwide and make an offer to purchase it. However, the old method of selling household junk clearly favored the buyer who was willing to put in the effort to find it. The old method – the yard sale – involves the seller perhaps placing a few ads and directional signs in the neighborhood, loading all their goods for sale onto wobbly card tables, then marking the items for sale at maybe 2% their original cost – followed by one-on-one negotiations with a single buyer during which the price is negotiated down to approximately 1% of its original cost. All the while, the seller is bluffing and enjoys no leverage in the negotiations whatsoever, knowing that he will load everything that remains into a trailer and donate it to charity shortly after the yard sale ends.
eBay changed this reality for sellers, providing an outlet for the simultaneous marketing and presentation of miscellaneous items to a worldwide (or at least nationwide) pool of buyers. Items sell for significantly more on eBay than they do at yard sales for the simple reason that they are offered to many buyers in many locations, and not just to the few who live in the seller’s neighborhood and are willing to spend their time at yard sales. There is a premise in auctions that the winning bidder will overpay, given enough prospective bidders. In 2007, it was reported that an economist from the University of California at Berkley tracked eBay auctions and discovered that in roughly 50% of auctions, the winning bidder actually paid more than the advertised “buy it now” price at which the item could have been purchased weeks earlier. Astoundingly, roughly half of buyers would have done better to spend a few minutes price shopping online and buy the item they wanted, rather than participating in the auction. While “value” is in the eye of the beholder (the buyer), it seems intuitive that with a large number of interested buyers there will be those who place a higher perceived value on the item, and there will be those who place a lower perceived value – with real “market” value being somewhere in between. The very existence of a competitive bidding atmosphere will drive offers higher.
Most small businesses change ownership without ever having been marketed for sale. The largest category of small business transfers are inter-family, mostly parents to children, followed by transfers to key managers or employees of the business. In many other transactions, the selling business owner has been approached by a competitor or a business in a related industry, or even just an unsolicited buyer who is interested in the business. Or perhaps the business owner has taken the bold approach of reaching out to a competitor or industry player, revealing that she is interested in selling. (We are not recommending this!) Some buyers arrive by word of mouth, through discussions with friends, family, employees or representatives of the business owner who know that the owner is interested in selling. The common denominator in all these situations is that the negotiations are one-on-one, the business owner negotiating the sale of the business with one buyer or buyer group.
Representing buyers, we advocate this one-on-one negotiating position. A buyer can achieve this favorable position by identifying and approaching acquisition candidates proactively, rather than limiting the search to the relatively few businesses actively listed for sale. The buyer should still expect to propose and purchase at a reasonable and fair valuation, but can be in an improved position if other prospective buyers are not actively looking at the same opportunity, in essence driving “bids” higher. Conversely, a business owner may not achieve the best price or transaction terms when negotiating with a single interested purchaser. At minimum, the business owner who is approached by an interested, unsolicited prospective buyer should seek experienced guidance regarding the value range of the business and whether the unsolicited offer is competitive. Most frequently, the business owner who is interested in selling should approach the process proactively, with experienced counsel, and prepare the business for offering to the largest possible audience of prospective buyers (confidentially, of course – how that can be managed is discussed in another of our articles).
Buyers are sometimes categorized as either “financial” buyers or “strategic” buyers. In simple terms, the financial buyer is a buyer who is purchasing the business primarily for its cash flow. The buyer may have any number of underlying reasons for wanting to buy a business, such as becoming self-employed in a new career, but fundamentally they will be driven to purchase or not purchase a business because of its cash flow. A strategic buyer is a buyer who enjoys some special advantage or synergy that most often makes the business more valuable to the strategic buyer than it is to the average buyer. In other words, the business is generally more valuable to the strategic buyer than the sum of its historic cash flow. The strategic buyer may enjoy significant cost savings as a result of the acquisition, having the opportunity to eliminate certain expenses in its existing business or in the acquired business, as a result of the acquisition. Or the strategic buyer may gain new distribution channels for its existing products, or add new distribution channels for the acquired company due to its existing business. The strategic buyer may gain a customer base for its existing business, or have an existing customer base to whom the acquired business can cross-sell.
There are two key points to take from this discussion of financial buyers versus strategic buyers. First, the baseline of the value of the business should be identified by the financial buyers. (If the assets of the business have a greater liquidation value – i.e., the business is worth more “dead” than “alive” – that is another matter and this discussion of financial buyers will not apply.) The financial buyers are relatively fungible, as is cash flow. Sure, some buyers will have greater interest in the business and perhaps be willing to pay a higher multiple of cash flow – for example, if they have experience in the industry and perceive greater opportunities. Generally, though, financial buyers will place a typical range of values on the cash flow of a business, and that should set the floor for minimum value. The second point is that strategic buyers should be identified and solicited, if they exist. The business owner is often in the best position to identify prospective buyers who will gain most from the acquisition, due to the owner’s depth of knowledge of the business. Contacting competitors, customers and suppliers about the sale of a business is a delicate matter and must be handled with care, but it is worth the effort to identify prospective buyers who may place the greatest value on the acquisition opportunity. This is particularly true if several interested strategic buyers can be identified and they know they are in a competitive bidding process (which again, must be managed with care).
Beyond identifying strategic buyers, it is helpful for the business owner to consider the profile of a likely financial buyer. Will the business be of interest to an investment group, or is it more likely that the buyer will be an individual is actively engaged in the business? Will the average buyer require financing to purchase the business, and is the purchase transaction eligible for financing to a qualified buyer? The great majority of businesses do not of themselves have sufficient collateral to secure conventional financing, and there are certain types of businesses that are very difficult to get financed. If the buyer is not likely to get financing for the business, how much cash will they need to invest and how much is the business owner willing to finance? The answers to these questions lead toward development of a “successful buyer” profile, which is important to have in mind when screening interested buyer prospects.
As a final point, it is important to have an effective marketing game plan to identify interested and legitimate prospective buyers, whether one or many. We have worked with several business owners who have (prior to our involvement) become involved in discussions with a single “interested” buyer, in some cases under contract with an offer, only to find out that the buyer prospect could never have obtained financing for the acquisition or was not sincerely interested. Our role in these engagements is typically to push the buyer prospect along through normal processes and ensure that the prospective transaction either proceeds through strict timelines, or is terminated. Often the business owner is interested in selling the business, but holding out in the hope that this interested buyer will come through. Some of these prospective buyers are sincerely interested and just do not understand what is required to purchase a business, or how to accomplish it, and we are able to help them through or at least identify that they will not make it through. Others are simply tying up the business owner’s time and resources, hoping to negotiate a below-market transaction. Knowing in advance which types of buyers will ultimately be successful, and on what terms, can save the business owner months or years of time dealing with buyers or deal terms that are unrealistic.