GROWTH. TRANSFER. LEGACY.
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Know your buyer? Your initial reaction to this title may be “How can I know my buyer? I haven’t even decided to sell yet!”
Nonetheless, understanding the type of buyer that your company will attract is vital. More importantly, gaining that understanding long before you go to market will impact many decisions about how to run your business between now and when you start to actively market the company for sale.
The classes of buyers are not interchangeable. I once worked with the owner of a subcontracting company. He told me “I want to find a strategic buyer. I know they pay higher multiples than anyone else.”
That’s nice in concept, but Strategic Buyers make strategic acquisitions. His business was only as good as its next bid. He had no proprietary systems, no products, no long-term customers and no contracts besides the current jobs. Strategic buyers pay for strategic differentiation. He was unhappy that I didn’t classify his self-defined “great reputation in town” as a differentiator.
Your business will determine what types of buyers you should seek, how your earnings will be viewed, and the multiple of earnings you can expect.
Main Street is the generally accepted term for businesses that sell for less than $3,000,000. Entrepreneurial Buyers are most commonly an individual or partnership. Downsized executives and entrepreneurs who have sold a previous business make up a large percentage of the buyer population for these companies. These transactions are usually handled privately, or through a business broker who advertises them on the Internet.
Cash flow for these businesses is called Seller’s Discretionary Earnings (SDE), and includes all the perks of ownership (wife’s car, no-show child employment and the like.) Anything that could be applied to a debt payment qualifies. For most Main Street buyers, their ability to service loans for the purchase usually tops out around 3 times SDE.
Mid-market companies sell for between $3,000,000 and $100,000,000. Financial Buyersinclude private equity firms and family offices. These buyers usually seek acquisitions where the cash flow is in excess of $1,000,000 a year.
Many lower Mid-market sellers are confused by the cash flow calculations. Financial Buyers’ cash flow measure is EBITDA (Earnings Before Interest Taxes Depreciation and Amortization.) Some sellers try to include the side benefits their company pays for in EBITDA. Financial Buyers assume that any benefits you have, a replacement manager will have as well, and they will ignore many of the SDE inclusions.
Private equity and Family Offices purchase businesses that are likely to produce a predictable return. Because the have investors (or wealthy family members) to please, their purchase prices are usually in the range of 4 to 5 times EBITDA, although the recent financial markets have driven that into the 6x territory for acquisitions over $20,000,000.
The Mid-market is also where sales are made to customers, vendors or competitors. Handling these transactions requires special care with confidential information. Since buyer and seller usually know each other, a broker-type intermediary is less necessary. Many times a transaction attorney or accounting firm can handle the negotiations.
Exit Planners provide special value to companies in the “Neutral Zone.” I define that as too small to be big, and too big to be small. Their EBITDA is healthy (usually $500,000 or more after owner compensation) but below the $1,000,000+ that the Financial Buyers seek. Yet at that level, few Entrepreneurial Buyers can handle the purchase price.
There are many options still available to a Neutral Zone company. You can choose a growth strategy to enter the realm of Financial Buyers. A Leveraged Buy Out (LBO) by experienced employees is likely to attract the interest of a lender. An Employee Stock Ownership Plan (ESOP) is a very attractive alternative in the right circumstances.
In all cases, a good planning runway will help you to know your buyer. Then you can position the business with control over the outcome you seek.
A short video on classes of buyers and the multiples they pay, along with a free calculator to determine your SDE or EBITDA are both available on our website of free tools for owners, Your Exit Map.
Article reprinted from my exit planning blog on Awake at 2 O'clock?
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