Whether you want to sell your business next year or a decade from now, you will have two basic options for an external sale: the financial or the strategic buyer.
The Financial Buyer
The financial buyer is buying the rights to your future profit stream, so the more profitable your business is expected to be, the more your company will be worth to them. Strategies that are key to driving up the value of your business in the eyes of this buyer include de-risking it as much as possible, creating recurring revenue, reducing reliance on one or two big customers, cultivating a team of leaders, etc.
Financial buyers want to maximize their profits and minimize their risks whenever possible. Accordingly, they often see businesses that are overly dependent on either suppliers or customers as a liability. Financial buyers have capital to deploy in good businesses. They typically seek companies within industries that can be consolidated and then after growing those companies sell at a higher multiple generating a high ROI for their investors.
In some cases, a seller may be able to get the best of both worlds by getting a financial buyer that has already made an investment in an industry and is looking to consolidate that industry. Hence, you may be able to secure more funding from them because they will begin acting more like strategic buyers (more info on that below).
The Strategic Buyer
The alternative is to sell to a strategic buyer. They will care less about your future profit stream and more about what your business is worth in their hands, typically calculating how much more of their product they can sell by owning your business. Strategic buyers are usually big companies, so the value of being able to sell more of their product or service because they own you can be substantial. Historically, this has led strategic buyers to pay more for your business than a financial buyer would.
For example, Nick Kellet’s Next Action Technologies created a software application that takes a set of numbers and visually expresses them in a Venn diagram. Next Action Technologies was generating approximately $1.5 million in revenue when they received their first acquisition offer; Kellet’s first valuation was for $1 million, a little less than revenue, which is pretty typical from a financial buyer.
Kellet knew the business could be worth more to a strategic buyer, so he searched for a company that could profit by embedding his Venn diagram software into their product. Kellet found Business Objects, a business intelligence software company looking to express its data more visually. Business Objects could see how owning Next Action Technologies would enable them to sell a whole lot more of their software, and they went on to acquire Kellet’s business for $8 million, more than five times revenue — an astronomical multiple
Preparing For Every Eventuality
The question is: Why bother making your business attractive to a financial buyer when the strategic buyer typically pays so much more?
As we discussed above, Strategic buyers have historically been seen to pay more than a financial buyer because strategic buyers are able to take advantage of synergies, leveraging a sales team, eliminating administrative costs, etc. However, we have seen a change in recent history. Financial buyers now know that they must be more competitive in certain industries. So, in return they are paying more, in some cases, outbidding strategic buyers. This typically occurs when a financial buyer is acting more as a “hybrid buyer” where they already have an investment in a portfolio company and act more like a strategic buyer.
The simple truth is that strategic acquisitions are rare. Each industry usually only has a handful of strategic acquirers, so your buyer pool is small and subject to a number of variables out of your control; the economy, interest rates, the competitive landscape, and a whole raft of other variables can all impact a strategic acquirer’s appetite to buy your business.
Think of it this way: imagine your child is a promising young athlete intent on going pro. You know that becoming a professional athlete is a long shot, fraught with unknown hurdles: injury, the wrong coach, or just not having what it takes to compete at the highest levels. Do you squash his or her dream? No, but you do make sure she does her homework, so if his or her dream fades, he or she has their education; you make sure he or she has a backup plan.
The same is true of positioning your company for an exit. Sure, you may want to sell your business to a strategic buyer in a spectacular exit. But a financial acquisition is much more likely, and financial buyers are looking for companies that have done their homework — companies that have worked to become reliable cash machines.
The Best Way To Make Your Business More Attractive To Buyers
It’s one thing to emphasize the need to appeal to both financial buyers and strategic buyers. However, you may find yourself asking a more fundamental question: How can you make your business more appealing to buyers of all stripes in the first place?
It all comes down to KPIs. Begin with leveraging the knowledge you gained from your most recent industry research and create KPIs for your business in as many key areas as seems reasonable. There are two main reasons for this: to improve the efficiency of your business and to make your business more attractive to prospective buyers. As you study and monitor these key metrics, you’ll naturally be de-risking as you will start catching any issues as they are happening live, so you can rectify the situation, therefore enhancing the value of your business.
The danger of not having such KPIs in place is that when potential buyers take a closer look at your business, they’ll see all the inefficiencies you might have neglected; these inefficiencies add up, and buyers may get cold feet if they believe they’ll have to put in plenty of their own work to make the most out of the acquisition. By running those inefficiencies down, yourself, you can improve the odds of a sale in the long term, and improve your profits in the short term.
There are several factors to consider when planning to sell your business, but as you plan, you will want to continue to run the business as if you are not selling. Doing so will allow you to continually add value to your business.
Have further questions on the roles of a Financial Buyer vs a Strategic Buyer? Contact the experts at Twelve Points Business Advisors to discuss.