Environmental and sectoral drivers are very important in determining whether a business gets sold or not. There needs to be adequate capital in the market along with active buyers and attractive valuations. When conditions are right, opportunity for exits will arise.
There are always practical considerations when an approach is made. Does the business need capital? What is the debt situation? What are the financial needs of the family or other shareholders? Does the bid compensate the value to the owner of the great personal investment they’ve made?
The question owners need to answer is how best to capture value making sure their personal needs and the ongoing needs of the business are satisfied. Usually, when it comes time to sell, a trade sale or a management buy-out are the available exit options. Here’s how they work.
In some ways, the trade sale is the simplest and cleanest form of business exit, as it involves the sale of the entire business to a single buyer, often a competitor or a partner. A typical scenario would be when a business becomes a growing and important part of a partner’s business - i.e., as a major supplier or customer. In a shrinking or consolidating market, there will be a compelling commercial logic that drives sales and acquisitions, especially among businesses that already know each other well. In such an environment the conversation switches from ‘how can we help each other grow?’ to ‘have you ever thought about selling?’.
This kind of exit scenario is often the best type because of the familiarity and trust that the parties have already built up during their business relationship. The transaction, then, becomes a matter of finding - and agreeing on - the best price. A trade sale usually results in a higher valuation, too, as trade buyers can achieve synergies and may be able to see and realise value in an acquisition that is not apparent to a financial buyer.
Of course, ‘best’ doesn’t necessarily mean ‘simple’. Depending on whether an approach is solicited or unsolicited, and how long the courtship has been, the owner might be in a position of ignorance about the real value of their business and the best way to proceed. On the one hand, it is positive to receive an approach; better to have the option of accepting or rejecting a bid than to have no bid at all. On the other hand, a bilateral offer can put pressure on both the business and the owner to act quickly with little preparation.
What an adviser typically does for a client at this point is something called ‘creating competitive tension’. The business owner, ironically, can often be in a poor position to accurately gauge the true market value of their business. There is always a danger that a business will prematurely accept a lowball offer from a trusted source because they lack the information a bidding process will create. That’s why advisers work hard to create competitive tension in any transaction.
Trade sales may be the cleanest and most straightforward way of exiting a successful business, but current market conditions mean we are seeing fewer and fewer of them. In a shrinking market, businesses tend to consolidate and seek mergers and acquisitions to achieve scale.
But in a growing market, other kinds of buyers are much more active. Often, experienced management teams will look to execute a management buyout (MBO), whereby the management takes over all or part of the business with backing from third-party investors and/or debt funding. Usually those third- party investors are private equity (PE) funds, who take a stake in the company in exchange for funding the deal, sometimes with other sources of funding, and provide expertise.
Like any sale, a buyout represents a chance to unlock wealth for the owner. MBOs naturally arise in situations where the owner is approaching retirement and the next generation of the family isn’t inclined to carry the business forward. So the opportunity for exit is in clear view and the owner is acting on it. In our experience, most companies are open to it when the relationship between management and the owners is good, although this type of sale can sometimes achieve lower valuations, especially if debt is involved.
MBOs will usually involve a private equity partner who provides much of the funding. However, where buyer and seller are far apart on price, the owner can help the buyer get to a higher number by rolling some of their equity over into the new capital structure or leaving some equity in as a deferred loan to be paid by the buyers. While doing this has the advantage of achieving a bigger payout, it leaves the owner exposed to post-exit commercial risk that must be taken into consideration. In most cases, owners want a clean break but, to get the deal done, keeping a legacy stake might be necessary.