Why Successful Business Owners Sell Out

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  • 7/29/2019 Why Successful Business Owners Sell Out


    Why Successful Business Owners Sell Out

    October 10 2009| Filed Under M&A,Private Equity,Small Business,Venture Capital

    In the world ofmergersandacquisitions, there are typically several hundred transactions per

    week. While many of the multibillion dollar, cross-border transactions attract most of the press

    coverage, a vast majority of deals involve micro- and middle-market companies. These

    transactions involve mergers, acquisitions,leveraged buyouts,management buyouts, or

    recapitalizations, and involve companies with enterprise values between two to several hundred

    million dollars.

    There are a variety of reasons why owners sell their companies or explore strategic and capital

    raising alternatives. A vast amount of deal structure possibilities exist to accommodate varying

    objectives. The owner (normally with the advice of an experienced M & A advisor) will seek out a

    structure that best meets one or more of his or her objectives.

    Read on as we explore the motives behind M&As from the seller's perspective. Understanding this

    process can be an important step for investors in researching a company they own or are

    considering buying into. What happens to a company once it's acquired is often determined in the

    details hashed out in the merger/acquisition process.(To learn about the other side of these

    transactions, seeThe Buy Side Of The M&A Process.)

    Why Owners Sell

    Owners who agree to sell their companies may be tired of running the business and seek either a

    full or partial exit. If an owner wants to liquidate 100% of his or her equity, acquiring investors will

    usually offer a lower acquisition price. This is partly a result of the greater difficulties that are

    anticipated in running the business after the transaction if the owner is not available to help with

    the integration process.

    Arecapitalization, where the exiting owner retains a minority equity stake in the business

    (typically 10-40%), is a more common structure. In this case, the exiting owner has incentive to

    help increase the value of the business (normally through part-time effort). The exiting owner will

    still benefit from a gradually diminishing role in the operation and the freedom to enjoy more

    leisurely pursuits. Once the owner is out of the picture, the combined entity will have a go-forward

    plan in place to continue to grow the business, both internally and through acquisitions. In

    addition, the exiting majority owner will see the value of his or her equity increase if performance

    benchmarks are reached. It is important to remember that large companies receive higher

    valuation multiples from the market compared to smaller companies, partly due to lower

    enterprise risk.

  • 7/29/2019 Why Successful Business Owners Sell Out


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    An exiting owner may also wish to convert his or her equity into cash. This is because many

    business owners have considerablenet worth, but a lot of this value is often value tied up in the

    business, and thusilliquid. Unlocking this equity through a liquidity event may reduce the seller's

    risk by diversifying his or her portfolio and allowing the seller to free up more cash.

    Another common exit scenario involves an elderly owner who is experiencing material health

    problems, or an owner who may be getting too old to effectively run the business. Such situations

    often necessitate the need to quickly find an acquirer. While business development officers of

    strategic companies can move the M&A process rapidly, large companies often do not respond

    quickly enough because they are hindered by a number of bureaucratic processes that cause

    delays (ex. managerial and board approvals). (For related reading, seeOwners Can Be Deal KillersIn M&AandHow The Big Boys Buy.)

    Buyer Motivation

    In the acquisition marketplace,private equityappears to be better suited to quickly engage the

    owner, assess the business and complete the acquisition. A reasonably well run mid-market

    company can be acquired within three to six months if both parties are genuinely invested in the

    deal. This is especially true if the exiting shareholder's accountants readily provide yearly and

    monthly financial statements, and if the acquiring equity group already has the accounting and

    legaldue diligenceteam ready to move in.

    Family disputes are also a common driver for an acquisition. A spouse or close relative may be

    abusing company assets for personal gain, resulting in poor company performance and low

    morale. Incoming investors can get rid of dysfunctional individuals and restore good management

    practices in the business, as well as provide peace of mind to the seller.

    A seller may seek to sell his or her company for operational or strategic purposes.

    For example, the owner may wish to:

    Gain market share. A larger acquiring company has complementary distribution and

    marketing channels or arecognizable brandandgoodwillthat the target entity can


    Finance an expansion. The acquiring entity has the cash to fund new equipment,

    advertising, or additional geographic reach, increasing the operational footprint of the


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    Raise capital for an acquisition. The acquiring entity has the capital or debt capacity to

    execute an accumulation play. In other words, it can acquire a series of smaller

    competitors and help to consolidate an industry. The target operates with fewer

    competitors in an industry, and has access to its former competitors' resources

    (management talent, product expertise, etc.).

    Place better management. The parent company has superior management that can

    unlock value in the target business. The acquired business can then be professionalized

    (have better IT systems, accounting controls, equipment maintenance, etc.). (For more

    insight, seeEvaluating A Company's Management.)

    Diversify a relatively focused customer base. Small companies often have a large

    percentage of their revenue base coming from a single or a relatively small number of

    customers. Customer concentration significantly increases enterprise risk because the

    business can go bankrupt if it loses one or more of its key customers. A diversified

    customer base - presumably with a diversified revenue stream - lowers the volatility of its

    cash inflow, increasing the company's value.

    Diversify product and service offerings. The addition of complementary product and

    service offerings into the target business allow it to capture more customers and increase


    Secure leadership succession. A business owner may not have invested time and effort

    into identifying and grooming a successor, necessitating the sale of the business in order

    to ensure that it continues to operate effectively. (For more, seeHow To Create A Business

    Succession Plan.)

    Other Factors

    Themacroeconomicenvironment can also be an impetus to sell. The vast pool of capital available

    in the U.S. economy has pushed up acquisition prices. As such, owners often look to take

    advantage of a "seller's market" and hire advisors to market their businesses for higher multiples.

    With vast amounts of cash competing for acquisitions, acquirers (particularly private equity) have

    become flexible in structuring deals in order to accommodate existing shareholders' preferences

    and objectives. However, while a seller's market provides such perks and benefits, if owners get

    too carried away from reasonable and fair prices for their companies, they risk blowing up the deal

    and losing millions of dollars.

    When is the Right Time to Sell a Business?From time-to-time many owners find themselves thinking about selling their business and cashing out.

    Thoughts of selling can be stimulated by a variety of factors. Regardless of the reason, an owner needs to

    pause and ask if now is the right time to sell the business.

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    How does an owner determine if the time is right to sell? Is there a systematic approach? How important

    are instincts and gut-feelings? Should an owner wait until approached by a prospective buyer? What needs

    to be considered when determining if its the right time to sell?

    In general terms, there are three conditions which indicate that the time is right to sell. The time is right to

    sell if the owner: (i) has a compelling or motivating reason to sell, (ii) is reasonably confident about thechances of meeting his or her objectives through the sale, and (iii) is psychologically prepared to relinquish

    ownership control.

    A Compelling or Motivating Reason

    Occasionally an owner has no choice, and must sell whether or not the timing is right. For example,

    divorce, the dissolution of a partnership, or the untimely death of a major shareholder can necessitate a

    forced or involuntary sale. In such cases the question is not whether to sell, but rather how to make the

    best of an unfortunate situation.

    Assuming that an owner is not forced to sell, there are a variety of motivations to sell. Such motivations fall

    into three general categories: (i) personal reasons, (ii) investment reasons, and (iii) strategic businessreasons.

    (i) Personal motivationsare essentially non-economic and non-business reasons for selling and caninclude major disagreements with co-owners, the lack of heirs, retirement of the owner or a key manager,

    the possibility of relocation, a desire to try something new, health problems, divorce, family problems, or

    the death of an owner. In some cases, the owner simply feels emotionally burdened by the business, a

    condition frequently referred to as burn-out.

    When a privately held company borrow...