 |
| Simon Gregory |
Considering the size of your buyer is more important than you think
Over the last 15 years I have met and consulted with over 4,000 shareholders, owners of Small to Medium sized enterprises. I have looked at the accounts of those companies and discussed the way in which these shareholders might find a buyer for their business once they are ready to sell. One thing that is extremely clear to me is that to achieve a good price, these shareholders need to be talking to companies that are far larger than they are. It sounds obvious, but it is something that is seriously overlooked when sellers are discussing selling to an interested party.
For example I remember meeting with the owner of a long held family business that had average revenue over the last few years of around Euro 12 million. The company was making a Profit After Tax, including what the shareholder was taking out of the business of Euro 1 million.
Although traditional thinking says that value is all about multiples of profit, my view is that value is more about the motive of the purchaser and what the buyer can do with the acquired company. Value is always improved when you have a competitive situation i.e. lots of buyers interested in acquiring your business all at the same time. However for purposes of illustration, let’s consider a traditional approach to valuation. The average multiple used across industry, where a competitive situation is absent is 5. We won’t go into why that is the case right now, but leave it for another time.
If we were to value the company mentioned above using the traditional approach, then the value would be Euro 5 million. This simply means that anyone that invests Euro 5 million in acquiring this company would get a year on year return on investment of Euro 1 million per annum, and therefore a complete return within 5 years. To my mind that sort of price makes buying a company one of the best ways of getting a return on your money. Where else could you invest Euro 5 million and get that sort of return on your money every year, and a complete return within 5 years. That’s not my point.
The point is that even on a traditional multiplier the buyer would need to have access to Euro 5 million in cash within its own business.
So let’s consider that here we have a Euro 12 million turnover company making a Euro 1 million profit. In order to have Euro 5 million to buy this business the buyer might need to have 5 times the seller's company’s turnover, arguably.
In other words to have Euro 5 million to acquire the company on a similar turnover to profit ratio as the selling company the buyer would need to have a turnover of around 60 million.
I am generalising here, but for purposes of illustration it helps us to consider that if a 12 million turnover company has a profit of 1 million, a company with 60 million turnover (5 times the turnover of the seller) might arguably be making a profit of 5 times that of the seller (i.e. 5 million). Albeit the 60 million turnover company might have accumulated cash within its business, the point I am trying to make is that to afford a price of 5 million. The buyers needs to be substantially larger than the seller.
As we think about this it becomes abundantly clear that in reality in order to have Euro 5 million to buy a company we must consider that to pay this price, realistically most buyers would need to have a turnover greater than perhaps Euro 100 million.
In other words to have Euro 5 million to acquire the company on a similar turnover to profit ratio as the selling company the buyer would need to have a turnover of around 60 million.
I am generalising here, but for purposes of illustration it helps us to consider that if a 12 million turnover company has a profit of 1 million, a company with 60 million turnover (5 times the turnover of the seller) might arguably be making a profit of 5 times that of the seller (i.e. 5 million). Albeit the 60 million turnover company might have accumulated cash within its business, the point I am trying to make is that to afford a price of 5 million. The buyers needs to be substantially larger than the seller.
As we think about this it becomes abundantly clear that in reality in order to have Euro 5 million to buy a company we must consider that to pay this price, realistically most buyers would need to have a turnover greater than perhaps Euro 100 million.
The important thing to consider though is that no seller wants to have 1 buyer. If you have 1 buyer that buyer will base his valuation on a traditional Return on Investment calculation a 5 times multiple. Most seller would prefer to have a choice of buyers in the hope that a competitive environment will drive the price higher.
In order to get a higher price than the Euro 5 million on the table from the one company, the seller would need to be in contact with players that are much larger than the Euro 100 million company.
In order to get a higher price than the Euro 5 million on the table from the one company, the seller would need to be in contact with players that are much larger than the Euro 100 million company.
Some people would say, no you are wrong Mr. Gregory. Companies that are smaller than Euro 100 million might not have the cash in their business, but they will have some of it.
Okay let’s say they have Euro 2 million in cash in their business. Well, they need to keep a million in the business as working capital. They can't expend it all on an acquisition.
This smaller company is prepared to spend Euro 1 million of its own money, and is prepared to borrow the rest in order to make the acquisition. This is when the seller runs into a major problem.
If the buyer has to borrow heavily, and borrow from a bank or financial institution, the bank will always think Return on Investment - they will always base their valuation on traditional methods.
The bank will want a quick return on their investment, because they are a bank, and of course they are not prepared to take long-term risks with their money.
Okay let’s say they have Euro 2 million in cash in their business. Well, they need to keep a million in the business as working capital. They can't expend it all on an acquisition.
This smaller company is prepared to spend Euro 1 million of its own money, and is prepared to borrow the rest in order to make the acquisition. This is when the seller runs into a major problem.
If the buyer has to borrow heavily, and borrow from a bank or financial institution, the bank will always think Return on Investment - they will always base their valuation on traditional methods.
The bank will want a quick return on their investment, because they are a bank, and of course they are not prepared to take long-term risks with their money.
The buyer will then be limited in terms of what he can borrow. The bank might want a return within 2 or 3 years.
So now we have a situation where the company has been traditionally valued at 5 times. The buyer is prepared to use Euro 1 million of its own money, and to borrow the rest in order to make the acquisition. The bank though will not take a big risk, and won’t approve of the buyer taking a big risk with the bank’s money. The buyer can only borrow 2 or 3 million at the most.
The buyer's offer now reduces from 5 times (Euro 5 million) to Euro 3 million or at the most Euro 4 million, and now sits below the seller aspirational value.
The closer a buyer is to you in terms of size the more they will need to borrow. The more they have to borrow the more likely that the bank will want an even quicker return on its investment. Smaller companies might express an interest in you, but they will not be able to afford to buy you.
So now we have a situation where the company has been traditionally valued at 5 times. The buyer is prepared to use Euro 1 million of its own money, and to borrow the rest in order to make the acquisition. The bank though will not take a big risk, and won’t approve of the buyer taking a big risk with the bank’s money. The buyer can only borrow 2 or 3 million at the most.
The buyer's offer now reduces from 5 times (Euro 5 million) to Euro 3 million or at the most Euro 4 million, and now sits below the seller aspirational value.
The closer a buyer is to you in terms of size the more they will need to borrow. The more they have to borrow the more likely that the bank will want an even quicker return on its investment. Smaller companies might express an interest in you, but they will not be able to afford to buy you.
In a survey I carried out once looking at the size of the acquirers of 250 sellers, where there was a competitive environment i.e. lots of companies competing to buy each of these 250 companies I discovered that 88% of the buyers had a turnover greater than Euro 10 million, but more interestingly just over 50% in total had a turnover greater than Euro 100 million. These larger companies were buying many companies with turnovers greater than Euro 1 million and in some cases companies with turnover in the hundreds of thousands. The vast majority of these companies had multiple offers where the difference between highest and lowest offers was significant.
Having seen thousand of accounts over the years, of companies of differing shapes and sizes, I know that many companies below Euro 100 million do not have the cash to acquire at the sorts of prices that make selling worthwhile for the seller. Occasionally they do, but it is very rare. In a later article though, I am going to talk about why there are exceptions to the rule, and why there are sometimes good reasons to contact companies that on the surface might not look like they have the money.
Generally as a rule of thumb, when you are selling a company you need to be talking to lots of companies that are significantly larger than you. If they are of similar size, they will not have the money. You will usually have to sell to them for a low price.
The buyer will want to pay a low price because not only does he have to borrow the money to buy your business, but in order to grow it he will have to invest in it in the very same way you would have to do if your were retaining the business and going to grow it yourself. He will therefore try to pay a low a price as possible, considering he has this extra investment in growth to make once he has bought it.
The buyer will want to pay a low price because not only does he have to borrow the money to buy your business, but in order to grow it he will have to invest in it in the very same way you would have to do if your were retaining the business and going to grow it yourself. He will therefore try to pay a low a price as possible, considering he has this extra investment in growth to make once he has bought it.
A buyer that is larger than you (lets stick with our example of the Euro 12 million company), let’s say a Euro 300 million turnover company, will already have in place a much larger infrastructure. In other words he does not have to invest in this infrastructure to grow your business. You can tap into that infrastructure straight away. The buyer will already have multiple channels of distribution already in place to effect greater and faster growth for your business. They will have a much larger field sales force than you have, significantly more customers than you have to whom they can introduce your products. They will have a greater geographic footprint than you have, they may also be able to open up new market sectors to your products, where you might have had some inroads, but where they already have significant presence. This larger buyer also has complementary products or services of their own which they can now sell to your existing customer base.
Here is the key. You buyer should be much larger than you are. They should have most or if not at least the majority of cash within their business available to acquire you.
If they have to borrow heavily you are on the slippery slide to a low price. They should already have in place a significantly larger infrastructure than yours, be able to introduce you to many more customers, increase your geographic footprint, and all the other things I have described above.
If they do not have these things in place already then the likelihood is, no matter how interested in your business they appear to be, they will not be able to pay you (in some cases the minimum you might accept) and they certainly wont be able to pay you the maximum or premium price.
If they have to borrow heavily you are on the slippery slide to a low price. They should already have in place a significantly larger infrastructure than yours, be able to introduce you to many more customers, increase your geographic footprint, and all the other things I have described above.
If they do not have these things in place already then the likelihood is, no matter how interested in your business they appear to be, they will not be able to pay you (in some cases the minimum you might accept) and they certainly wont be able to pay you the maximum or premium price.
There is nothing worse than expending, time, finance and energy, on buyers who can ‘talk the talk’, but when it comes down to it, do not have the finance or the synergies, to even consider paying you anything more than a traditional valuation based on them getting a quick return on their investment, because they couldn’t borrow enough to pay you a decent price. Size really does matter.
The next article will consider research strategies and how to identify the sorts of buyers that will pay a premium price for your business.
