Understanding the buyer's perspective in acquisitions isn't just an effective strategy—it's the secret weapon and a competitive advantage for business owners, CPAs, and lawyers aiming for triumph in M&A. The most successful negotiators, presidents, writers, and business executives comprehend the motivations of their counterparts. In this article, we aim to condense how buyers view acquisitions, recognizing that different elements appeal to various types of buyers.
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What the process of buying a business looks like
Motivations for an Acquisition: When Do Buyers "Buy" instead of "Build" or "Partner"?
Strategic Acquisitions
When a company expands into new markets or seeks to gain more market share, there are three classic corporate strategies to consider: building, buying, or partnering.
When a company decides to build, they’re leveraging their own expertise and resources to “build” a new product or service, maintaining complete control over its product or service offerings. Often, companies may decide not to build if they don’t have the in-house expertise, require speed-to-market, or when execution risks are too high.
When a company decides to buy, they value speed to market, interested in acquiring external expertise, or want to mitigate execution risk. Acquiring a company can also help skip product testing challenges, providing immediate access to established processes, products, distribution, and/or customer base.
When a company decides to partner, they want to share the risks and upside. Compared to an outright acquisition, they can avoid legal complexities and utilize combined strengths that complement the partner. Partnerships can be trickier than outright acquisitions when deciding “how” to split risks and rewards.
Financial Acquisitions
Financial buyers, such as private equity firms, family offices, and special-purpose vehicles, acquire businesses for these specific reasons.
High Returns & Efficient Capital Use: The primary purpose behind financial buyers is seeking a return on investment. Often, private equity funds have a return target and will structure deals creatively to meet those return targets.
Spreading Out Risk: With a portfolio of multiple investments across several industries, funds may acquire additional businesses in different industries, reducing the risk of financial losses if one industry underperforms.
Leveraging Expertise / Scale: As disciplined investors, funds often implement transformation to improve operations or leverage expertise in their other holdings in similar industries. A common acquisition motivation is getting better economies of scale within the same industry (“roll up” strategy), where an acquirer will “roll up” multiple companies within the same industry to increase bargaining power with suppliers and customers.
Strategic Acquisitions: Private-equity-backed companies may explore strategic acquisitions for the reasons listed above under “Strategic Acquisitions”. Because the company is still backed by private equity (or family offices) seeking a return, they will be much more financially focused than a traditional strategic acquirer.
How Buyers Find Acquisition Targets
Strategic buyers are constantly looking for potential targets that can complement their long-term goals. They aim to enhance their operations or penetrate new markets with innovative technologies from acquired firms. Corporate M&A teams may utilize their industry networks and professional contacts to identify acquisition targets. They partner with intermediaries, such as business brokers or investment banks, who actively match them with companies that fit their strategic plans. These intermediaries know these buyers will pay premium prices for compatible acquisitions. For instance, a corporate law firm that wants to expand into IP rights could be connected with an IP consultancy by a business broker or investment bank.
Financial buyers, such as private equity firms, typically seek out companies with a strong growth or profitability track record. They use various methods to find such companies, including cold outreach and referrals from industry insiders. As industry outsiders, they often rely heavily on intermediaries who leverage their networks and expertise to identify investment-ready companies in the industries they are targeting. For example, an intermediary may connect a private equity firm with a family-owned manufacturing business where the next generation does not want to continue running the business, but the private equity firm has a ready management team in place.
Business owners and advisors should be prepared for unexpected acquisition interest from both strategic and financial buyers. To learn more about navigating such situations, read our article “The Knock on the Door”.
Become a Referral Partner Know a business owner looking to sell or explore M&A opportunities? Exit Advisors streamlines the process of identifying ideal acquirers and preparing businesses for sale.
How Buyers Evaluate Opportunities
A typical buyer may review dozens of potential acquisition targets before pulling the trigger on one. This evaluation will almost always involve assessing the company's:
Current and Historical Performance: Buyers review a company's financial health and past success, looking at profit margins and revenue growth to understand its historical performance.
Growth potential / Future performance: Strategic Buyers seek targets with strong growth potential that can improve or extend their existing operations, focusing on how they can create synergies to accelerate growth and expand market reach. PE/Financial Buyers are interested in the business's ability to generate stable, recurring revenue, valuing companies with predictable financial futures and the potential for steady growth.
Risks: Identify operational, market, and financial risks that could impact the acquisition's success and establish a path to mitigate those risks.
Valuation Expectations: Ensuring the seller's valuation aligns with the buyer's investment parameters and expectations. For strategic buyers, the “valuation” will always be compared to the cost (and opportunity cost) of building in-house or partnering. For financial buyers, the valuation has to be in line with their return on investment targets.
Experienced M&A professionals can engage business owners to align their business with these buyer screening criteria, making it more attractive to potential buyers. This may be a multi-year process of mitigating common “deal killers” and shifting the business model to be more attractive to potential acquirers.
Negotiations, Deal Structuring, and Financing
During negotiations, both parties aim to create a deal that benefits them. Deals get done if there is a Zone of Possible Agreement (ZOPA). Creative deal structuring techniques can reconcile differences in future expectations. Successful deal structuring involves finding ways to add value for both sides. Strategies like earnouts, contingent payments, owner financing, carve-outs, and continued owner employment are used to enhance the deal's value and align the interests of the buyer and seller. Throughout the process, knowledgeable and experienced M&A professionals can provide valuable guidance.
Due Diligence
It is important to note that even with a signed "Letter of Intent," many business deals fail during the due diligence stage. The "Surviving Due Diligence Guide" contains ten essential tips to help sellers navigate this critical stage effectively. These tips include maintaining transparency, ensuring clean financial records, and taking care of legal and human resources issues. Knowledgeable M&A professionals can guide sellers through this process, getting in front of common due diligence issues and maximizing the chance of a successful deal close.
Post-Acquisition Success
Success after buying a business isn't just about sealing the deal; it's fundamentally linked to the details of the original acquisition contract. This contract serves as a roadmap for the relationship and operations after the purchase, ensuring both the buyer and seller know what to expect and how to proceed.
Why a Good Contract Matters:
For the Buyer:
Risk Reduction: A good contract for the buyer reduces surprises and potential issues, increases the likelihood the business integrates well with the buyer's existing operations and the buyer realizes positive returns on the deal. It allows plans for contingencies for when the business acquired is truly what the seller represents and what the buyer believes they are buying.
Continued enterprise value: A poorly constructed contract can destroy enterprise value after the deal. Unethical founders or selling teams may plant seeds in the original contract that create misaligned incentives. The founders may “buy back” the business for pennies on the dollar, destroying tremendous enterprise value in the process.
For the Seller:.
Success Bonuses: Sellers can receive additional rewards if the business thrives post-sale, providing an incentive for ongoing success. Ensuring the contract clearly lays out how these post-sale bonuses are tied to specific, achievable milestones ensures sellers will actually receive those additional awards.
Clarity in Role: For sellers and their management teams staying on post-acquisition, the contract specifies their roles and compensation, facilitating a smoother transition.
Consequences of a Bad Contract or Post Acquisition Failure:
Lawsuits: Poorly defined terms can cause misunderstandings and disputes that disrupt business operations and relationships, ultimately leading to lawsuits. For instance, an “earnout” contract with unclear terms may result in one party believing the earnout criteria was not met, while another party believes it was met (we commonly see this with earnouts tied to profit goals).
Trust and Value Deterioration: For both buyers and sellers, poor deal success could create significant trust issues (“red flags”) for future deal makers. For instance, a buyer with a reputation for strong-arming sellers and business owners may result in business owners thinking twice about selling to them. Similarly, serial entrepreneurs and business owners may find it tough to sell their second business if their first business sale was a disaster.
Crafting a contract that carefully balances protections, incentives, and clear expectations is essential for maximizing the benefits for both buyers and sellers and for the overall success of the acquisition.
Summary
In this article, we’ve covered the significance of understanding the buyer's perspective in acquisitions for business owners, CPAs, and lawyers. We’ve covered motivations for acquisition from strategic and financial buyers, as well as how buyers find acquisition targets. Additionally, we’ve outlined criteria buyers typically use to evaluate opportunities, including performance, growth potential, risks, and valuation expectations. We stress the significance of effective negotiation, deal structuring, and financing, along with general tips to navigate due diligence successfully.
For expert guidance on preparing for M&A, maximizing your valuation, ensuring a successful deal close, and achieving post-acquisition success while avoiding common pitfalls, connect with our advisory team today. info@exitadvisors.com