Merger or Acquisition
The third exit strategy involves selling the company to a single purchaser, whether it's an individual or an organization, and whether its to a Strategic Buyer, VC with Successor, or Large Agency. The exit is typically through a merger or acquisition (M&A). This is the most common way businesses are sold as it is the least expensive way. The buyers have greater access to capital which is typically needed for growth. They also have access to new, skilled management that would ensure the company’s growth potential. If the buyer is from the same industry sector, then the successor company may have greater market share which would enhance growth rate. Traditionally, these buyers’ goals do not align with the entrepreneurs, and that’s were the problems lie that too often lead to an unsuccessful transaction.
The fundamental problem is that a small business entrepreneur’s culture is radically different than that of a large corporation. The small company’s entrepreneurial culture that provides the owner with control and freedom is not conducive to a large corporation’s culture thereby lowering its value and the buyer’s interest. If the large corporation has an interest, they usually want new management with greater skills for continuity with existing management. New managers will not have the prior owner’s relationships with customers, employees and suppliers and will change the entrepreneurial culture of the small business. This typical “Wall Street” acquisition model has failed in the past.
For companies that have a real upside at becoming a much larger organization, the seemingly least expensive route of merger or acquisition turns out to actually be the most expensive.
When small business owners are ready to sell their company to an outsider, traditionally they enlist a business brokerage firm to list it for sale like you would if you were selling real estate. Once the sale is consummated, the brokerage firm gets paid their commission and the owners get the balance of the sales price. Business brokerage firms are very good at knowing the geographical, economic and industrial environments that a company competes in and can be a true partner in getting the job done. But the selling transaction will most likely be with a single purchaser and could take a very long time. The smaller the business the longer the time as there are few buyers for small companies. It is simply not worth the time of a large buyer to invest in the due diligence of purchasing a small company.
The single purchaser transaction commonly involves a "Valuation Gap" problem. That valuation gap widens when selling to professional buyers, such as a Strategic Buyer, Venture Capitalist financing a Successor, or Large Agency such as Private Equity Groups. These are great M&A purchasers because they will pay cash - in relative quick fashion. They may insist that management remains active for a few years. The downside is that they discount the sales price seeking to pay less for more. Their job is to make sure that their investors receive as much value per buy/sell transaction as possible.
The good news is these M&A purchasers are typically flush with cash. It's called "Capital Overhang." There's so much of it they are starting to be less resistant to lengthy negotiations - (they'll acquiesce to your demands a bit more than they otherwise would.) And they are starting to lower their investment threshold from $15 to $25 million in annual sales.
But the bottom line is that these professional purchasers may purchase a small company for cash and relieve the owner from the possible burden of running a company day to day, as time goes by, but for the reasons stated above, if it can find a buyer, the small company may get substantially less than what its potentially worth.