How do you select the best possible buyer for your business? There are many criteria to consider but two key ones are an ability to pay and an interest in paying a premium.
Assessing the ability to pay for private companies is not as straightforward as it is for public companies, which have to disclose their financial information to their shareholders (by way of EDGAR in the US and SEDAR in Canada). Private companies do not have to disclose financial information in North America (they do in most European countries). While there are a number of paid services that provide private company financial information such as dun & bradstreet, the information they gather is provided voluntarily and is not always entirely accurate or up to date.
The other area where ability to pay is difficult to assess is if the company has a relationship with a private equity group. The company may appear small and unable to acquire but the private equity group may have access to hundreds of millions of dollars.
The rationale for paying a premium may include:
- Economies of scale
The combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
- Economy of scope and cross-selling opportunities
Economies of scope are attained when, for example, efficiencies are gained by increasing the scope of marketing and distribution to additional products (sometimes creating product bundles as seen in the Telecom sector).
- Unlocking underutilized assets
In some cases proprietary resources such as R&D, patents, proprietary processes and technologies and even personnel are underutilized because of limited access to capital or other constraints. Acquisition by a more well resourced company can unlock these assets.
- Access to proprietary technology
In some cases start-up or R&D focused companies have developed technologies that can have an immediate and broad impact on the operations of leading incumbents and substantially improve their competitiveness.
- Increased market power
Acquiring a close competitor can increase market power (by capturing increased market share) to set prices.
- Shoring up weaknesses in key business areas
When talent is hard to attract, acquiring businesses that perform functions that are under performing can be an efficient way to fill gaps.
An example of synergy includes increased purchasing power as a result of bulk-buying discounts.
- Geographical or other diversification
Acquisitions can achieve immediate access to new geographic or product markets. In some cases this can also serve to reduce earnings volatility.
- Providing an opportunistic work environment for key talent
Growth through acquisitions provides managers for new opportunities for career growth and advancement.
- To reach critical mass for an IPO or achieve post IPO full value
Larger companies typically have more financing options thereby reducing capital risk. Once public, companies need sufficient trading in their shares to realize full value.
- Vertical integration
Vertical integration occurs when a company acquires its supplier and can result in significant savings if the supplier has substantial market power.
Determining beforehand whether a private company has these goals or can potentially achieve these results is nearly impossible. The best way to find the company that will pay the most is to approach all possible buyers, talk to them and discuss the possible fit.
Recommended Further Reading
For more on the rationale for paying a premium, see: 5 Examples of Acquirers Paying a Premium
For more on how long an acquisition takes, see: How Long Does it Take to Sell a Business?