A variety of factors have been working together in the past several years to create opportunities for owners of private businesses to achieve liquidity by selling their businesses to private companies. The mid-to-late 1990s saw a wave of consolidation in various industries that were well received by Wall Street, and the low interest rate environment of most of that period led to low cost financing options for acquirers. While this trend has slowed, there is still a great deal of interest among private company owners in achieving liquidity, and public companies are continuing to evaluate acquisitions.
Several factors have led to decreased acquisition activity by public companies of late. At one time, one needed only to include in one’s proxy the words “rationalization” and “consolidation,” and perhaps the phrase “highly-fragmented industry” in order to be a winner on Wall Street. However, the operational problems experienced by many of the high-flying consolidators after their initial rollups and aggressive acquisition programs have resulted in a fall from grace for many companies whose business plans call for aggressive growth through acquisition.
Another factor limiting deals is, ironically, the strength of the economy. In an effort to slow economic growth and reduce the likelihood of inflation, the Fed has increased interest rates for seven consecutive quarters. The current interest rate environment has increased the cost of financing deals by increasing the cost of debt and increasing the cost of equity for most non-tech sector companies. Uncertainty related to the future of pooling accounting has offset some of this increase in the cost of deals, providing an incentive to consummate deals before poolings go the way of the dinosaurs.
In this environment, public acquirers are more selective than ever in their acquisitions. A large number of deals are getting done, however, and it is the private companies who are best able to position their businesses as acquisition targets which will continue to find liquidity opportunities among public companies.
The key to maximizing the likelihood of potential proceeds from a transaction with a public business lies in recognizing why public companies buy private companies. The reasons all boil down to maximizing the value of the public company. Public acquirers are not a form of welfare for small business owners. If a public company buys your company, chances are the managers of the public company believe that whatever consideration they paid in the deal will be more than offset by the future benefits of owning your business; i.e., no earning dilution per share to the public company.
Public companies buy private companies to meet a variety of financial and strategic needs. It would be impossible to list all of the potential needs that an acquisition might meet, but some of the more common motivating factors include:
Many consolidators need an extensive geographic presence. Your business will likely be more valuable to an acquirer if it allows the acquirer to fill a gap in its current service area.
Does your business market a unique product or service to the same customer base as a public company? If so, the public company might purchase your business in order to increase the diversity of products it can offer to its current customers.
If you have a customer base that is appealing to a public company, the public company might be interested in marketing its products/services to your customers by bundling them with the ones you are already selling. For example, the retail financial services business is likely to see an increasing number of this type of transaction, as banks, brokerages, insurance agencies and underwriters buy each other in order to market additional products to the combined customer base.
In industries where economies of scale are possible, the realization of significant post-deal expense saves makes acquisitions attractive. The promise of significant expense savings was part of the appeal of the consolidation craze of the mid-1990s, but the consolidators had widely varying degrees of success in realizing the savings.
Do you provide a unique and necessary input to a public company? If so, that public company might be interested in purchasing your business in order to guarantee itself a source of supply.
In order to maximize the value of your business in a sale to a public company, it is important for you to understand the particular strategic and/or financial needs of the potential buyers. If you are active in industry trade associations or read industry periodicals, you will no doubt have a good idea which public companies are buying businesses similar to your own. Once those public companies are identified, you can start researching the public company to determine its strategic and financial goals so that you can emphasize how your business can help to achieve those goals.
Corporate culture is also a key issue in the success of many transactions. An assessment of the compatibility of the target’s culture with that of the purchaser is becoming an increasingly important part of the evaluation and due diligence process. If you have managed to foster a professional, cooperative culture in your business and have a dedicated staff and competent managers, this can be a real selling point. Many experienced public acquirers have done at least one deal where the attitude of the employees did not “feel” right and it resulted in double-digit monthly turnover rates. Those experienced public acquirers are likely to look very carefully at whether your employees display a professional attitude. If you want to maximize the consideration paid in the deal, make sure that your employees carry themselves with a professional demeanor and that your corporate culture is consistent with that of the potential acquiror.
When public companies acquire private companies, they typically perform at least a rudimentary “build vs. buy” analysis. When you talk to a public acquirer, do not emphasize what your business could do if you replaced all the equipment, rebuilt the building, and changed the name. It would be irrational for a company to buy your business only to be faced with the cost of building a new business from scratch immediately after the deal. If you believe that the full potential of your business cannot be realized without making fundamental changes to the business, then go ahead and make those changes. If they do indeed maximize the value of the business to a public acquirer, then they maximize the value to you, as well.
Regardless of whether a private company manager is considering a sale of the business in the immediate future, it is an important shareholder value maximization tool to position a private company for sale to a public acquirer. Once liquidity opportunities arise, they either move forward quickly or wither away. The lesson here is to manage the business today to maximize its potential sale value so that when a sale opportunity arises, the private company will be in a position to maximize the proceeds to shareholders from the deal.
Reprinted from Mercer Capital’s Transaction Advisor – Vol. 3, No. 2, 2000.