Successful businesses don’t have to go looking for potential acquirers—potential acquirers are likely to come looking for them. Most of our family business clients have no intention of selling in the near-term, and yet they often receive a steady stream of unsolicited offers from eager suitors. Many of these offers can be quickly dismissed as uninformed or bottom-fishing, but serious inquiries from legitimate buyers of capacity occasionally appear that require a response.
What Kinds of Buyers are There?
Buyers are generally classified into two categories.
- Financial buyers are groups like private equity funds that purchase businesses with a view toward earning a return on their investment over a finite holding period. These buyers generally use financial leverage to magnify their returns, and expect to exit their investment by selling the business to another buyer after three to seven (or maybe even ten) years. While financial buyers may have specific plans for making the business run more efficiently and profitably, they are generally not anticipating significant revenue synergies or expense savings from wholesale changes to the business. Rather, they tend to be more focused on incremental changes to boost value and clever financial engineering to be the principal engines driving their returns.
- Strategic buyers are competitors, customers, or suppliers of the business who have a strategic goal for making the acquisition. Such buyers certainly want to earn a return on their investment, but that return is expected to come from combining the target’s operations with their own, rather than through financial engineering. In other words, strategic buyers look to long-term value creation through assimilating the target into their existing business, not a short-term return from buying low and selling high. Strategic buyers may anticipate revenue synergies through the combination or may foresee the opportunity to eliminate operating expenses in either the acquired or legacy businesses to fuel cash flow growth.
Distinguishing between financial and strategic buyers is important for evaluating unsolicited offers, but we suspect that a more important distinction is that between motivated buyers and opportunistic buyers. Successful family businesses will attract motivated buyers who have the capacity to pay an attractive price for the business, but should strive to avoid opportunistic buyers who are seeking to take advantage of some temporary market dislocation or cyclical weakness to get the business at a depressed price.
Evaluating Acquisition Offers
Most family businesses have no intention of selling; however, when a legitimate, unsolicited offer arrives, what do you do?
Evaluating acquisition offers is ultimately the duty of the board of directors, not the family at large. Uncle Charlie may have strong opinions on the proposed deal, but if he is not a director, he does not have the responsibility or authority to respond to the offer. That does not mean that the directors will not care about Uncle Charlie’s perspective. As we’ve discussed, it is critical for the board to understand what the business “means” to the family, and the meaning of the business to the family may well inform how the directors evaluate the offer. For larger families, the prospect of receiving a potentially attractive unsolicited acquisition offer underscores the value of a regular survey process, whereby the board and senior management periodically take the pulse of the family on topics at the intersection of business and family.
Family business directors should evaluate offers along several dimensions.
What has prompted the offer? If it is a strategic acquirer, what sort of operational changes would be expected post-transaction? Will a sale result in facility closures, administrative layoffs, or discontinuation of the business name? Or, could the sale increase opportunities for employees and expose the brand to new markets? If the suitor is a financial buyer, what sort of debt load will they place on the company post-acquisition? Will the company’s ability to withstand normal economic downturns be compromised? Will the buyer want members of the family active in senior management to continue to run the business? The answers to these and similar questions should be considered in the context of what the business means to the family and help inform whether the offer should be entertained further.
Does the buyer have the financial capacity to actually execute the transaction if it is agreed to? If external financing is required, will it be available to the buyer when needed? Basic due diligence goes both ways. Going through a lengthy negotiation and due diligence process only to have the transaction fall apart at the closing table due to lack of financing will leave a bad taste in the family’s mouth.
Price & Transaction Structure
What seems on the surface to be an attractive price may, upon further examination, turn out to be a far less attractive transaction. A sale of stock may have a lower nominal price than a sale of assets, yet result in higher after-tax proceeds. A high nominal price may be subject to contingencies regarding future performance which cause the economic value of the offer to be far less. Or, a high nominal price may be payable, in part, in shares of the buyer rather than cash—what is the family’s appetite for trading stock in the family business for stock in a different business over which they will likely have no control? There are many other components of transaction structure, such as required representations and warranties or escrow provisions that can significantly influence how attractive an offer really is.
Price is not Everything
Just because the price is adequate and the terms are acceptable does not mean that the timing is optimal for a sale. Directors should carefully weigh the potential outcomes for shareholders by deferring a transaction: Is the family better served by taking the bird in hand or waiting for more birds to materialize in the bush? If the company is on a growth trajectory or has its own acquisition opportunities to pursue, it may command a larger multiple down the road. Understanding the risks and opportunities associated with the timing of a transaction requires directors to be well-attuned to company, market, and industry dynamics. Family directors-in-name-only are unlikely to have anything meaningful to add to such deliberations.
Does the family have a plan for putting sale proceeds to work? Once again, what the business “means” to the family comes to the fore. Will proceeds simply be distributed to the various branches of the family, to use or invest as they see fit? Or will proceeds be retained at the family level and redeployed in other assets for the benefit of the family? If so, are there reinvestment opportunities available that will “fit” the cash flow needs and risk tolerances of the family? Will such investments provide the same degree of family cohesion as the legacy business? A sale of the family business may have unintended, and potentially far-reaching consequences for the family.
Responding to Acquisition Offers
Once the board has evaluated the unsolicited offer, there are essentially four responses to choose from:
- Reject the offer. If the directors conclude that the proposed price and/ or terms are unattractive, or if the timing of a transaction does not align with the broader goals of the family, the board may elect simply to reject the offer.
- Negotiate with the potential acquirer. If the directors conclude that the timing is right and that the suitor would be an attractive acquirer, the board may elect to negotiate with the buyer with a view toward consummating a transaction. If the perceived “fit” between the family business and the potential acquirer is good, proceeding directly to negotiating price and terms of the transaction may result in the quickest and smoothest path to close. However, without any exposure to the market, there is a risk that the negotiated price and terms are not really optimal. There is a reason private equity firms like to tout their “proprietary” deal flow to potential investors—direct negotiation with sellers presumably results in lower purchase prices than winning auctions does.
- Engage in a limited sale process. Given the potential for underpayment, directors may elect to discreetly contact a limited number of other potential acquirers to gauge their interest in making a competing bid for the business. The benefit of doing a limited market check is that it can generally be done fairly quickly without “putting the company up for sale” with the attendant publicity that the family may not desire. The initial suitor will, of course, generally prefer that even a limited sale process not be engaged in, and may seek some sort of exclusivity provision which precludes the seller from talking to other potential buyers. Directors will need to consider carefully whether the potential benefits of a limited sale process will outweigh the risk that such a process will cause the initial suitor to rescind their offer and walk away.
- Engage in a full sale process/ auction. Finally, the board may conclude as a result of their deliberations that the unsolicited offer signals that it is an opportune time to sell the business because pricing and terms are expected to be favorable in the market and the family’s circumstances align well with a sale. In a full sale process, the company’s financial advisors will prepare a descriptive investment memorandum for distribution to a carefully vetted list of potential motivated acquirers. After initial indications of interest are received, the universe of potential buyers is then narrowed to a manageable group of interested parties who are invited to view presentations by senior management and engage in limited due diligence with a view to making a formal bid for the business. With the help of their financial advisors, the directors evaluate the bids with regard to pricing, terms, and cultural fit, selecting a company with which to negotiate a definitive purchase agreement and close the transaction. A full sale process will likely involve the most time and expense, and may expose to competitors the family’s intention to sell, but carries with it the potential for achieving the most favorable price and terms.
Bringing Together the Right Team
There is a sharp experience imbalance in most transactions: buyers have often completed many transactions, while sellers may have never sold a business before. As a result, sellers need to assemble a team of experienced and trusted advisors to help them navigate the unfamiliar terrain. The transaction team will include at least three primary players: a transaction attorney, a tax accountant, and a financial advisor.
Definitive purchase agreements are long, complicated contracts, and an experienced attorney is essential to memorializing the substantive terms of the transaction in the agreement and ensuring that the sellers’ legal interests are fully protected.
Trusting the buyer to do your tax homework can be a very costly mistake.
Business transactions also have significant tax consequences, and the tax code is arcane and littered with pitfalls for the unwary. Trusting the buyer to do your tax homework can be a very costly mistake. An experienced tax attorney is essential to maximizing after-tax proceeds to the family.
The financial advisor takes the lead in helping the board evaluate unsolicited offers, setting value expectations, preparing the descriptive information memorandum, identifying a target list of potential motivated buyers of capacity, assessing initial indications of interest and formal bids, facilitating due diligence, and negotiating key economic terms of the definitive agreement. My colleague Nick Heinz leads Mercer Capital’s transaction advisory practice, and Nick likes to say that his job in a transaction is to run the transaction on behalf of the company so the company’s management can focus on running the business on behalf of the shareholders. Transactions can be time-consuming and mentally draining, and it’s simply not possible for company management to devote the necessary time to managing the transaction process and the business at the same time. An experienced financial advisor takes that burden off of management.
When it comes to assembling the right team, business owners sometimes blanch at the cost. However, the cost of a quality and experienced team of advisors pales next to the cost of fumbling on the transaction. The family will only sell the business once, and there are no do-overs. As we recently heard someone say, “Cheap expertise is an oxymoron.”