Who Are The Buyers For Privately Held Companies And What Is Their Acquisition Criteria?

According to studies conducted by business researchers, approximately 10,000 businesses change hands each year Australia., of which 98% were acquired for a price under $5 million. Understanding who the buyers are and their acquisition criteria will enable business owners to be better prepared when the time comes to sell. Unrealistic expectations of value and factors that drive value result in many business owners being unable to sell their business. When a business is on the market for a long period of time, pre-disclosure to employees, customers and suppliers can be detrimental to the business. Alternatively, proper valuation, packaging and presentation to the most likely buyers enhances the probability of a sale within a reasonable period of time.

The broad categories of buyers include financial buyers (sometimes called investment buyers), synergistic buyers, and individuals. Within each of these categories there are subgroups that often have very different acquisition criteria.

The Financial Buyer

There are approximately 11 well-known investment or venture capital buyers in the Australia plus other lesser-known groups that come into and out of the market on a frequent basis. In general, these types of buyers are groups of people who have pooled their funds for the purpose of acquiring either spin-off divisions of public companies or midsize privately held firms. These buyers may operate in the form of public corporations, private corporations or one of several partnership entities; however, in most instances they form a separate "holding company" for each of their acquisitions. The financial buyer's primarily goal is to acquire a company or a group of companies and then cash out, usually within five years through either selling the business to a public company or taking the business public.

The company to be acquired must either be large enough to be considered a "Platform Company", or be a synergistic Add-On Company. A Platform Company is usually already a midsize or large firm that holds a dominant position within its industry. Once a Platform Company is acquired, then an "Add-On Company" will be a smaller firm within the same industry. The financial buyers will provide the capital that enables the Platform Company to grow internally as well as by way of acquisitions of similar businesses. Then when the Platform Company becomes large enough to be an attractive target for either being acquired by another large company or to take public, the financial buyer cashes out.

The financial buyer's seed capital usually comes from their pool of investors who are often wealthy individuals that have substantial business experience in corporate Australia. These individuals may still be active in their companies serving as high ranking officers or individuals who have recently retired and have the funds to invest in growth businesses. Long-term financing is usually arranged through banks and mortgage companies. Often mezzanine financing is needed to bridge the gap between the sales price and the long-term financing. Mezzanine financing is typically provided by financial firms who specialize in these types of transactions. Mezzanine financing is often unsecured or at least in a secondary position to the long term lender. Seachange Business Brokers have considerable expertise in this type of bridging finance. The mezzanine lender often receives stock in the company being acquired as an additional incentive to provide the needed funds. Often, the seller is asked to take back stock in the acquiring company as part of the selling price and ride along with the other investors until they can all cash out.

Acquisition Criteria:

Target companies who are a dominant player in their industry and already have the infrastructure to support a regional or national operation. Generally, the Platform Company must have gross revenues in excess of $8 million.
Add-On Companies must have gross revenue in excess of $3 million and be in the same industry as the financial buyer's Platform Company.
The target company must have key management personnel who are willing to stay on and manage the company. Typically, financial buyers do not have readily available management with the necessary operational skills to run the target company.
Financial buyers have no interest in industries that have no dominant players on a regional or national basis or where the total market for the industry is small with little room for significant growth.

The Synergistic Buyer

The synergistic buyers are U. S. companies and Asian companies who are already established within an industry. They are usually a dominant player within their geographic region or on a national basis and seek rapid growth through acquisition. These buyers will be operating as public corporations, private corporations or an established partnership. Often the target company is merged in with the acquiring company either immediately or over a period of time. The synergistic buyer's primarily goal is to acquire a company or a group of companies within the same industry to gain economies of scale and business growth not otherwise available. These buyers are seeking long-term growth rather than rapid growth and quick cash out sought by the financial buyers. Private companies may be looking for sufficient growth and size to go public; however, the principals in the acquiring firms typically plan on remaining in the operations on a long-term basis.

The synergistic buyer's seed capital usually comes from their own equity funds. Long-term financing is usually arranged through banks and mortgage companies. Sometimes mezzanine financing is needed to bridge the gap between the sales price and the long-term financing. Sometimes, the principal in the target firm is given stock in the acquiring company as part of the selling price and hired to continue managing the acquired firm or a division of the acquiring company that includes the acquired firm.

Acquisition Criteria:

Generally, target companies must have gross revenue in excess of $1 million and be in the same or similar industry as the synergistic buyer.
The target company must offer unique market share not readily available to the acquiring company, such as opening in a new market not previously served by the acquiring company or obtaining product lines and/or services not previously provided, but synergistic to the acquiring firm customer base.
Target companies will be especially attractive in industries where economies of scale are possible whereby the acquiring company can obtain significant post-deal expense savings, such as elimination of dual facilities, support staff, or other overhead expenses.

The Individual Buyer

The individual buyer category encompasses a variety of buyer types that include wealthy individuals, corporate executives, engineers and salespeople working for large firms, and foreigners who have recently moved to Australia, and individuals. The individual buyer category represents the largest number of prospective buyers for small to midsize businesses.

Wealthy individuals often are people who have taken early retirement from corporate Australia and after a brief period of golfing and gardening decide to get into their own business. They tend to acquire midsize companies grossing in excess of $2 million. Seachange businesses and their associated relaxing lifestyle have a strong attraction for this type of buyer.

Corporate executives, engineers and salespeople make up a large portion of those who buy small to midsize businesses. They are often driven to buy their own business due to events in their corporate life such as being asked to move to another city, loss of their job due to corporate mergers or downsizing, being passed over for promotion or fed up with corporate bureaucracy. They tend to buy businesses that gross under $2 million. Again Seachange businesses and their relaxing lifestyle have a strong attraction for this type of buyer.

Asian buyers now make up 20% to 30% of the buyers for small to midsize businesses and as much as 60% for specific type businesses such as convenience stores, dry cleaners and liquor stores. They are people who have moved to Australia within the past few years. They usually work for family members or friends for a few years until they can better understand the Australian way of life. They often have substantial equity funds due to having sold their holdings in their country of origin and/or they are often able to borrow money from friends and relatives here in Australia. Due to language barriers and an unfamiliarity with loca of marketing techniques, they tend to buy businesses that do not require significant outside sales efforts and where the customers come to the business based on convenience rather than promotional activities.

The majority of the individual buyers have little or no experience in operating the type of businesses they buy. If individuals have a lot of experience in a specific business, they will tend to start a business rather than buy one. The number of entrepreneurs who start their own business are ten times greater than those who buy existing companies. Conversely, those people who start their own business are far more likely to fail or go out of business than those who have purchased an existing profitable business. Business brokers report that seven out of ten businesses they sell are still in business five years later.

While on the surface it would appear that someone with a lot of experience in a specific business would be the best buyer; however, entrepreneurs who enjoy starting and growing an existing business have a start-it-from-scratch mentality. They don't want to pay for something that they think they already know or can do themselves. Business owners of small to midsize businesses tend to buy other existing businesses only when they can acquire the business at a bargain price.

Sources of equity and debt capital for individual buyers come from their own equity funds, family members, financial institutions and seller financing. Buyer equity funds usually represent 30% to 50% of the transaction price. The equity portion of the acquisition price must be liquid and available to the buyer unencumbered by debt. Mezzanine financing is not normally available to individual buyers unless it can be backed by real property equity.

Long-term financing is usually arranged through banks and mortgage companies. Unfortunately in Australia conventional lending institutions still insist that business loans are by and large backed by real property. However Australian business lenders may accept guarantees of wealthy property owners as a substitute for the would be borrowers lack of real property. The same lenders may also insist on a fixed and floating charge over the business’s assets, but the reality is that they place little value on assets, unless it is in the form of a specific chattel mortgage on a significant new asset, e.g., a large truck.

Not unexpectedly then, significant portion of transactions involving small to midsize target firms are seller financed. This is usually due to the target company's poor financial record keeping or when the business has been in business for less than three years. Most every business owner has heard of a transaction where an owner provided financing for the buyer and the buyer destroyed the business and defaulted on the loan. In most cases, the terms of the financing would have predicted the failure. A high price, low down payment, and/or short-term payout often contribute to seller finance defaults. Transactions properly structured are usually successful. In fact, after a seller-financed notes has matured for six months to one year, there are Australian financial groups who buy owner financed notes. Typical owner financing includes a reasonable selling price, a down payment of 30% to 45% and a payout of 5 to 7 years, with interest currently at 10%. The note is typically secured by the assets of the business being acquired and the personal guarantee of the buyer. A lien showing the note security is registered with the appropriate Commonwealth or State authority such as ASIC, REVS or the Land Titles Office. Furthermore, the terms of the note should allow for the note holder to invoke rapid foreclosure proceeding in the event of default.

Acquisition Criteria:

Target companies typically have gross revenues between $200,000 to $3 million. Businesses with gross revenue under $200,000 typically do not provide sufficient net earnings to attract buyers. Businesses with gross revenue in excess of $3 million become difficult for individuals to obtain the necessary financing and to compete with other categories of buyers seeking the larger businesses.
Buyers tend to seek businesses that provide products and/or services that are easy to learn without long periods of training and high costs of entry. Many retail, wholesale/distribution, and service businesses meet this criteria. Businesses requiring professional licensing are usually limited to buyers who either have the license or can get one without incurring major costs or time delays.
Most individual buyers seek businesses that have current earnings at least similar to their most recent salaries, and upside potential for earnings growth. Buyers look for businesses that have good growth potential, but they are not willing to pay a price based on future potential.
While financial results are important, other lifestyle considerations can be equally important. Issues such as being able to control one's destiny rather than letting someone else do it for them; building equity for the future rather than working at a limited future job that can end at someone else's decision; and being able to choose when and where you go to work.
Location of the business in proximity to the buyer's home is often a significant consideration. The prime motivation of many individual seachange buyers is to escape the pollution and congestion of cities like Sydney. Individual buyers of small to midsize seachange businesses can often live on acreage thirty kilometres or more from their newly acquired business, yet have a commuting time of less than twenty five minutes.
The business must have "curb appeal." The condition and appearance of the equipment and facilities must be appealing or at least not unappealing. A little paint and attention to cleanliness goes a long way towards making a business attractive.
Businesses with full-time employees give buyers confidence that the business has continuity and stability. Having employees who can run the daily operations is more appealing than those businesses that are highly reliant on the owner to make daily operating decisions or have personal relationships with the company's customers.
Businesses that have verifiable and current financial records enable a buyer to quickly do their due diligence and obtain sources of financing. Most lenders require copies of the last three years of tax returns and a year-to-date financial statement within 60 days of the acquisition. While allowances can be made for non-recurring and personal expenses that impact the bottom line, no allowances are made for income missing from the top line.
While buyers may not always know the latest techniques for valuing businesses, they are capable of determining if the business makes sufficient earnings to earn a liveable salary, pay the new debt service and provide a reasonable return on the investment. Ultimately, these factors are the test to see if the price and terms of any deal are reasonable.

Selling a business can be a traumatic and frustrating experience or it can be a financially rewarding experience and provide peace of mind knowing that the business that has been nurtured with blood sweat and tears will continue on with job security for its employees and a continuing source of products and services for its customers. Owning a business is part of the American dream. Cashing out can be the continuation of that dream or a nightmare depending upon how the transaction is handled.

Hiring an experienced business intermediary to guide you through the complicated process of a business sale can insure that the business is priced right, packaged to put the best foot forward and presented to the right buyers in a confidential and professional manner. The costs of the business intermediary's services are usually more than offset by their ability to prequalify the maximum number of prospective buyers, to obtain a higher price due to proper valuation, and to successfully complete the transaction in a more timely, confidential manner. When buyers see that a business owner is trying to sell their own business, the buyer will reduce the seller's asking price by at least the amount of what would have been a brokers fee. So if the seller ends up accepting the lower price, what did he save? He had to do all the work normally done by the broker, most likely not as well, yet did not get paid for it.