Ah, the Beauty of an Auction Process: Strategics, Private Equity, Family Offices, ESOPs

Determining the optimal buyer for your company demands way more than simply embracing the highest bidder, and the analysis is not a walk in the park. Owners of privately held businesses must assess a myriad of proposed transaction structures and evaluate each of their inherent implications. The issues are legion: amount of proposed cash at closing, hold backs, rolled equity requirements, earn-outs, debt financing, ongoing employment duration, non-compete clauses, escrows, closing probability & time-line, deal integrity, purchase price adjustments, cultural fit, employee impact, post-closing business strategy…

Understanding the Buyer Types and Trade-Offs

1. Strategic Buyers

Strategic buyers are typically operating companies in the same or an adjacent industry. Their goal in buying companies is to enhance competitive positioning, enter new markets, and/or achieve synergies through the strategic acquisitions.

Potential Positives:

Strategics may pay a premium due to perceived synergies and corresponding leveraged growth rate potential within the industry
Can turbo charge seller’s rate of growth through enhanced economies of scale, specialized expertise and buyer’s network strength

Inherent Risks:

Cultural misalignment
Business integration challenges
Employee and operational overlap redundancies

2. Private Equity Buyers

PE firms exist to acquire companies, help them grow, and eventually sell their business investments for a substantial profit. They typically partner with existing management and will bring in new leadership as necessary or required.

Potential Positives:

Experience in scaling businesses which is their primary focus
Injection of growth capital to spark business growth rate
Typically retain founders, owners and some management as equity partners
“Second bite of the apple” opportunity for founders and owners

Potential Negatives:

Typically require retention of founders, owners and some management for 2-5 years
Former owners’ loss of control
Emphasis on financial returns can pressure decision-making and conflict with founder’s perceived “best practices”.

3. Employee Stock Ownership Plans

ESOPs are a ready buyer of founders’ and owners’ equity, at prevailing valuations, regardless of market conditions, and they make purchases without emotions or fabricated timelines. They are exceptionally flexible and can be tremendously tax efficient.

Positives:

Sell now. Sell later. Sell some. Sell all.
Create business liquidity solutions for equity partners who have differing financial needs and various time horizons
Provide upside opportunity for longstanding, loyal employees
Can be very tax efficient

Potential Negatives:

Difficult to create substantial, immediate cash for existing owners without risking over-leveraging the business’ balance sheet
Demands solid, core middle management to step up and run the business as majority shareholders exit

4. Family Offices

Family offices manage the wealth of ultra-high-net-worth families and often seek long-term investments in private businesses whose core values align with the family office.

Positives:

Long-term investment horizon.
Flexible deal structures and alignment with culture and legacy values.
Can be solid long-term partners with growth capital availability and strong networks

Potential Negatives:

May have limited specific operational expertise or experience within the business
Can be less aggressive in competitive auction processes due to their long-term investment time horizon
Depth of due diligence process can extend closing timelines

In Summary:

While the highest bid may seem appealing on the surface and/or the logical choice, it often comes with caveats and contingencies. Further, it can be indicative of a less experienced buyer and inherent, corresponding head winds such as an extended due diligence process, buyer financing issues, seller financing requirements, challenging earn-out hurdles, aggressive post-close restructuring issues. According to Bain & Company, nearly 20% of M&A deals fail post-close due to cultural misalignment or execution issues, which can erode value despite a high purchase price (Bain, 2022).

A well-run auction process, navigated by strong, experienced professionals, can help to determine the best overall fit — not just the best price.

Sources:

Bain & Company. (2022). "The Cultural Edge in M&A".
PwC. (2023). "Family Business Survey".
Deloitte. (2023). "M&A Trends Report".

This information is intended to be educational and is not tailored to the investment needs of any specific investor. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Opinions expressed are those of the author and are not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.