Navigating Sell-Side M&A: A Guide to Understanding and Executing a Strategic Sale of a Business.
Part 1. Why Go to Market?
The decision to seek a strategic Buyer for a company that you’ve founded or that you lead on behalf of shareholders represents a critical inflection point in the lifecycle of a business. As part of the comprehensive series Navigating Sell-Side M&A we explore various elements that comprise a successful M&A outcome for small- to medium- sized businesses, beginning with the first in the series: Why Go To Market?
ACQUIRED vs SOLD.
An M&A transaction is usually driven either by an unsolicited outreach by an interested Buyer that is consummated (semantically speaking, they were “Acquired”) or the business elected to run a formal M&A Sales Process (they were “Sold”). The former is often initiated and negotiated as a two-party process and, from the Seller’s perspective, is usually somewhat opportunistic in that they were not actively contemplating a sale. The latter is a very formal process requiring multiple parties; requires active participation by the Seller and is difficult to execute without external assistance (e.g., Legal, M&A Advisory, Tax, etc.).
In cases where the company is approached by a potential Buyer, the asymmetry of information is often quite detrimental to the Seller. If a Seller has a single offer, there is no way of knowing if it is a good valuation and associated deal structure without additional information being obtained about the current market, historical trends, prior transaction details etc. Owners / Leadership may do their own Discounted Cash Flow (DCF) calculations and talk to industry peers, but ultimately, their acceptance of the offer comes down to their feeling “satisfied” with the terms. This may be a convenient way to sell the business, but there is considerable risk that substantial value is left on the negotiating table.
Bravery Group receives outreach from Owners / Leadership regarding whether an unsolicited offer received is something they should accept. The answer is typically that they are being undervalued against market data, our industry knowledge and various other deal specific attributes. This shouldn’t be surprising, and while the convenience of an opportunistic exit to an attractive Buyer is worth some degree of discount, it’s absolutely critical that Sellers understand how much they are foregoing for this “convenience.” A strategic advisor at this critical step can mean the difference between an acceptable or “nice offer” and a life-changing one, especially if the advisor has a depth of experience and context within the Seller’s industry.
When a business is sold, it’s a structured process designed to find the right combination of Buyer fit, valuation and subsequent opportunities (synergies). The most common rationale for electing to sell a business is:
- To Realize Value: Everyone understands that owners / investors / leadership want to convert the business value into realized gains; however, as much as this is (privately) the biggest determinant of the decision to go-to-market, most Buyers expect that Sellers will want to continue to build value after their exit.
- Be Part of “Something Larger:” Boutique companies are often narrowly focused and reach a point where additional growth becomes more difficult as the business simply doesn’t provide the breadth of service offerings the market desires. Being part of something larger solves this for new client acquisitions as well as with “land-and-expand strategies.” This is also a common means to enable expansion beyond a Seller’s geographic market concentrations.
- Strategic Positioning: Smaller businesses are often more susceptible to changes in market dynamics (both good and bad). The recent move to zero and first-party data in the digital marketing category means that smaller firms that are highly concentrated in this area are increasingly more valuable acquisition targets, while third-party data experts will have to undergo a strategic repositioning simply to stay relevant.
- Constrained Growth: A bootstrapped business (i.e., one that is growing from internal financing sources) usually faces a perpetual shortage of funds for building out sales, marketing, R&D etc. As such, growth can be constrained whereas an acquisition by a company with larger finances would be more willing to commit resources to growth.
- Client Selection: Digital marketing, as an industry, continues to experience consolidation as clients seek more integrated solution providers. Capable firms that thrive in a best-of-breed approach are under threat from more integrated competitors and need a wide array of offerings just to maintain their client presence. Acquirors, on the other hand, see an acquisition as a means of expanding within the Sellers’ client base as well as a means of offering a wider range to their own clients.
- Ecosystem Maturation: Providers of services related to a software platform (Google, Sitecore, Adobe, Salesforce, etc.) are seeing a growing desire on the part of the SaaS partner to optimize their alliances network. A desirable combination can reap benefits for both parties by improved visibility and reputation within the partner ecosystem. It’s these ecosystems that represent a level of traditionally untapped value in many transactions.
- Scaling IP: Digital Agencies tend to build and deploy IP as a Services Enabler rather than as a deployable platform. This is the difference between a single-tenant solution with customizations and mounting tech debt, and a multi-tenant product that is uniformly deployed across the client base with customizations confined to the products configuration layer. Two very different strategies. To build scale through a multi-tenant offering takes a software product mindset and significant investment in the product(s) or a wider client base. Scalable IP, when used as a discrete solution for client engagements can represent a significant value proposition for strategic Buyers, especially if the IP is relatively mature or fully commercialized. On the other side of the coin, client implementations that are saddled with tech debt are unappealing.
- Operational Maturity: At a certain stage of a firm’s evolution, the need for finance and operational maturity becomes critical to further growth. This can be acquired directly through a financially savvy COO, an operationally savvy CFO, or via the operational maturity of a Buyer. When it gets to the point where there is too much margin leakage from immature systems and processes, a change is required.
- Business Development Maturity: As above, the level of strategic value delivered through the business development process is critical to growth and requires investment in Martech and AdTech, including the associated resources and processes.
Having established the reasons for wanting a sale, we now turn to whether a business should pursue a strategic sale.
WHEN TO EXIT.
Everybody knows that realizing the value of what has been built is a primary reason for owners seeking an exit. As the optimization of valuation can play part in the question of when to exit, we will discuss this more extensively in a coming post. However, there are other strategic factors influencing the decision to seek an exit.
There are inflection points in services business where growth demands a corresponding maturing or upgrade of the organization’s capabilities (e.g., hiring for key roles such as Sales, Marketing, Account or Alliance Managers, system upgrades etc.). Often, the desire for high owner distributions comes at the expense of this investment which invariably leads the business to plateau as each additional percentage point in growth requires disproportionately larger efforts to overcome the friction of outgrown process and infrastructure. Philosophically, owners need to decide whether they want a growing business or a steady annuity stream – because the two are often at odds with each other.
It has been our experience that digital agencies need at least three significant process and infrastructure overhauls to grow to $50M in Revenue – typically around $1M in Revenue, between $5-10M and $20-30M. Leadership should be constantly evaluating whether operating as a standalone entity is a credible pathway to further growth when a strategic buyer will immediately bring a lot of the processes and infrastructure needed to facilitate growth.
Even when the financial and strategic goals are met, the decision to sell something that’s been a “vision” can be quite difficult and even emotional. Understanding when “handing over the reins” to a larger combined organization is to the benefit of the business and its employees is, at times, a mental hurdle to overcome. Among the questions to be considered include:
- What role do I want to play post-acquisition?
- Am I too entrepreneurial to operate in a position with less autonomy and authority?
- Is an earnout aligned to my personal objectives?
- Can I manage through the “politics” of a larger organization?
- How vested am I personally in the company I’ve built or led?
Most Buyers will typically expect a core group of the acquired management team to remain with the business. In practice, this means that key employees and owners will be expected to remain for a 2-3 year period. As such, owners need to build this into their own timelines, especially when one or two of the original founders may be looking to leave ahead of the others.
While a business outlook may look very positive, an adverse disruption in the market can reduce a company’s worth to nothing. The desire to diversify this risk and take some “chips off the table” is another common reason firms go to market. Growing inside a larger company with a portion of valuation tied up in the success of the acquiring firm is an effective way to accomplish this.
In the end, the decision to sell a business is complex and going it “alone” represents an enormous risk to valuation, retention of employees and attainment of any earnouts. As previously mentioned, founders typically have a once in a lifetime opportunity when selling a business, so seeking appropriate counsel is a prudent step to ensuring a proper understanding of value, market dynamics and means to achieving desired outcomes.
You can reach the author, Paul Newton, at email@example.com should you have any questions or simply want to learn more about the M&A process.