Who Actually Buys a Business Like Yours?

A conversation with Tom Kerchner

Most owners have a picture in their head of who will buy their business, such as a competitor or a larger company in the same industry. That picture feels logical, but it’s almost never accurate. In our experience, the buyer is almost always someone the seller has never heard of, and that surprises people. It probably shouldn’t, given how large and varied the buyer universe actually is, but most owners never had a reason to think about it before they started the process.

The Buyer Universe Is Larger Than Most Owners Realize

The lower middle market is somewhat unique in that it attracts almost every category of buyer. Individual buyers, often high-net-worth individuals who want to own and operate a business, are active here. SBA lending limits have expanded to $5 million and above, with lenders sometimes layering on additional financing, which means a single buyer can acquire a business in the $5 to $10 million range. Small investor groups are also common, sometimes just two to five people pooling money and adding debt financing. There are thousands of these groups, and some of them are quite good buyers.

Search funds, typically one person looking to find and acquire a single business to run, have become more common and more viable as more of them come to market with capital sources already lined up. Mainstream private equity groups are active throughout the lower middle market, particularly when they’re looking to add companies to a platform they already own. Family offices, which tend to buy and hold businesses indefinitely rather than on a fixed investment timeline, are another category many owners aren’t aware of. And then there are strategic buyers, meaning companies already operating in or adjacent to your industry, though as we’ll get to, they’re often not the strongest buyers.

Strategic vs. Financial Buyers and Why the Line Has Blurred

A strategic buyer is already in your industry or close to it. A financial buyer is making a pure investment, planning to buy the business, grow it, and sell it in five to seven years. The long-held assumption is that strategic buyers pay more because they stand to gain the most from synergies. That hasn’t been our experience. Most strategic buyers end up offering less, not more, and the reason is fairly straightforward. They already have the expertise, the customer relationships, and the industry knowledge, so they don’t feel the need to pay top dollar to acquire more of what they already have. A financial buyer needs all of it and may be willing to pay accordingly.

The more interesting development is what’s happened in the middle. A lot of private equity groups now own companies in specific industries and are actively acquiring others in the same space. They’re financial buyers at the top level but behaving like strategic buyers when they make acquisitions. When a PE group owns a $20 million platform valued at 6 times EBITDA and acquires a $5 million company at 5 times EBITDA, the moment those two businesses combine, the smaller company’s earnings are now part of a larger business trading at a higher multiple. Value is gained immediately through the combination, and as the platform keeps growing, the multiple tends to expand further. That’s why these hybrid buyers are willing to pay more than either a pure strategic or a pure financial buyer acting alone, and right now they tend to be the most competitive buyers in the lower middle market.

A Note on Private Equity

Private equity has a reputation problem with a lot of business owners. The image that comes to mind is firms that load companies with debt, extract fees, and leave them worse off than they found them. That version of private equity exists, but it’s not the common model. We have thousands of PE groups in our database and have worked with many of them over the years. Most are buying companies, keeping employees, investing in growth, and eventually selling to another good buyer. Deal structures also vary more than owners expect. Some groups want to buy 100 percent, while others prefer to buy 80 percent and leave the prior owner or management team with a stake and a second opportunity to benefit if the business grows. Because there are so many PE groups, the right fit for a given seller often exists somewhere in that pool.

When a Buyer Comes to You First

Private equity groups and large strategic buyers have people whose job is to contact owners directly, calling, emailing, knocking on doors. It happens constantly, and it’s worth understanding what’s actually going on when it does. The buyer’s goal is to be the only buyer. They want to avoid competition, and they’re often skilled at making the seller feel like the relationship is special and there’s no need to talk to anyone else.

What we typically see when an owner engages with a single buyer outside of a formal process is that the deal drags out, because there’s no pressure on the buyer to move quickly. And when an offer finally does come, it tends to land at the low end of what the market would have produced. We get called in fairly often after these situations have stalled or fallen apart entirely.

When we take a company to market, we typically receive five to fifteen offers. The spread between the lowest and the highest right now is running around 60 percent, and that gap exists because of competition and exposure to the entire market. A seller working with one buyer has no way of knowing where in that range they’re landing, or that there was a range at all.  A recent example – the second largest company in the sellers industry had been the only buyer they were talking with before we started our process. After introducing competition including six other offers, this company raised their original offer by 67%.  This never would have happened without buyer competition.

How We Think About Buyer Fit

When we take a company to market, price isn’t the only thing we’re looking at. The first question we ask an owner is why they want to sell and what they want the next chapter to look like. Some owners want to stay involved for years. Others want to be out in six months. Some want to keep working but hand off management. Each of those situations shapes the buyer search differently, and the right process surfaces buyers who actually fit the seller’s situation, not just the business.

Terms also vary more than most sellers expect, ranging from all cash to a mix of cash, seller notes, earnouts, and rollover equity. The highest headline number isn’t always the best deal once you look at the structure and what risk it shifts back to the seller. We had a situation a few years ago with a distribution business where our client took the lowest offer with the worst terms. The reason was that the buyer genuinely needed the seller’s involvement in growing the combined business, and the seller, who’d been partly bored, found that genuinely interesting. Sellers usually do take the highest offer, but not always, and the right process gives them enough options to make that call from an informed position.

We also look at the buyer’s track record, not just in closing deals but in what happens to the companies and employees afterward. We ask for references and talk to prior owners who sold to them. Most of our clients care about more than the number on the wire at closing, and finding out how a buyer actually behaves after the deal is part of the job.

What Tends to Surprise Owners

Our clients are almost always surprised by the number of offers, the range of buyer types, and the quality of what comes in. Most expected one or two obvious candidates. The strongest offers rarely come from the buyers they would have predicted. We have a deal under contract right now where the winning buyer is a financial company primarily known for lending, not for acquiring businesses. They brought deep pockets and, as it turned out, specific expertise in the industry. None of us would have put them at the top of the list at the outset.

If a business has clean financials, a stable or growing trend, and a team that can operate without the owner, it’s going to sell. The goal of a competitive process is to make sure it sells to the right buyer, at the best terms available, and with a structure that actually works for the person who spent years building it.

_______________________________________

BMI Mergers & Acquisitions is a lower middle market M&A advisory firm representing business owners in confidential, value-maximizing transactions. Our advisors have over 40 combined years of experience across manufacturing, distribution, technology, healthcare, and business services.