Many sellers do not know what to expect when they are ready to sell. They have many questions, such as
- What value will I receive?
- What is the process?
- What are some of the key documents?
- How much information should I divulge without affecting my business?
Strategic and Financial Buyers
There can be different types of buyers for your business, and they would value your business differently. There are mainly two types of buyers - strategic or financial buyer. A strategic buyer is one, who is already present in the market or industry and thinks that by working together or acquiring the business there are benefits to both the parties. Generally a strategic buyer buys a business forever.
Strategic buyers prefer to buy the whole business via an acquisition or by merging with the other company if they are about equal in size. There are other forms of collaboration too, such as a joint ventures or collaboration or strategic alliance. In such an arrangement, firms come together for a particular purpose- such as technical collaboration, marketing/ sales arrangement in a particular country or region and others. These agreements are often limited time engagements allowing each of the firms to build knowledge and capability in a new market.
A strategic buyer often buys (or enters equity relationship) to:
- enter a new market,
- enter a new country,
- buy access to new technology,
- overcome limitations placed by the governments,
- grow market share, and
- many other reasons
They are companies like Commercial Vehicle Group, Cooper, Danaher, Dover, Emerson, Endress & Hauser, Fuji, IDEX, ITT, Littlefuse, Pentair, Samson, Voith, Wika etc.
A financial buyer is one that owns variety of unrelated businesses for certain period of time-ranging 1 year to 7 years (sometimes longer). Venture capital, Private Equity, Mutual Fund and Hedge Fund companies are examples of financial buyers. In case of private equity, hedge funds and venture capital, ownership period can be between 2-7 years. These firms are often run by individuals who have strong background in finance or high level of operational experience as senior leaders of highly successful firms. They often come with experience in raising capital, helping a firm enter new market, growing internationally, hiring new talent, upgrading processes, etc.
Scope of GGI activities in India
GGI is an M&A advisory group. The scope of our activities is two-fold.
1. We show Indian acquisition targets that we are aware of to our non-Indian clients or we do specific searches for Indian target companies on behalf of a client. Upon request we advise and assist our clients throughout the transaction.
2. Because India is uncharted territory to many companies, GGI helps those customers to acquire a better understanding of their specific industry, size and growth of markets as well as business culture by offering specific programs:
- market studies: market channels, competitive landscape, size, growth of a specific market etc
- identification of joint-venture / cooperation partners
- analysis of greenfield investment vs acquisition
- identification of acquisition targets
Feel free to contact us for more information.
Financial buyers are investing in a business to make it more valuable by the time they sell it. Most financial buyers only focus on investing in businesses they understand well by having worked in them. Or they hire consultants to advise them on strategic and operational issues. Many financial investors are also able to add a lot of value to a business by having a deep understanding of the businesses they invest in. When the financial buyers acquire more than 50% stake they own a majority stake and often come with a plan to run the business. When they acquire less than 50% they still come prepared to advise and provide board level guidance majority owners and senior management.
There is a distinction in types of financial buyers too. Venture Capital firms generally invest in start-up firms, whereas Private Equity and Hedge Funds largely invest in established firms in various stages of growth. Some examples of reputed private equity firms in Industrial market are 3i, Actis Capital, AIF Capital, American Industrial Partners, Carlyle, Doughty Hanson, Industrial Growth Partners, Wind Point Partners.
Valuing Your Business
Most buyers these days are pretty savvy at buying businesses internationally. They hire investment bankers or consultants who help them value businesses. Essentially, in an M&A transaction the price is what a buyer is willing to pay and a seller is willing to accept. For firms that are profitable and generating cash valuation is often done on the basis of future earnings potential. Various methods used to value profitable firms are explained below. When a firm is not profitable it is often purchased by valuing its assets. These techniques are not discussed in this article.
In valuing an investment, a buyer wants to know when I will earn my investment back. If an investor buys a company X that has revenues of $100 and after tax profit of $10. If he purchased the company for $100, he will earn his money back in 10 years; if he purchased the firm for $200, he will earn his money back in 20 years, assuming the company delivers same revenue and profitability for next 10 to 20 years. Of course, this is where the buyers and sellers differ. A seller believes best years of the company are ahead of it and that its profits will grow at a high rate. Buyer on the other hand wants to be as realistic as possible.
To find a happy medium in between, advisory firms use multitude of approaches that are discussed below:
1. Multiples Approach
- Investment Bankers regularly watch price to earnings ratios of similar publicly traded companies. Ratios such as:
- Price to earnings (PE),
- Price to book value (PB),
- Price to sales (PS), or
- Enterprise value (EV) to earnings before interest taxes depreciation and amortization, EBITDA (EV/EBITDA) ratios.
- Based on the attached chart and a few more, the buyer would arrive at a value range.
- Companies that are large, top three in the market and with great growth potential command prices closer to the higher range.
- Smaller companies and those who lag behind the market leaders earn in the middle of the range.
- Ownership of key brand, technology and bright prospects often earn higher valuations.
- Companies with poor financial health such as too much debt, high receivables, or high payables are viewed as less attractive.
2. Discounted Cash Flow Method
- This method involves developing a financial model for the business. Within the financial model assumptions are made about growth prospects, short term and long term profitability of the business and many other assumptions.
- Models alone cannot be relied upon for value judgement; rather the outcome is used to develop a point of view regarding the range of possible outcomes.
3. Strategic Value
- Many strategic buyers see synergies in the business. Some examples are:
- Ability to sell their products through sellers' channels
- Ability to sell seller's products through their channels
- Consolidating overlapping capabilities and using excess capacity or capability for other projects
- Extracting more profitability via introduction of new technology, better manufacturing techniques, reorganization of production lines, etc.
- Extra revenue or profitability means more value for the strategic buyers. However easy it is to model in the extra revenues or profits, it's not easy to extract it. Many times a strategic buyer sees more value in a business compared to a financial buyer they may not be willing to pay that extra value to a seller. Especially if they doubt their own ability to achieve it.
Source: Reuters Knowledge, Amit Israni