Valuation multiples in the middle market are “unprecedented” due to low interest rates, relatively cheap debt available in today’s market, and high amounts of dry powder chasing the same deals. According to GF Data, average valuations reached 7.4 times, the highest quarterly mark the data base has recorded in 15 years.
With such high valuations, it can be hard for buyers and sellers to see eye to eye. Although strategic acquirers may be willing to pay more than financial buyers to capture long-term value in an acquisition, they still must calculate if the deal makes sense.
Sellers tend to have a rosy picture of their business and their hockey stick projections for future cash flows can clash with the buyer’s perspective. Sellers will naturally compare their company to other transactions and expect to receive a similarly high multiple, even if the transactions are not comparable. As a buyer, you might be willing to pay more to lock in the deal, but you also must be realistic.
It is extremely important for strategic acquirers to differentiate themselves on something other than just price. There are many non-financial factors that come into play, especially when it comes to acquiring a privately-held, not-for-sale business. We call this the owner’s question. Other than price, identifying what factors matter most to the seller can help you sweeten the deal without increasing the price. Here are a few tips to consider:
1. Establish trust
Establishing a positive relationship with the owner early in the M&A process will help make you the preferred buyer. Trust is critical in these transactions because many owners think of their business as their baby and will be unwilling to sell their company to someone they don’t like or trust.
2. Communicate strategic fit
Gain the owner’s buy-in by sharing why your company is the best new home for the seller’s business. As mentioned previously, business owners have an emotional attachment to their company and may feel more comfortable selling to someone who shares their perspective and understands the company and its culture.
3. Address non-financial factors
Find out what is most important to the seller other than price and address these issues. It might be taking care of key employees such as family members who work at the company, continuing the owner’s legacy, or providing perks like health insurance and a car payment. You’ll be surprised by how much “other” factors matter to a business owner. We once had a client acquire a company without being the highest bidder because the owner was concerned about his reputation following the sale. Our client, unlike the other bidder, planned to keep operations (and jobs) in the owner’s home town, which was a source of pride for him.
4. Get creative on deal structure
Sometimes it’s possible to structure the deal in a way to maximize both the buyer’s and seller’s advantage. For example, you might help the seller avoid double-taxation issues, or the seller might agree to a lower purchase price if you let them do a tax-free transaction. Get your lawyers and tax professionals involved to review the best way to structure the deal.
5. Be quick
Nothing kills a deal faster than lack of momentum, so make sure you are responsive and ready to act. Before getting into discussions with an owner, take the time to prepare any materials you might need, such as first meeting presentations and due diligence requests. Too many delays can suggest that you aren’t serious about the acquisition and the owner might back out of the deal.
6. Move on
Lastly, if you still can’t come to an agreement with the seller when it comes to price, it might be time to move onto your next best option. Having a robust pipeline of prospects is essential for a strategic acquirer. Deals fall apart for many reasons – disagreements about price, the owner getting cold feet, another buyer swooping in with a more attractive offer, or uncovering red flags during due diligence.
Offering the highest price is not the only way to successfully acquire a company, even in a high multiple market. Smart acquirers think outside the box, recognize the various factors that motivate an owner to sell, and put together an attractive offer. For strategic acquirers, understanding the relationship between price and value is essential for putting together the right deal.