How Are Middle Market Companies Valued And Sold?
By: Duane Donner
The steps to selling a middle market company1 are generally not that well known. Yet, there is a proven methodology that, when followed, increases the likelihood of a firm obtaining a premium value and getting a deal done. Over the next several weeks we will take a deep dive into this methodology of valuing and selling middle market companies.
Owners of companies typically see their universe of buyers consisting of fellow partners, employees, competitors, key customers, major suppliers, and perhaps local investors. While these are all valid options, there is also a vastly larger buyer universe consisting of domestic and international public and private companies as well as private equity firms. The challenge is not finding potential buyers but finding the right buyer or investor. At the outset, it is not always obvious who the best buyer might be, and there is a high probability that the owner has never met the buyer before. It takes a systematic approach to identify and connect with the best candidates.
Most of us are amateurs when it comes to selling our businesses, since we tend to do it only once or twice. Institutional buyers2, on the other hand, buy and invest for a living. Consequently, they have a lot of experience getting deals done and shaping deal terms in their favor. Financial buyers acquire businesses for institutional and high net worth investors, and these shrewd buyers have invested over $2 trillion buying companies. Strategic buyers prefer acquiring small to medium‐size firms and while these deals happen every day, it is a challenge for the uninitiated to get into this market. If you already know potential buyers because they are a customer, partner, family member, or competitor, you should ask yourself if they are willing and able to pay fair market value.
How is fair market value determined?
Let’s first look at the definition of this term. Fair market value is the most likely price at which a business will change hands within a reasonable period of time between a willing buyer and a willing seller in an “arm’s length” transaction. While this definition helps, it does not shed much light on how price is determined. Nor does this definition give much guidance on how owners can exert leverage when dealing with professional institutional buyers and investors. The solution to determining fair market value in a manner that also provides the seller with leverage lies in making a market. How do you make a market? You make a market by creating a competitive deal environment consisting of multiple buyers and investors.
There is a proven methodology that, when followed,
increases the likelihood of a firm obtaining a premium
value and getting a deal done.
There are five major phases to creating a competitive deal environment:
I. PREPARATION & PACKAGING
II. BUYER RESEARCH & DEVELOPMENT
III. MARKETING & BUYER COMMUNICATIONS
IV. NEGOTIATIONS & LETTER OF INTENT
V. DUE DILIGENCE & CLOSING
The PREPARATION & PACKAGING phase starts with an in‐depth analysis of the company’s business model, historical financial performance, and outlook. This information is then packaged into a set of documents that concisely and authentically tells the company’s story and forms the thesis around why the company would be a good acquisition or investment.
The BUYER RESEARCH & DEVELOPMENT phase systematically researches, identifies, and targets potential buyers and investors culminating in a specific list of qualified buyers and the decision makers therein.
The MARKETING & BUYER COMMUNICATIONS phase engages potential buyers and obtains indications of interest from the subset of firms expressing a strong interest in the company.
The NEGOTIATIONS & LETTER OF INTENT phase structures and frames the deal culminating in a Letter of Intent.
The DUE DILIGENCE & CLOSING phase allows the buyer to verify all the representations made by the seller, finalizes the deal structure, and executes a definitive purchase agreement.
As we continue this series of blogs, we will dive into each of these phases in detail from the vantage point of owners and CEOs who seek both a premium price and a high probability of completing a deal.
1 Middle market companies are typically defined as having annual revenues between $10 million and $500 million.
2 Institutional buyers and investors consist of private equity firms (i.e., “financial buyers”) and larger corporations (i.e., “strategic buyers”).