06.08.18

The Cuckoo in the Nest

The potential dangers of selling your business to trade.

By Tom Matthews

As a growth investor, I am fortunate to spend a lot of time with business owners in the SME community.  I love listening to the stories of how these entrepreneurs set up their businesses and the key events that drove their decision-making.

I always come away inspired by these individuals who decided they weren’t going to follow the “usual” career track of “get a job and work your way up the corporate ladder”.  These risk-takers were not prepared to follow someone else’s path – whether that was their parents’, teachers’ or peers’.  They decided to do it their way.

However, when I ask these entrepreneurs what’s their biggest regret, I often hear the same response.  That is: “selling my business to a trade buyer”.

What is a trade buyer?

A trade buyer is a company usually in the same industry as the target company.

What do trade buyers look for when assessing an acquisition target?

When assessing the merits of whether to acquire another business, trade buyers consider the strategic rationale of doing so.  Typically, this includes whether the acquisition is likely to help the parent business to:

  1. Increase revenue – e.g. cross-selling each company’s services to the other’s client base
  2. Reduce costs to increase profits – e.g. removing duplicate roles within the combined group
  3. Reduce competition from within the industry
  4. Achieve skills or technologies quicker and / or at a lower cost than they can be built
  5. Attain scale
  6. Enter a new / adjacent market
  7. Enter a new geography.

To achieve these strategic objectives, trade buyers are sometimes prepared to offer high prices for acquisitions.

The dangers of selling to a trade buyer

Whilst trade buyers may offer high valuations to SME business owners, their reason for doing so can be because there are synergies with their existing operations.  These synergies are often the cost savings as a result of replacing staff at the SME business with their own people.  Trade buyers sometimes deliberately do not make their intentions clear regarding their plans with the staff of the SME business.

Just like the female cuckoo, which lays its eggs in other birds’ nests and, once hatched, the cuckoo fledgling pushes the other birds’ fledglings out of the nest, trade buyers often end up removing the staff at the SME business and replacing them with their own people.

Other complaints I hear from SME owners who have sold to trade include:

  • No focus / attention from the senior management of the trade buyer after the acquisition – often the SME business ends up being a small, non-core, component of the much larger group.  Senior management, who were so keen to bring the target company into the group, move on to the next acquisition or strategic initiative and lose interest in the SME business
  • Sometimes the senior personnel of the parent company end up leaving after the acquisition.  New senior management are hired by the board of the large parent company and the strategic direction changes.  The SME business is no longer of strategic importance to the group
  • The promises that were made by the trade buyer before the acquisition are not kept
  • Cultural integration issues.

Key benefits for SME owners of partnering with a growth investor versus selling to trade

1)    Growth investors typically do not have an existing business in the same industry to acquire the target company.  Rather, we look to partner with SME owners and leaders to accelerate the growth of these organisations and turn good companies into great market-leading businesses.

Growth investors provide capital to fund rapid growth, as well as strategic support and access to networks of experts to achieve accelerated and sustainable business growth.  This can help to take the business forward to the next stage and leave a successful personal legacy for the SME owner.

2)    Rather than seeking to fire staff and cut costs, growth investors look to incentivise the key people at the heart of the businesses that we invest in.  This is often through equity participation to ensure interests are aligned.  This involves bringing these key people into the equity and supporting their transition from employee to equity owner.  By bringing in the right investment partner, SME owners can be sure that their key staff (many of whom are often friends and family members) will be looked after.

3)    By bringing in a growth investor, SME owners can sell part of their company rather than all of it while continuing to develop their business.  This can help de-risk their own personal finances, whilst allowing them to stay closely involved and in control of their business.  With the combination of personal financial security and the help of an experienced growth investor, SME owners can afford to be bolder in their strategic decision-making.

4)    By selling part of their business on completion and retaining an ongoing equity stake, SME business owners can realise some of the value tied up in their company but ride the next stage of the growth journey and benefit from an additional ‘pay day’ on exit of the enlarged group.  This “two pay day” structure often generates higher total proceeds for SME business owners than if they sold 100% of their business to trade.

A call to all SME owners…

Steve Jobs described you as the crazy ones, the misfits, the rebels, the ones who see things differently.  Just like you carved your own path when you decided to start your business, don’t follow the same road as everyone else when you sell.

If you are considering selling your business, or you would like to know whether a growth investor might be right for you, then please email me at info@pemba.com.au to find out more.

Photo by bennett tobias on Unsplash

 

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