Simon Pearson, Anna Faelten and Stefan Koeck discuss the exit options available to tech entrepreneurs in the UK.
EY’s most recent survey of entrepreneurs, the Fast Growth Tracker, showed that 65% of UK founders expect to exit their business within five years.
When looking to sell a company, understanding the key differences between a Private Equity (PE) sale and a Trade acquisition is important. It is essential to develop “Buyer Empathy” (an understanding of their key motivations and processes) in order to recognise their similarities and differences as you embark on your transaction. Below, we’ve set out essential takeaways to consider when approaching a transaction.
PE buyers are focussed on the risk and return they can achieve by buying a business and selling it at a later date. Most PE houses are looking for a well-managed business with a history of consistent growth in earnings and underlying cash flows as well as a defensible business model.
The primary objective of a PE firm is to generate a return for their investors (Limited Partners in the investment fund). This return can be analysed using two metrics: 1) the internal rate of return (IRR) and 2) a multiple of money (MoM). Historically PE investors have targeted an IRR of at least 25% and a MoM above 2.5x. However, a prolonged period of low interest rates coupled with significant amount of PE dry powder (money not invested) has led to reduction in this benchmark. An IRR of 20% and MoM of 2x is good rule of thumb for assessing the minimum return that PE investors will target.
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Top tips for a successful PE transaction
- Get your house in order – Collate historical information and KPI data to support an investment thesis. PE funds have investors that they have to answer to. PE are professional asset buyers and have the resources available to rigorously assess and contract to acquire a business they like, especially if they see the core of a leadership team they feel comfortable with.
- A comprehensive business plan – PE funds will have target returns that their performance is measured against. A business plan will need to be able to support PE level returns in order to be attractive to this buyer group. “Support” in this context needs to be robust – with supporting evidence and triangulation to independent market views on growth and market trends. (Our next article will pick up this in more detail – most businesses fail to get close to the standard required to deliver an efficient process).
- Define your objectives – PE can be a demanding business owner. However if the objective is to grow the business quickly (e.g. through international expansion or acquisitions) then their financial resources and expertise can help accelerate change
These are operating companies and are often competitors, suppliers or customers of abusiness. Strategic buyers are interested in fitting a target into their own business. Their interest in acquiring a company may include: 1) vertical expansion i.e. buying a supplier, distributor or other part of its supply chain; 2) horizontal expansion i.e. acquiring another business within the same industry value chain; 3) eliminating competition; or 4) enhancing its existing product portfolio. We discussed preparing for positioning for sale in a previous article: How to exit: Strategic positioning
In order to generate a return on investment trade acquirers typically focus on the cost or revenue synergies available. Cost synergies are usually a reduction in personnel or infrastructure which is duplicated across the buyer and target. Revenue synergies derive from an enhancement of the product, or access to new customers and distribution networks.
Trade buyers often need to answer the question “Why would I buy the asset when I can build it myself?” For example, can a larger trade buyer build the technology themselves or is it easier and cheaper for them to simply acquire an innovative start up? From the sellers perspective the question is how defensible is your product and can it be easily developed by a larger player?
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Top tips to generate interest from a Trade buyer
- Prove the scarcity of your asset – When selling a product or service one of the most powerful negotiation tools is the ability to demonstrate scarcity or uniqueness. The same applies for a sale of a business. The company needs to be shown to compare favourably to competitors in terms of market share, customer loyalty, stickiness, features, etc. Proven scarcity (and demand for the same) is likely to significantly push up the selling price but may even be the reason the buyer signs on the dotted line.
- Know your Sponsor – Trade organisations are large entities with internal politics of their own. An acquisition may pose a threat to internal stakeholders. It is therefore advisable to aim high and try to get support at the highest level possible. Knowing who the sponsor is and what will help him / her to push through the decision internally is of critical importance. Accessing the right person is sometimes tricky because it is often a product or line manager who holds the existing relationship. Here, having a connected advisor should help.
Approach to Transactions
For strategic buyers looking to integrate a company into their existing business the investment horizon is medium to long term. Typical milestones include the First 100 Day Plan and the first year of integration, followed by check points and evaluation at the 2nd and 3rd anniversary. Successful integration can be a high stakes exercise, if things go badly in first 12 months it is not uncommon for the deal sponsor to suffer either a reduced role or to leave their current organisation.
PE buyers typically have an investment time horizon of four to seven years. When they acquire and subsequently exit the business, the overall business cycle will have an important impact on the return they receive on their investment.
A PE acquirer will make multiple transactions over the course of a year. Working through diligence and completing a transaction is part of their core competency and is typically done in a timely fashion. In contrast strategic buyers may not have a dedicated M&A department and are often encumbered by a slow moving internal governance and sign-off process. Our experience is that M&A transactions with strategic buyers often take longer than with Private Equity investors (see article “Preparing for exit: Everything UK tech entrepreneurs need to know”).
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It’s not uncommon for a large acquirer to turn up mob handed with their diligence teams – property, tech, IT Security, PR, HR, IP, legal, marketing, sales, finance plus line of business and corporate development from their own organisation. We have had over 50 people from some large organisations but 15-20 is pretty normal. Keeping focus across a large diligence team takes time and effort. It is important to spot emerging issues and ensure these are fully understood to allow a buyer to accurately get to an informed view. Tight project management of this is always a key characteristic to delivering an optimum process.
Selling a business is never an easy or simple process. However, the rewards can be great and ultimately life-changing so if selling there are a few things to consider. Whether a Trade buyer or financial investor is the right choice depends largely on the motivation and goals for selling the business. The reasons for exploring an exit must be carefully considered. Do you want to have an active role in the company going forward or simply ’cash-out’ a portion of your equity? Do you want the highest price possible or one that allows you to remain autonomous? Every buyer, whether strategic or financial, brings a unique perspective to the table.
A Trade acquisition will often result in more cash being received upfront. Full ownership is transferred to the acquirer with part of the cash received dependent on any earn-out agreement (this is a contractual arrangement in which the seller receives additional payment in the future if certain financial goals are met). PE deals require management to share in the risks and rewards of ownership, incentivising them to work in the interests of the company by offering them the opportunity to buy into “sweet equity” (instrument in the form of options, performance rights or rights to be issued further equity shares) and therefore allow to participate in any upside potential.
The next article in this series will take a deeper look at setting forecasts, discussing the key elements of a winning business plan.