How Strategic Buyers Buy Agencies
This guide will explain the process that prospective buyers use to acquire other businesses. We're going to focus specifically on how strategic buyers (a classification of buyer in M&A) look for agency businesses to buy. Agency businesses are often a good fit for strategic buyers and there are a large number of completed M&A deals to support this premise. It's important for agency owners to understand how the M&A process works and how these strategic buyers actually go about searching for target companies to buy. Understanding Buyer Types in M&ABefore we get into how M&A deals work and how strategic buyers buy agencies, we need to understand the different classifications of buyers in mergers & acquisitions. Typically, we put these different types of buyers into three classifications.
First, we have strategic buyers. Strategic buyers are other operating companies that actively seek out acquisition opportunities in the same or related industries to bolster their own operations. By acquiring another business, strategic buyers can create financial synergies that benefit their existing operations. This can be accomplished through increased revenue and cost savings associated with the merger or acquisition. Furthermore, a strategic buyer may look to align its current operations with those of the new acquisition. This is done to enhance existing products and services and create a more competitive edge in the market.
Second, we have financial buyers. Financial buyers are established professional long-term investors who seek to make a return on their investment by purchasing companies at prices lower than what they plan to sell for. To finance these acquisitions, financial buyers use leverage, meaning they borrow money from other investors and financial institutions to finance the purchase price of the business they are buying. The primary motivation of these investors is the cash flow of the target business and their desired exit strategy. Financial buyers typically work on a five- to ten-year time frame, utilizing various exit strategies to realize their return on investment. Before an exit, financial buyers often look to improve cash flow through capital investment and cost-cutting or through achieving economies of scale by purchasing complementary businesses.
Third, we have another category of buyers that are often overlooked in M&A transactions, but that account for a large number of M&A deals completed each year. This group is often generally called individual investors. These investors buy small businesses looking to replace the current owner/operators so that they can run the business (often as a second career). As a side note, we are only talking about investors that buy small businesses to replace the existing owner/operators here. If the investor were very wealthy, they would structure their business more professionally and operate as a financial buyer.
This guide is going to focus on strategic buyers, but before we move on, we need to understand the difference between financial and strategic buyers. Financial buyers typically prefer to purchase a business and not actively manage its daily operations. Strategic buyers are other (often much larger) operating businesses that look to make acquisitions in order to improve their existing business. To learn more about these two different categories of buyers and how they operate we recommend this article, here.How Strategic Buyers Search For M&A DealsThis section aims to explain how strategic buyers actually begin their search for target companies to buy. Some businesses are in effect "always looking," and others go through phases where they look to do M&A deals and phases where they are not actively looking. This section will explain the process of how they search for target companies from start to finish.
First, they determine their acquisition strategy. If they are looking for agency businesses to buy, this step would involve getting clear on why they want to make an acquisition. What is the underlying motivation for doing a deal? Are they trying to enter a new market segment? are they looking for a new presence in a different geographic location? Are they looking to expand their product or service line? Without a good acquisition strategy, the M&A process can be extremely wasteful and time-consuming.
Second, they determine their search criteria. This is when they begin their active search for buyout targets. Normally, this process involves going through intermediaries. These intermediaries act as professional middlemen facilitating the deal between buyer and seller. If you own an agency business and you're looking to sell it, then your choice of intermediary is important. These intermediaries will have multiple working relationships with different strategic (and financial) buyers and will bring your business to their attention. Your choice in determining which intermediary to go through is largely dependent on the size of your business. If you own a large business (doing $100m + in revenue), then you would want to consider going through an investment bank. If you own a business doing between $5 million and $100 million, then your best bet is probably an M&A firm. If you are looking to sell a small business, where the new owners will likely be doing the job your business performs every day, then business brokers are your best option. These ranges are not set in stone, and there will obviously be some overlap here, but generally, these guidelines will probably be in your best interest because the quality of the relationship that you have with the intermediary will be mostly determined by the number of businesses they have strong working relationships with. Put another way, if you want to sell a large business, you would want to go with an intermediary that has enough contacts that are large enough to be able to afford to buy your business. A big part of getting paid well for a business comes from getting a number of these prospective buyers to compete with each other so that you can attract and draw in multiple offers.
Typically, when working with an intermediary, the first step is to draft a teaser. This is a short document (one or two pages) that gives prospective buyers key insights into your business' performance but keeps the identity of your business a secret. The intermediary will help the agency owner create this document. These are then typically distributed to strategic buyers by intermediaries. If those prospective buyers like what they see, then they will sign an NDA (non-disclosure agreement) in exchange for a second document. This second document is called a confidential information memorandum (or CIM for short). This is a second document that will also be created with the input of the intermediary. The CIM gives more insight into operations and how your company works and typically has complete financial statements.
The third step in the acquisition process is to use the information in the CIM to conduct a valuation of the business for sale. This is how they determine a price range that might make sense for them to offer you in exchange for your business.
The fourth step is the negotiations. This is when they meet with you and you negotiate a price to sell at. From here, the buyer will typically draft a letter of intent, which is a short, non-binding document formally summarizing the points you've discussed up until this point. This will likely say that they intend to pay you XYZ for your business provided that everything surrounding the deal is as it has been represented to be.
The fifth step is called due diligence. Here, they will visit your business, observe operations fist hand and attempt to confirm that their valuation was made with the right assumptions about your business. This process can last for weeks or several months and is often tedious as the buyer will want to learn everything they can about your business.
Finally, the deal will close with the signing of a definitive purchase agreement. For more detail on how these strategic buyers search for M&A deals and how this process works, we recommend this guide here.
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