Finding Acquisition Targets

Let's oversimplify things a bit and divide all businesses into three groups:

• Group One: Those businesses that are actively for sale.
• Group Two: Those businesses that are not actively for sale but may be open to seriously exploring the possibility of being acquired.
• Group Three: Those businesses that absolutely are not for sale.

In this section we'll first discuss Group One and then Group Two.

Businesses Actively for Sale

In most circumstances, someone who wants to sell something will try to get the word out and promote that product or service he wants to sell. In selling one's company, this isn't always the case because putting a business on the market can cause concern among customers and employees. Many business owners want to sell, but are also very concerned about keeping the intent to sell as confidential as is possible. That being the case, finding businesses that are for sale often involves a few steps such as talking to an intermediary, signing a non-disclosure agreement, providing information about yourself or your company, and getting "screened in" by the seller, or the seller's representative. Ads and announcement of businesses for sale are often long on generalities but purposefully lacking in identifying details. The methods below are useful as a first step in finding opportunities, best described as getting leads for possible acquisition targets. Be understanding of the seller's concerns about confidentiality and discretion, and be prepared to jump through a few hoops before receiving the details you need to decide if you are seriously interested in a particular acquisition opportunity.

Business for Sale Websites

It used to be that the most common way to search for businesses for sale was through the classified sections of local and national newspapers. The web has taken over many of the functions of classified ads, and businesses for sale is no exception. There are several websites that specialize in listing businesses for sale that allow you to search by type, size, geography, and more. Some of the better-known business-for-sale websites include:

BizBuysell
Business Mart
Merger Network
BizQuest

While the chances of finding a company on one of these sites that meet your defined acquisition needs is not that great, these sites, and others like them, are worth a look. In fact, it's worth looking at them once a week or more often because new offerings are added regularly. Some of these sites can save your search and send you an email if and when a match comes up. Some people have developed their own searching tools that automatically search these sites as often as a couple times a day in the hope that a company meeting their specific criteria will appear and they'll be able to act on it right away.

These sites tend toward listing very small companies; those with sales of under about $1.5M, but there are exceptions.

Other Web Based Searching

Many brokers and intermediaries do list the companies they are currently representing for sale such that Google or other search engines could find them. Also, some business owners set up their own websites to advertise their company for sale. It is certainly worthwhile to try a few search engine searches in the hope that your ideal acquisition opportunity will turn up.

As part of our business brokerage activities, we have developed proprietary tools that search for businesses for sale, both on the web and in proprietary databases. There may be other business brokers that have developed similar proprietary tools.

Classified Ads in Newspapers

Even with the advent of the web and its arguably superior ability to handle the function of classified advertising, there are still newspapers, and those newspapers still run classified ads. Many papers include a "Businesses for Sale" or "Business Opportunity" section in their classified sections. As with web-based business for sale sites, chances of finding your ideal strategic acquisition candidate are not that great. However, classified sections of local newspapers are worth a look, especially if you are looking for a small company(s) within one or a few local markets.

If you are looking for a larger acquisition candidate(s), your best bet is The Wall Street Journal. Its classified section, called "The Mart," includes a subsection called "Businesses for Sale". Thursday has the most extensive business for sale listings. However, even on Thursdays, the Businesses for Sale section of this newspaper has far fewer ads than in years past. Note that for The Wall Street Journal, advertisers can limit their ads to various regions of the country, so if you're looking to buy a company in, say, northern California, don't look at a Wall Street Journal purchased in Connecticut.

Brokers and other Intermediaries

A good intermediary will have packaged the companies he is representing for presentation to buyers. That is, the intermediary will have prepared a comprehensive write-up that details the acquisition opportunity, including a description of the company, its history and future prospects, and, of course, it's current and recent past financial situation.

The problem is that intermediaries almost always work for the seller. Therefore, reasonably enough, they sell the companies that they have been hired to represent for sale. If you learn that an intermediary happens to be representing a company that meets your acquisition criteria, by all means check out what that intermediary is offering.

Some buyers contact several intermediaries to apprise them of their acquisition criteria. Other than the time investment there is certainly no downside in dong this. However, understand that there is no such equivalent to a multiple listing service as exists in the real estate industry, so in most instances, brokers will only know what they and perhaps a few associates have for sale.

Most intermediaries get far more calls from prospective buyers than they do from prospective sellers. Calls from buyers are not always taken all that seriously unless that broker happens to have a listing that matches the buyer's stated criteria. It is a rare broker who will aggressively search for a business for sale for a particular seller. It is simply easier to sell what you have for sale than what you don't have for sale.

Attorneys, Accountants, and Consultants

Lawyers and accountants, and some consultants by nature of the work they do, have inside knowledge of what is going on with their client's businesses. A lot of business owners consult their lawyer or accountant early on, when they are considering a sale. So, telling your own lawyer and accountant as well as other lawyers and accountants who you may know that you are looking to acquire a business just might lead to learning about a company(s) for sale that meets your criteria.

Trade Publications & Associations

Some sellers will advertise their business for sale in trade and professional publications. In our experience, this avenue tends to be limited to smaller companies, but a quick look is certainly worth the effort. Expect trade publication business for-sale ads to be particularly oblique. Sellers are rightly concerned that their trade publication may well be read by their employees and their competitors.

More than occasionally, trade associations get inquiries from their members interested in buying and selling their businesses. Some trade associations are very good about assisting with acquisition opportunities. We have been invited many times to give presentations about buying and selling companies at industry conventions because members have asked for information on the subject. Your trade or professional association is worth contacting about your acquisition interest.

Gray Area Sellers

A few businesses are actively on the market and may be found by the methods outlined above. While you might find a few good acquisition candidates from the pool of businesses that are listed for sale, the odds of doing so are not great. What's more, once a desirable business is actively advertised for sale, it will attract several qualified buyers leading to significant competition among the suitors.

There are a lot of business owners that aren't actively looking to sell but would consider selling under the right circumstances. We call these the gray area sellers. It is among these gray area sellers where we believe the best strategic acquisition opportunities lie.V

Finding these gray area sellers is not easy. In chapter V we will outline the emotional attachment many entrepreneurs have with their business. Selling one's business is an emotionally wrenching undertaking, such that even an owner considering selling will not always readily respond to a query about selling.

As we specialize in finding these gray area sellers, we have a great deal of experience in finding and arranging the purchase of businesses that aren't officially for sale. Our methods involve the proverbial mix of science and art, so it's difficult to layout a procedure in a recipe like format. Having said that, here are some of the methods we have found to be successful over time.

Direct Approach via Traditional Mail

Now that communications methodologies like instant messaging, texting, and Twittering are commonplace, even email seems almost old fashioned. Sending a paper letter by first class seems to some to be downright antiquated. Nevertheless, this is still one of our main methods of finding leads for gray area sellers.

Yes, we still often use first class letters that are hand stamped and hand signed in our initial effort to locate acquisition opportunities for our clients. It's not just that we are old fashioned. We have tested other methods and varied our approach, but have come back to snail mail as a very effective tool for this type of endeavor.

Our search letters are very pinpointed, by industry, size, geography, and more. We use the list services of a few companies that enable a user to do this pinpointing and list buying online. One source we use is InfoUSA and another is zapdata. The former company compiles their lists from Yellow Page listings and the later uses D&B information (D&B is their parent company). We also use Thomas' Register (ThomasNet.com). ThomasNet is not really designed for this purpose, but in some circumstances it is quite usable for certain very specific industry segments.

Our letters are always addressed directly to the owner(s) and the envelope is always marked "confidential". We always make clear that we are not fishing for a listing, nor seeking a fee. Our most effective letters explain, in detail, what our buyer is looking for. Business owners are accustomed to getting solicitations with vague promises of generous buyers for their businesses but that ask for large upfront fees before those buyers are revealed. We need to differentiate our letters from those shady solicitations.

Finally, we always promise discretion and confidentiality, even to the extent that we won't share sensitive information with our client company without their permission. This is a key point: if business owners who are actively selling their companies are concerned about confidentiality (and they are), those who are at the just might consider it stage are doubly as concerned about their customers, competitors, and employees learning that a sale is being contemplated.

This direct mail approach is cumbersome and expensive. Not only do the letters have to be printed and folded, etc., but record keeping of responses and follow-up needs to be hand entered into a database. In an age of electronic communications, it is comparatively very slow. We do it for one key reason: it gets results. It's not magic; depending on the industry we often consider a response rate of 2% pretty good, and that's a willing to talk response, not necessarily a seller. But in the sensitive area of approaching business owners about an issue as weighty as selling their business, it works as well as or better than any other method we have tried.

Email

As the availability of appropriate emailing lists improve, email becomes a more viable method of finding gray area business sellers. However, the necessity of reaching the owner directly and of confidentiality makes email a less than ideal search method. Also, the old fashion first class letter on quality paper seems to have more impact than does an email no matter how well it's worded or how sophisticated its graphic decorations. E-mail is also often ignored by the receiver both because of the amount of spam received everyday and since it is so easy and inexpensive to send. In fact, a significant percentage of your e-mail inquiries may end up filtered out as spam. However, emailing is quicker and cheaper than snail mailing. The list compiling companies mentioned above offer email lists along with their traditional postal list services.

Networking

It couldn't hurt to get the word out that you are looking to buy a particular kind of company. Sales representatives and vendors make it their business to know what's going on with their customers and may hear of possible opportunities. In all likelihood, a lead from a source like a vendor would be just that: a lead. It would be along the lines of "Joe at ABC has been saying he wants to retire soon so he may be interested in talking" or "Bill at XYZ seems to be spending more and more time away from his business and might be open to discussions."

Why Phone Calls Often Don't Work

We have tried using telephone calls to solicit potential sellers. These seldom succeed unless we have a pre-existing relationship with the seller. Unfortunately, when you call a potential seller you not only run the risk of interrupting him when he is doing a more pressing task, but you also often trigger an almost reflexive no. After all, he just received a surprise phone call from somebody that he does not know asking him a highly charged question: do you want to sell your business?

Private Equity Groups

Private equity groups (PEGs) are in the business of buying companies, improving them and enhancing their value, and then reselling them or exiting them through a public offering.

If you are looking for a relatively large company to acquire, private equity groups are a source to look to. You are unlikely to find bargains, but you will find sophisticated and rational dealmakers who are more than willing to talk to you.

A good, though expensive, source to search for private equity owned companies by industry and company type is Private Equity Info.

Intermediaries

Unlike most intermediaries, we focus on aggressively searching for synergistic acquisitions targets for our clients. We maintain a comprehensive database of inquiries we receive from owners who are considering selling, but haven't pulled the trigger yet. We have also developed some proprietary technology that efficiently searches other intermediary sites, business for sale sites (such as bizbuysell.com), private equity sites, and other sources based on our client's acquisition criteria.

Summary

At any given time, a few businesses are actively on the market. Also at any given time, there are some businesses, those we term gray area sellers, that are not actively on the market, but may be open to talking about being acquired in whole or part. A strategic buyer looking for a particular type of acquisition is more likely to find it in the second group. There is no magic method for finding the perfect acquisition. However, the methods described above have proven successful in many cases.

Special Situation: Buying a competitor

How many times have you thought about how much better your business could be if you could eliminate one or more of your major competitors? Well, it can be done legally, ethically, and efficiently by buying him.

The other advantages of a strategic acquisition discussed throughout this book still apply. In buying a direct competitor, you will assuredly gain customers, market share, and significant economies of scale and other efficiencies. You can also gain considerable pricing power, lower your marketing costs, and gain additional very real advantages if your major competitor is suddenly no longer a competitor, but instead a new division of your company.

Buying a competitor can be quite a business coup. While there are special advantages in buying a direct competitor, there are special difficulties as well. It's not easy to approach a competitor, even a friendly competitor, with a proposal so bold as a buyout. If you were to directly approach your competitor with such a proposal, the likely knee-jerk answer would be "NO." Even if the answer was more along the I'll think about it lines, once that competitor thought about how he'd have to share intimate financial and other details about his business with a competitor, the answer would still likely be a no.

You can't blame your competitor for being especially sensitive, even to the point of suspicious, to an inquiry from a direct competitor. If the situation were to be reversed, if your competitor were to ask you about selling your business to him, you would be very apprehensive as well.

Approaching a direct competitor is usually best done through an intermediary. An intermediary versed in strategic acquisition can add a level of protection by promising discretion and by assuring all non-disclosure agreements and procedures are followed. Even the fact that an intermediary has been retained will indicate to your target competitor that the inquiry is a serious one, not a fishing expedition or an attempt to gain information through subterfuge.

An intermediary can be particularly helpful in convincing a competitor of the advantages to him to take the inquiry seriously, the main one being that his business may well have more value to a direct competitor than to any outside buyer.

Both parties would share the advantage that the sales process would be likely be relatively smooth and the deal would very likely end in a successful close. After all, buyer and seller may well know one another. Even if that isn't the case, they surely know a lot about one another's business, as they have been directly competing for quite awhile. Due diligence would probably be relatively easy given buyer's knowledge, not only of the industry, but of the target company and certainly the direct marketplace where buyer and seller compete.

So, if there is a chance that a direct competitor of yours may be open to acquisition discussions, it is certainly worth an inquiry. Be understanding of your competitor's apprehensions, but do explain the benefits that would accrue to him. Again, an experienced intermediary can be of considerable help in approaching your competitor and shepherding a deal to fruition.

One word of caution: There are strict federal anti-trust and restraint of trade laws designed to prevent reduction of competition that can be construed as harmful to consumers. As a practical matter, it is highly unlikely that these laws would come into play for the kinds and size of business that we are addressing in this book. These are typically an issue in the case of very large companies. However, if acquiring a competitor might result in significantly limiting competition in a particular marketplace, run it by your attorney before getting too far down the road toward that acquisition.

What's a Merger?

Buyers often refer to acquisitions as mergers for a number of reasons. These include the fact that many business owners dislike the idea of being acquired, since it conjures images of loss of control, loss of employment, and even of failure. Using the softer term, merger, when referring to a transaction may also allay some concerns among customers and employees.

Any transaction in which owners of both entities end up with equity can be referred to as a merger. However, real mergers are rare and mergers of equals are even rarer. In fact it is widely believed that the largest "merger of equals" of all times was really nothing of the sort, and that portraying it as such contributed to its failure to thrive. Here's the way that ABC News explained it:

It was supposed to be a perfect union of carmakers.

When the two companies merged in 1998, Daimler Chairman Juergen Schrempp promised a "merger of equals." But it wasn't long before Chrysler executives complained the bullheaded Germans wouldn't listen to the Americans.

In fact, unless both owners end up with 50% of the equity, which is rare, there are no mergers of equals. Few sophisticated buyers will purchase less than 51% of a company and few sellers are willing to retain a substantial amount of equity unless they can maintain majority ownership. The sad reality is that there are few protections for minority shareholders in closely held companies. The majority shareholder can hire himself and his family members with generous compensation, he can engage in transactions with other entities that he controls, and so on in order to redirect profits to himself.

The exception to this rule is for venture capital firms and private equity groups. They are sometimes willing to buy less than 50% and management is often willing to retain less than 50% equity in transactions with these kinds of companies. The reason is that PEGs and VCs buy with the intention of growing the company and exiting the business in three to five years.

A PEG or VC has a big incentive not to play games and reduce apparent profits – they want to maximize the price that they receive for the company when they flip it. PEGS and VCs are also in the business of buying other companies and have a reputation to uphold. If a PEG buys a majority share in a company and treats the sellers, who retain a minority interest, badly, then they will find it harder to convince other sellers to retain an interest since sellers often talk to the management of companies already in the portfolio of a PEG to which they are considering selling. Management in a company that has a PEG or VC as an investor has the same incentive. Nevertheless, when we've seen offers from PEGs that are willing to purchase a minority interest in a closely held company they often contain strong protections for the minority shareholder, including the right to force the sale of the entire company to a third party.

That is not to say that a transaction cannot contain an equity component for the seller. A seller may be willing to retain a small equity position (perhaps 5%). This small share of equity can be used as a way to bridge a gap between the seller and the buyer. It may be attractive from a buyer's perspective too, since it is essentially owner financing the cost of which is directly related to the success of the business. Having the owner retain equity can also be a strong motivator if the owner will be joining the management team of the acquirer.

One structure in which the seller retains equity is the leveraged recapitalization. In a leveraged recapitalization, the company being sold takes a loan for the majority of the purchase price, the new owners put in some equity capital, and the existing owners retain an equity stake. For example, a company valued at $10,000,000 might be recapitalized as follows:

Existing owners equity capital:	1,000,000
New owners' equity capital:	1,500,000
Bank Loan:	7,500,000
Total Capital:	10,000,000

The existing owners retain 40% of the equity in the company, but pocket 9,000,000 in cash (less transaction costs and taxes of course). The owners then grow the business and exit by selling (usually in 3 to 5 years).

There are, of course, issues with this deal structure, such as the ability of the business to repay the loan from cash flow, maintaining adequate capital to grow the business, how well existing owners and new owners can work together, the skills that each party brings to the table, and how major decisions are made. An owner who wants to take money off the table, however, can take a lot of money out of the business while maintaining significant upside potential and gaining a new partner that brings skill and capital to the table.