Wow did I get a real world demonstration of the saying, "Beauty is in the eyes of the beholder," recently. If I could rephrase that to the business sale situation it could be, "Strategic value is in the eyes of each unique buyer." We were representing a small company that had an online hospital information system - specifically, a nurse staffing and shift bidding and scheduling application. They had received a handful of sales from some of the early adapters in the hospital industry.

Raising Capital vs. Selling

The owner was at a crossroads. To keep up with their very well funded competitor (some of the Web MD investors launched a competing product), they recognized that they would require a substantial capital investment. They understood that they had a window of opportunity to achieve a meaningful footprint before their much better capitalized competitor established market dominance. They realized that their ability to scale was critical to their ultimate success and felt their best route was to sell out to a strategic buyer.
The good news is that the owner made a very sound decision going this route rather than trying to raise capital. Speed to market was critical and he reasoned that the strategic acquirer route would be more expeditious than the capital raise approach. He recognized that his company, standing alone would not be able to overcome the conservative hospital decision process of going with the well-known, branded, larger vendor.

Identifying the Perfect Buyer

The ideal company buyer is a larger company that provides information technology and software products in the human resources and staffing departments within hospitals. They could plug this software capability into their existing product line and distribution channel and immediately drive additional sales. They would strengthen their position within their accounts and prospects by offering an additional productivity enhancing product that would promote companion product sales. It would also provide a unique door-opener to other major accounts that would want this high ROI product.
With the input from our clients, we located a handful of companies that fit this profile. We were pretty excited at the prospects of our potential buyers recognizing all of these value drivers and making purchase offers that were not based on historical financial performance. The book, memorandum, confidential business review, executive summary, or whatever your investment banker or merger and acquisition advisor calls it, will certainly point out all of the strategic value that this company can provide the company that is lucky enough to buy it.
As part of the buying process, we usually distribute the "book" and then get a round of additional questions from the buyer. We submit those to our client and then provide the answers to the buyer with a request for a conference call. We had moved the process to this point with two buyers that we thought were similar strategic buyers. The two conference calls were surprisingly totally different.

Option #1: The Financial Buyer

The first one included the M&A advisor and the Chief Financial Officer. Their questions really indicated that they were used to analyzing potential acquisitions strictly from a financial perspective. They focused on our client's EBITDA, gross margin, growth rate, cost of customer acquisition and other historical financial metrics. We had a very bad vibe from these guys. They were refusing to recognize that this was a high gross margin product growing in sales to more than 200% year-over-year, and had a higher level of selling and promotional expense than a mature commodity software application. We couldn't determine if they just didn't get it or were being dumb like a fox to dampen our value expectations.

Option #2: The Strategic Buyer

The second call from the other company included the M&A advisor and the HR systems product manager. The whole tone of the questioning was different. The questions focused on growth in sales, pricing power, new client potential, growth strategy, their status at the major accounts, and ownership of intellectual property.

Differences in Purchase Offers

Well, we got the initial offers and they could not have been more different. The first company could not get beyond evaluating the acquisition as if it were moving forward in the hands of the current owner and with his ability to grow the business. Their offer was an EBITDA multiple bid without taking into consideration that the product sales had grown to more than 200% year-over-year and the marketing and promotional expenses were heavily front end loaded. In spite of our efforts to convey that this was a competitive bid situation and that we were in front of their competitors, they refused to be moved off this financial approach to the valuation of this high-potential product.
The second company understood the strategic value and they reflected it in their offer. We had done a good deal of strategic positioning with this buyer. We discussed with them the tremendous potential growth rate they could achieve with this product being incorporated into their product portfolio and being sold into their install base, and prospects through their highly developed distribution channels. We recognized that they would not pay for this potential with all cash at closing. So, we encouraged them to include a significant portion of transaction value in an earnout based on product sales over the next three years.
The financial buyer's first offer was all cash at close. When we compared that offer to the conservative mid-point of our strategic buyer's combined cash and earnout offer, our transaction value was 300% higher with the strategic buyer. This was the biggest disparity between offers I have ever experienced, but it was quite instructive as to the necessity to get multiple opinions by the market of potential buyers. This is especially important where a meaningful percentage of the company's value is contained in their technology and intellectual property.

Establish Strategic Value

There are some companies that, no matter how hard we try, will not be perceived as a strategic acquisition by any buyer and they are going to sell at a financial multiple. Those companies are often Main Street type companies like gas stations, convenience stores and dry cleaners that are acquired by individual buyers. If you are a B2B company, software, high-tech, health care technology company, have a competitive niche, and are not selling into a commodity type pricing structure, it is important to get multiple buyers involved and to get at least one of those buyers to acknowledge the strategic value.
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