Most people would think that it is more difficult to sell a large company than a small company. As he explains in his latest Corporate Finance Column, Les Nemethy is not one of those people.
While there are exceptions to every rule, I would suggest that it is easier to sell a larger company than a small company, everything else being equal, for the following five reasons, some of which are inter-related:
1 Investors are typically looking for larger acquisitions that will “move the needle”.
Depending on the industry, it becomes more difficult to find investors for companies with less than EUR 8-10 million in revenues and at least EUR 1 mln in cash flow.
2 It takes just as much work to buy or sell a small company as a large.
Because of the difficulty in obtaining information, sometimes it even requires more effort to conclude a transaction with respect to a small business. Transaction costs as a percentage of transaction size are therefore much higher for small companies.
3 It is harder to obtain quality information from a small company.
Small companies often lack systems, whether Customer Relationship Management (CRM), Enterprise Resource Management (ERM), or even more sophisticated accounting packages that permit sophisticated management accounting analysis. Often smaller companies are run by an owner-manager who keeps information on excel spreadsheets. When performing due diligence on a smaller company, obtaining appropriate information is like pulling teeth. A good advisor can be worth his weight in gold in helping the owner of a small company prepare for a due diligence; alas, small companies are least able to afford good advisors (part of the “trap”).
4 Small companies may lack depth in management.
Often the CEO is a “one man show”, and the company lacks a second tier of management capable of independently making decisions. As the owner of a company typically leaves after his company is acquired, this may leave an acquiror in a precarious situation. This lack of management depth also creates a certain level of risk for small companies: in a large company, if someone leaves, a colleague is usually immediately available to fill the position. In a small company, the replacement will more likely be recruited from outside, adding delay and risk. Large companies are generally able to afford better staff and may have a little more built-in staff redundancy.
5 Valuation of larger companies is often more advantageous.
Certainly than for smaller companies, commanding substantially higher multiples of revenues, cash flow, EBITDA (Earnings before Interest, Tax, and Depreciation), etc.
I call this a “trap” because the above factors may make a small company completely unsaleable, or if saleable, at a valuation where the owner is unwilling to sell. For example, years ago, we had a sale mandate for a EUR 3 mln revenue business that organized conferences, where no buyer was willing to step forward, because the two owners of the business had full control of all information and sales, and the business would probably not have been able to sustain or grow revenues in the hands of a new manager.
So if you are the owner of a small-ish company, what steps might you take to make your company more saleable?
1 Identify one or more ideal buyers.
Who do you think might want to buy your business? Consider evolving your business in a direction that would be desirable to these buyers (e.g. market segments served, types of clients, etc.)
2 Aim to become a larger company.
You can do so by organic growth, merger or acquisition. This growth should ideally not be by way of diversification, but focused on a single core business, if possible.
3 Qualitatively improving the company.
Having it run more like a large company (e.g. with a high quality management team, better systems, better corporate governance) can help at least partially to dig the company out of the trap. Of course this must be carefully balanced with keeping expenses in check, and maintaining financial performance.
4 Prepare thoroughly for a sale.
Create an excellent teaser, information memorandum and data room, which will signal to investors that the company is well-managed and capable of generating quality information. This may help shift the cost/benefit of investors in favor of considering an investment in your company. A good advisor may help you anticipate the type of information an investor will require and prepare extensive information disclosure.
5 Be prepared to stay on for a longer transition.
This will help reduce risk for investors, particularly where there is an “earn-out” type transaction (e.g. 20-30% of the sale price is paid out one or two years after the first closing).
6 Select advisors that you can trust.
Carefully select your advisory team, lawyers and, if possible, financial advisors. Ideally, each should have many similar transactions under their belt.
There is no guarantee that the above measures will work, but they should take you in the right direction.
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.