Selling to Third Parties: Avoiding Tainting the Marketplace

Sun, 11/27/2016 - 20:00


In this post, we turn to one of the three primary Exit Paths, selling to a third party, and some of the challenges that most owners don’t know exist in the process. Specifically, we'll look at the concept of tainting the marketplace.

Many advisors first learn about their clients’ intentions to sell their businesses through an unexpected phone call in which their clients say, “I’ve just signed a letter of intent to sell my business. Can you look it over for me and give me your thoughts?”

Too often, owners begin the process of selling their businesses after being approached by a prospective buyer, usually weeks or months before calling a single advisor. Alarmingly, some business owners discuss and even begin negotiating the sale of their businesses without calling an advisor at all. Professional buyers prefer working with owners without advisors because owners without advisors tend to be unaware of the full range of options available to them in the mergers and acquisitions (M&A) market.

While this may seem to be a mere inconvenience to owners—in that the amount of help they could have received from their advisors was minimal or nonexistent because they either called late in the sale process or not at all—the consequences of owners navigating the sale process alone can be devastating. Owners without advisors are like lambs being led to slaughter, and they often bring their businesses and families along with them by entering the sale process alone.

Leading the lambs away from the slaughter

If and advisor's business-owning client seems to be taking the path toward a sale slaughter, there are three possible outcomes:

  1. The client sells to the best buyer for the best price (exceedingly rare)
  2. The client sells either to a less-than-ideal buyer or for a less-than-ideal price (somewhat common)
  3. The client does not sell (most common)

In this post, we will discuss the most common outcome of a buyer-initiated sale process—no sale—using a fictional case study.

No-sale Sam: How entertaining sale offers without a plan hurts value

Sam Stone founded a business in a niche market: online sales of custom-designed, organic, Middle Eastern meals. Though Sam’s market was growing, it also was dominated by four international corporations. Last year, one of the corporations approached Sam with interest in buying his business, but both parties ended up walking away after disagreements over the price to be paid for Sam’s business. During negotiations, the business’ operations and Sam’s emotions suffered because Sam dedicated most of his time to trying to sell his business.

This wasn’t Sam’s first foray into attempting to sell his business. Two years earlier, one of the other corporations approached him with interest in buying his business, but negotiations fell through when the two parties disagreed on the value of Sam’s business. Sam’s business suffered then too, since Sam spent most of his time in negotiations rather than increasing his business’ value. Both failures to sell left Sam feeling frustrated.

After two failures, Sam realized that his unplanned approach to selling his business was inadequate, inefficient, and ineffective. So, he called two investment bankers to analyze his sale prospects. Ironically, both bankers’ market analyses showed that the best buyers for Sam’s business were the two corporations he had turned down over the last two years. Both bankers approached the corporations again, but neither was interested in giving Sam’s business a second look. Thus, Sam realized that his unplanned approach was not only inadequate, inefficient, and ineffective but also damaging to his business’ value: He had turned two interested buyers into two uninterested bystanders.

Sam’s scenario is so common that professionals in the M&A community have a name for it: “tainting the marketplace.”

What can advisors do?

Business owners, for all of their successes, often are unfamiliar with the time, effort, and money required to successfully navigate the process of selling their businesses. Thus, advisors need to contact them before a professional buyer makes the decision to pursue a sale to a third party for them. Advisors must educate their clients on the following key points:

  1. The first qualified buyer to approach them is not necessarily the best qualified buyer to whom to sell. The first qualified buyer may not offer the best terms of sale.
  2. Most buyer-initiated relationships come with a caveat: They do not end in sales that maximally benefit sellers. By rushing headlong into what seems to be a great opportunity, owners give leverage to one buyer rather than making several buyers compete for the opportunity to buy the business.
  3. Responding to prospective buyers consumes—and often wastes—money and energy.
  4. Owners who respond to the likeliest buyers in their niches taint the marketplace because buyers rarely give a second look to a business they have already rejected or been rejected by. Such buyers become justifiably concerned by sellers who ask for a second consideration and often assume that something must be wrong with the business if the owner has essentially come crawling back to them.

The advisor dilemma

It can be difficult for advisors to determine how to reach out to their clients long before receiving the “I just signed a letter of intent to sell” phone call. They may not ever receive that call in the first place: According to BEI owner surveys, a mere 15% of owners have had even one conversation with their advisors about their plans to exit their businesses. To preempt the gut-wrenching “letter of intent” phone call, advisors must consistently target clients with important information regarding the most important financial event of their business lives: exiting their businesses. Advisors must take initiative, because the evidence shows that owners can’t and won’t.