Trade buyers have different motivations so can sometimes dig deeper – but you need to be clear on your own, says Glenn Elliott.
An entrepreneur can realise value in their business via three avenues: by selling to another company, selling a share to private equity, or listing on a stock market.
The three are very different, so as an entrepreneur, you might think it’s all about making the most money – but that’s not always the case.
Understanding each path
Let’s look at the stock market option first. This only applies to a certain number of companies, as only a small amount are appropriately sized and structured for this. A whole lot of things have to be in order for it to happen, too, such as timing and the market being in the right place.
This is then the rarest choice a Founder may have to make. So selling to another company – known as a trade sale – and private equity investment are the two most common paths.
Sometimes, a trade buyer has the potential to pay more than private equity, which may be a motivator for Founders. But before being swayed by flashing pound signs, it’s crucial to consider how different the deals are.
Trade vs PE – what’s the difference?
If you sell to a trade buyer, typically, you’re selling all of your company to another company. You normally agree to an earn-out where you work for a period, usually 12 to 24 months, with performance targets to release part of your payment.
If you choose private equity investment, you might sell about half your business to a private equity house, which backs you to carry on running it for the next four to five years, or less if you’ve said you want to transition out.
Private equity funds all work off similar financial models. They get their capital from investors who tend to be university pension funds, large family private offices, or perhaps the investment arm of a charitable foundation, and they all expect similarly sized returns.
Some firms are more confident in their ability to add value during the investment cycle, so they might pay a bit more. Some are more confident in certain sectors or types of businesses and that might also make them comfortable paying more.
But in general, there is a financial model behind private equity, so if you receive 10 bids from different firms, they are often in roughly the same ballpark.
Trade buyers sometimes underbid but sometimes can outbid. So let’s look at three reasons why trade bidders sometimes can pay more.
Occasionally, trade buyers can have deeper pockets
You might have a healthy revenue and profit, which makes you worth a certain amount to private equity. But there’s a type of trade buyer that doesn’t care about this – they just care that you’ve created a piece of technology they want now. They’re interested in this over your raw numbers and possibly also the team that helped create it.
Another reason is they might have a way of monetising your clients differently. For example, a trade buyer might be more interested in the fact you’ve got 1,000 senior corporate client relationships.
If they owned you, they could carry on selling your software, but also some other product they have, maybe insurance. They’re not actually looking at your revenue or profit lines but that they could make more money from your client base than you are.
A trade buyer might also look at your numbers and think they could make more profit from the same amount of revenue because you have duplicate cost bases, and they could make big cost savings. That could be finance, software engineering, HR, sales, or marketing. This type of trade buyer doesn’t look at your profit but how much profit they would make.
I did this myself a few years ago when we bought our biggest competitor in Australia. This was a £6 million revenue business that was barely making any profit. Their cost base overlapped with ours, so I could turn that revenue into £4 million profit, whereas they were only making up to half a million.
Making sure the deal is right
One thing that can put Founders off a trade deal is that you need to give out a lot of information – about your product, past sales, future sales, vision and more. Many entrepreneurs don’t want to give that away to a competitor, and it’s a reason they don’t pursue trade deals.
A trade acquisition is also typically the end of the road for your company as an independent vehicle. We bought seven businesses in my time at Reward Gateway, and each time, we were really buying the customer base. We immediately then subsumed the acquired brand.
Usually, it also means the end of a Founder’s involvement because it’s often a bigger company with an unfamiliar culture over which they have no control.
How to choose?
If what matters most to you is money now, and you don’t care about future involvement or what happens to your business next, then you should run a trade deal.
On the other hand, if you think, “I’d like to get some money out of the company now, but I’d like to carry on running it because our best days are ahead of us,” then private equity could be a great option.
Private equity is the solution for entrepreneurs who are fully going for it and have no intention of leaving in the next 10 years; or those who are thinking their time is coming, but aren’t quite ready to walk away. When you sell to private equity, you are still on the management team, and that’s the big difference.
In private equity, the investment period is always four to five years to double or treble investors’ money. If you want to leave early, you need to hire a new CEO, and you can discuss that upfront as part of your deal. It is also common to do a private equity deal first, then five or so years later to do a trade deal.
If you want to leave early, you can negotiate your level of involvement. It’s common to become a non-executive director – just be careful not to breathe down the new CEO’s neck.
Ultimate considerations
You might want to walk away quickly onto your next venture or retire. You might not care if you could hold on for more money later. If you want to maximise money within the short term, trade could give you the best price and closure.
If you want to maximise money in the medium term, private equity will get you more. You will sell roughly half your shares, and then in five years’ time, when the business has doubled in size, you can sell the other half, so it’s likely you will get more.
Either way, if you’re a Founder looking at your next step, you have to think about what’s right for the business and for you. I can’t tell you which you should prioritise. What I can tell you is I have been on both sides, and I’m now exactly where I need to be.
