Sellers Beware: Different Types of Buyers
By Tsu-Li Liew
When a small business owner decides to sell their business, they would ideally want to find a buyer that will fit in, successfully take over and hopefully grow the business. However, it is important for an owner to know that each buyer will have their own reasons to buy an existing business, instead of building one from scratch. There are different types of buyers that a business owner might encounter when selling their business.
Knowing their motivations and their plans on running and growing a business will help the owner decide which type of buyer will be best to take over. According to Forbes, there are three main types of third-party buyers. However, individuals who are associated with the business or the business owner are potential buyers as well. Below are the different types of buyers that a business owner may come across when selling their business.
Individual buyers are regular people who could be very similar to the small business owner in terms of their outlook and goals. They are looking to buy a business in order to manage and grow it, instead of starting from scratch. There are many different reasons that an individual buyer is looking to buy and manage their own business. According to the 2016 BizBuySell Demographics of U.S. Small Business Buyers & Sellers report, the top motivations for a buyer to purchase a business is to be their own boss, to have a better income opportunity, to have a better lifestyle, to have supplemental income and wanting to leave a corporate job. The survey also notes that almost half of these individual buyers have previously been small business owners, which means they will have some experience. Individual buyers also prefer to buy businesses that are independent stores and not part of a franchise.
What sets individual buyers apart from other types of buyers is that they will be interested in the product or service that the business offers and also the infrastructure of the business. The infrastructure are aspects of the business that happen behind the scenes and will include the team of employees and the systems in place that are necessary to run the business, among others. An individual buyer will be interested in such matters because once they own the business, they will need to know this information in order to ensure a smooth transition into running the business.
In order to effectively market the business to individual buyers, the owner should focus on the value of their product or service and the effectiveness of their employees and business infrastructure. An individual buyer will likely prefer businesses that have already been established and are therefore more stable. Depending on whether the individual buyer has previous experience with managing a small business, they might appreciate some guidance about the industry and the consumers, as well as some advice on how to run the business.
Strategic buyers are either individual buyers or companies that come from a similar or related industry as the business owner. Oftentimes, they are competitors with the business owner. The main reason strategic buyers are looking to buy similar or related businesses is to add more value to their own company when both businesses are integrated. According to Investopedia, a strategic buyer expects to get more value from purchasing the business than other buyers. For these buyers, they may be able to cut costs in areas where the newly acquired business and their own business overlap. Other benefits could come from expanding their geographical reach, increasing their product offerings, and securing additional distribution channels.
For example, if a strategic buyer who runs a grocery store wants to expand their consumer base, they could offer to buy another grocery store in the next town over or a grocery store that offers different and more niche products instead. An example of this is the acquisition of Whole Foods by Amazon in 2017. When Amazon bought Whole Foods, they were able to access Whole Foods’ consumer base and its physical locations. According to the New York Times, this allowed Amazon to become a bigger player in the food and beverage market, in direct competition with Walmart, the biggest grocery retailer in the United States.
There are many reasons why selling to a strategic buyer is attractive to a business owner. Since these buyers place more value on the business than other buyers due to the additional value that a strategic buyer foresees, a business owner might be able to get a higher price when selling to a strategic buyer. Strategic buyers also tend to look at the business as a long-term investment, since they will be integrating the business into their own. This means that they will be interested in whether both businesses’ work culture will be able to mesh well together. On the other hand, the business’ brand identity and the financial performance to an extent will not matter as much to them.
However, there are some downsides to selling to a strategic buyer. As they are fusing together two businesses, there are some job positions that might become redundant. Therefore, a few employees might lose their jobs when this happens. According to Rhoades McKee, strategic buyers do not pay the full price in cash at closing and rely on seller financing as well. This means that a business owner will still be connected to the business for a time after the sale.
Financial buyers are the least common buyers that a small business owner will come across. These buyers are looking to buy businesses as an investment. Usually after three to seven years of investing in the business, they will want to sell it, preferably at a higher price than they bought it for in order to maximize their profits. Therefore, the main goal of a financial buyer is to find and buy a business that is very profitable and has room to grow. There are many types of financial buyers. In this Entrepreneur list, three of the six types of buyers are some sort of financial buyers: a private equity firm, a family office, and a holding company. Each of these types of buyers have their own advantages and disadvantages, but one thing to remember is that it is uncommon to find these buyers in the small business market.
A sale to a private equity group will take time and might cost more than a sale to other buyers, but it can be very profitable and successful, according to Rhoades McKee. It is important for a business owner to know that private equity firms want a deal done in a certain way, and it might be expensive for a small business to go through. If the owner wants to make the business the best it can be, a private equity group will be able to provide the financial means. Since private equity groups want to resell the business in a few years, the owner’s employees might find themselves out of a job when that happens. If a business owner values legacy, a deal with a private equity group might not be ideal, even if the sale price is high.
Unlike a private equity group, a family office will tend to hold onto the business for longer and be less active in its management. Their goal is to generate wealth for the family over multiple generations. However, it is very unlikely that a small business owner will find a family office buyer, unless they both operate in the same industry. Holding companies or shell companies do not sell their own products or services and only own other companies by seeking a controlling stake. They earn money through dividends of the stock of businesses they own. A business owner might be able to generate cash by selling part or all of the business to a holding company. However, in both of these cases, the owner will still be running their business. These types of buyers are great if a business owner is seeking more cash or guidance, but if the owner wants to give control over the business to someone else, these are not the ideal buyers.
There are other buyers that are much closer to a business owner than they expect, and these are the employees of the business. If an owner wants the business to maintain its current path, selling the business to an employee is a good option. Employees will know the daily operation of the business well and will be able to manage the business when the owner leaves. However, finding an employee to take over might be tough and will depend on the team that a business owner has.
Selling to employees might have other drawbacks. According to Entrepreneur, employees often do not have the money to buy the business. They might not value the business as much as the owner, since they have knowledge of the infrastructure of the business and the parts that do not work well. Approaching an employee to buy a business might also lead them to think that there are no other prospective buyers.
In the case where an employee is interested in taking over and growing the business, the owner will be able to set the price and terms. The owner can then set up a promissory note for the business as security and collateral in case they will need to step in. In order to prepare the employee to take over, the owner could start giving them more important roles in the business to see how they handle themselves and give them guidance accordingly. Inc has a general guide on selling a business to an employee.
Oftentimes, small businesses are passed on to family members. There are many different options for an owner to pass the business on, whether through gift planning, a sale of business over time, or other transition structures. A business owner should also consider having a succession plan in the event of a death, disability or sudden retirement. This plan can provide stability for the business and the employees in an uncertain time. One of the major advantages for a business owner is that they can personally train the family member early on and integrate them easily into the business, while they familiarize themselves with the team and management duties.
Rhoades McKee lists a few important questions that an owner should know the answers to when considering selling the business to a family member: 1) who is the ideal member of the family to purchase the business, 2) are other family members interested in buying the business, 3) are non-family employees on board with the change in leadership, and 4) will the owner stay on in a consulting or employment role after the sale? It is important that everyone around the business owner is on board with the change and understands the plan in order to ensure a smooth transition.
While a small business owner may encounter different types of buyers during the sale of their business, it is ultimately up to the owner to decide which buyer will be best suited to take over the business. Each buyer has their advantages and disadvantages, and it will depend on what the owner wants for their business’s future. An owner who knows the different buyers and their motivations will be able to change their marketing strategy in order to attract a certain type of buyer.
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