EXIT STRATEGIES: Strategic vs financial exits

Businesses acquired by corporations can be expected to have both financial and strategic contributions. Many acquisitions are undertaken for roll-up, consolidation or expansion purposes. These businesses typically are purchased to add revenue and profit generation through their own inherent operations although the acquirer may gain some synergistic benefits from operating at a larger scale or some benefits through reducing duplicate functions, but the prime consideration is generating operating profit from the business purchased.

The purchase price would be driven by the current and potential profit of the acquired business itself.

While the additional synergies may make it more attractive, the seller would need to prepare the business for a financial buyer. Acquired businesses which are expected to contribute significant synergistic benefits to the acquiring corporation may contribute little inherent profit.

They are acquired because of the benefits which the acquiring corporation expects to achieve through the combination of the businesses. In most cases, these acquired businesses bring some asset or capability to the acquirer which the corporation is able to leverage through their own operations thereby generating significant future revenue and profits for the acquirer.

A seller who was able to make such a contribution would seek out a strategic buyer. Some firms will be able to do both. That is, they will have good profit capabilities and also be able to provide strategic benefits to the acquirer. But one will be more significant than the other. To the extent that strategic value benefits are greater than inherent profitability benefits, the seller would be much better off seeking a strategic buyer. Financial sales are always going to be limited by the profit generating capability of the seller.

A strategic sale, however, is only limited by the size of the opportunity generated within the acquiring corporation. Thus, a very large corporation which can significantly leverage the strategic contribution of a small acquisition may be prepared to pay many times its financial sale value to ensure it receives the benefits of the acquisition rather than allow it to be acquired by one of its competitors.

Financial or strategic sale: which one?

I often confront entrepreneurs with a stark choice – what is the best strategy to prepare your business for a sale – build up the profits or develop underlying assets and capabilities for a strategic sale. You might well ask ‘Why can’t you do both?”.

I am sure some companies have both financial and strategic value, but when they look at the processes involved and the priorities which will determine where to use their surplus cash, you often see a clear choice – they don’t have the resources to do both so they need to decide which strategy is going to generate the highest exit price.

There is sometimes the possibility that a single venture can throw off more than one exit. This can happen where the firm has developed IP across multiple markets or solves quite different problems. It may be worth separating the different IP into distinct ventures and preparing each for an exit.

Another possibility is that a single venture may have quite different activities each of which could be directed towards their own sale, perhaps with some being financial sales and others being strategic sales. This can happen, for example, where IP is the basis of a sales transaction of a product but is then followed by maintenance or service sales.

The IP may appeal to a global corporation but they may have no interest in the local services business. In such a case, it may be worthwhile splitting the business and selling the different parts to different buyers.

Companies which are sold as a financial sale are those which provide the buyer with a platform which enables the buyer to generate a stream of future earnings through the use of the resources contained within the acquired business. While these might be augmented by the buyer through the insertion of better processes, more capable management and better funding, essentially it is the same underlying business which is generating the profit stream.

Thus any acquisition valuation will be based on the net present value of those future earnings. Most businesses fall into this category. Financial buyers typically buy retail, wholesale, light manufacturing, transport, property and services based businesses.

You increase the value of such businesses by reducing the inherent risks for the buyer, improving the visibility and reliability of future earnings forecasts, improving on-going profitability, building growth into the business and finding ways to create growth potential for the buyer.

The preparation process involved in selling a business to a financial buyer will be extensively reviewed in later chapters. By contrast, those businesses which appeal to strategic buyers have some underlying assets or capabilities which a large corporation can exploit through the buyer’s own organization. Small companies will often develop products or services which can be sold by the acquirer through their very large distribution channels. In the right circumstances, a buyer might be able to scale the revenue by 50 to 100 times that of the seller just by having the right access to global customers.

The key to a strategic sale is to find a large corporation which can exploit the underlying asset or capability of the seller to generate very large revenues. In these situations the size, revenue, number of customers or employees or level of profits of the seller may be entirely irrelevant. It is the size of the revenue opportunity of the buyer which is the key to strategic value.

A business which has the right type of assets or capabilities which can generate strategic value may be much better off putting additional effort into developing those assets and capabilities to provide greater or earlier revenue generating power for the intended buyer. A higher exit price will be achieved if the buyer can scale or replicate the asset or capability faster and can integrate the seller’s business quicker.

The only size consideration for the seller is to be big enough to provide the launch platform for the buyer to fully and quickly exploit the strategic value. The process of preparing a business for a strategic buyer will be reviewed in later chapters.

Entrepreneurs need to be sensitive to these two types of ventures as it directly impacts on the manner in which the business would be developed for an exit.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. A series of free eBooks for entrepreneurs and angel and VC investors can be found at his site here.