Previously, I wrote a blog on exit strategies. It focused more on the why, when, and how of exiting a business. This second part to the topic will address the financial realities of exiting. Based on recent observations, readings, and discussions with people in the industry, I have developed a summary of what has taken place, and what guidelines can be drawn from all this activity.
Who Are the Buyers?
This discussion has to begin with who is buying whom, because there is no potential for exiting a business unless there are buyers interested in facilitating that exit. So, we need to start with defining the two broad classes of potential buyers of a talent development business: strategic buyers and financial buyers.
A strategic buyer wants to find a firm that fits its existing business model. It might include a different set of content or delivery methodology, or even geographic reach, but by and large it is intent on adding the business to its existing portfolio. Some strategic buyers want to integrate the new business into its existing umbrella brand; others will want the business to remain relatively independent. Usually, the add-on is a firm that closes a gap in the offering of the strategic buyer. A strategic buyer is not necessarily interested in selling its businesses but is in a longer-term play that will significantly add to its shareholder value, and if a publicly traded company, its earnings and stock price. Often, these companies have been around a long time and intend to be around for even longer.
A financial buyer is solely in the deal-making business: to accumulate assets for its portfolio at the lowest price, grow them, and sell them at the highest price within a relatively short window of perhaps three to six years. Usually, these are private equity companies funded privately by both individual and institutional investors who expect a strong return on their investment. These private equity firms often bundle many of their businesses into subscribed funds that have specific time period and earn-out specifications.
These buyers’ one goal is to grow their businesses on both top and bottom lines as quickly as possible so they are attractive to other buyers. This is often orchestrated by buying a “platform” firm, which is already doing well or may even be an industry leader. In these cases, the added firms often lose their branded identify and fall under that of the purchasing company. Or, in some cases, a total rebranding takes place of the consolidated firm.
What Are the Pros and Cons of Buyers?
One of the main differences between these two types of buyers is time: It is much shorter for a financial buyer than for a strategic buyer. Also, the financial buyer has much more pressure to perform over this shorter period, whereas the strategic buyer can wait it out for a while.
Integration is typically more of a challenge for a strategic buyer who wants to bring the businesses together under the same umbrella. This involves a likely change in leadership and the challenge of integrating cultures. There are of course financial economies of scale for the strategic buyer, who can streamline back-office operations rather than having separate operations for each business it acquires. For example, John Wiley & Sons has bought five companies; each maintains its own brand, but is also a “John Wiley Company.” They benefit from consolidated HR and, in some cases, IT services.
For most financial buyers, particularly those in private equity, there is little interest or benefit in integrating back office operations across many of its portfolio firms, because it sells these as separate entities rather than in bundles.
One distinct difference is in how these buyers evaluate and retain senior leadership. While both carefully conduct their due diligence around the senior leadership team, strategic buyers typically put more emphasis on the quality of the team, especially the CEO. This is largely because they intend to keep the firm for an extended amount of time and expect that CEO to protect the culture of its business, integrate capabilities with other businesses under the same umbrella, and take the business to a new level.
Financial buyers are typically quicker to pull the cord on CEOs and senior leadership team members if they don’t think they have what it takes to grow the business rapidly. In every case in which I have been a board member of a private-equity-owned firm, the CEO was replaced within a year with someone who had a track record of growing much larger businesses.
What Are They Paying?
Because most of the purchases taking place in the talent development industry are by private firms, it is difficult to truly know the prices paid for acquired companies. And, some of the public companies do not necessarily disclose relatively small purchases within their total business, or in some ways mask these individual purchases. But we can at least come to some educated guesses and provide some high-level guidelines from secondary research.
Some strategic buyers have relatively scarce assets and plenty of cash, so buyers will typically spend a premium, eventually obtaining enough scalability to fit into a strategic road map. They intend to be in the business for the long haul, so overpaying isn’t that critical. But, failure to integrate and deliver on growth objectives and retain leadership talent can create significant problems. So, strategic buyers try to meet the asking price of the seller and negotiate hard around managing the risk associated with these issues.
For the financial buyer, purchase prices, and therefore multiples, depend heavily on three factors: growth rate, cyclicality, and margins. If a company has 10+ percent of CAGR (ideally recurring revenue) and 20+ percent EBITDA margin, it can easily trade for 10-12x EBITDA in today’s market. But typical training companies trade at 6-9x EBITDA, and at .75 to 1.2x revenue, because they tend to be cyclical without recurring revenue. One commonality across deals, whether strategic or financial, is that 95 percent of them involve some type of earn-out. But it isn’t unlikely for 40-60 percent to be paid in up-front cash, with the remaining amount paid out over two to three years depending on performance. This is one way the buying company protects its investment.
Another relative commonality across types of buyers are the criteria considered when considering a purchase. Although both look strongly at the financial condition of the business, the financial buyer typically ranks these criteria in the following order: gross margin, EBITDA, EBITDA growth, revenue, and revenue growth. In addition, the quality of clients and the intellectual property “owned” by the business are key purchase criteria, with the latter being very important to a strategic buyer.
Who Is Attractive?
Firms that focus on one, or just a few, targeted audiences are more attractive than those trying to meet the needs of all audiences. This could be industry- or job-specific.
In addition, very attractive firms are those in the business of governance and compliance, wherein companies are required by their industries to meet certain criteria for operating, and which often require certification. Examples include everything from corporate legal, ethical, and diversity compliance to certification for HVAC technicians, mortgage brokers, financial planners, and other trades. Firms with a recurring revenue gained through subscriptions, SaaS business models, and platform libraries are also attractive, in that performance is more predictable and therefore more manageable. The steady flow of cash, assuming high retention rates, makes these businesses much easier to control. Of course, possessing a very clear and uncomplicated offer is key to being attractive as a seller, and owning a significant portion of market share adds to this attractiveness.
Other factors affecting both attractiveness and accompanying valuations include revenue growth, concentration of customers, recurring revenue sources, management team caliber, and market concentration of customers. On the other hand, companies that are not attractive targets are those with poor leadership, in highly competitive markets, that try to be all things to all people, and simply lack discernable differences in the marketplace.
Are you ready to exit? If not, what do you need to do to better prepare you and your business? If you are, do you have a plan for when and what type of buyer you desire? Most important, do you have a good idea of what your expectations are for such a process?