Understand “Buyer Hierarchy” and why it’s important.
What is “Buyer Hierarchy”? Simply put, it’s the relative potential of buyers to close a transaction based on their level of interest and financial resources. Most business owners would intuitively rank buyers in this order:
#1 (Most Likely) Key Employee
#2 (Likely) Industry Buyer (competitor, synergistic, vertical integrator etc)
#3 (Least Likely) Unknown Buyer (going to market/listing business)
While these rankings may be true for certain industries or specific businesses, this presumed buyer hierarchy is almost the opposite of reality. Business owners often believe that their buyer is “at hand” and requires just a few phone calls to implement an exit strategy.
Key employees or managers may seem like the best buyer for your business: you already have an existing relationship, they understand the business and it can be seen as a reward for years of loyal and hard work. Unfortunately, sales to key employees are very rare unless the seller is willing to play bank and finance the majority of the acquisition price. Also, skills and aptitudes that make for a reliable manager may not translate into an ownership role and a lack of financial resources by the new owner may risk the financial health of the business. Finally, if you can’t put a deal together you may risk damaging the relationship—the key employee may feel embarrassed or slighted and leave your business. You’re left without a buyer AND your key person.
You may know an “Industry Buyer” who has indicated some interest in an acquisition. The “Industry Buyer” is assumed to be financially qualified and it makes sense that an acquisition would help them grow. However, there are risks associated with approaching someone within your industry. You’ll need to disclose that you’re for sale and you’ll need to provide financials and other proprietary information. If the “Industry Buyer” is not in a position to close a deal then you’ve probably lost your confidentiality and risk losing some competiveness.
The “Unknown Buyer” seems the least likely to a seller because they are an abstract and unknown entity to a business owner. It seems simpler to first approach your key employees or someone within your industry before going out on the market. There are good reasons to put your business on the market first before approaching the “Key Employee” or “Industry Buyer”:
- Your business will be exposed to a national or international pool of buyers, increasing the chances of identifying a buyer.
- Going to market will give you a better sense of the “market price” of your business—not just what your “Industry Buyer” is willing to pay or your “Key Employee” is able to pay.
- When you do approach an “Industry Buyer” they’ll know that your business is being marketed and will be motivated to make a timely offer if interested. They may not want to risk your business being sold to a stronger competitor or new entrant.
- Maintaining confidentiality is easier with market buyers. Approaching “Industry Buyers” and “Key Employees” greatly increases the chances of losing confidentiality.
For these reasons we invert the “Buyer Hierarchy” described above. First we go out on the open market confidentially. Based on that feedback we then decide if, and who, we should approach within the industry. Finally, if we haven’t identified a buyer we’ll then discuss the pros and cons of approaching a key employee—but this is generally done as a last resort.
Understanding your buyer pool is critical to a successful transaction.
