Selling Your Business to a Competitor: Analyzing the Risk-Return Trade-offs
Prepping the sale of a company is stressful enough before bringing competitive nuances into the fray. One risky consideration when getting a deal done will always revolve around the idea of sourcing competitors as potential buyers for your business. While a source of some of the best buyers willing to pay a premium, competitors can also increase the risk of long term business sustainability. There remains a clear element of “it depends” when it comes to even considering selling-out to the competition. Below I’ll attempt to analyze the general decision, go over some of the internal and external (rhetorical and otherwise) questions to ask and finally wrap-up with some nuances we’ve seen in this process that may be helpful. In broad painted strokes, selling to the competition can be somewhat of a double-edged sword.
Why Sell to a Competitor?
There are a number of obvious reasons a competitor may have keen interest in your business.
In general, some of the best deals go to competitors. The biggest reason: they’re typically willing to pay more for a strategic acquisition and when it comes to selling a business, money talks. Competing CEOs with big egos may also find it irresistible to stoke company growth and eliminate competition by gobbling-up a competitor. Part of our process in getting a premium for your business includes building a list of both strategic and financial buyers who may have interest in an acquisition. This list is then checked and rechecked by the seller and advisor. Discussions revolving around those on the list, who should and should not be included and an overall (sometimes sensitive) strategy for outreach is had between advisor and seller. The who, what, when, where, why and how questions are asked about the list. Any potential buyers whose inclusion pose a threat are weighed carefully. In many cases, the most threatening competition is wholly eliminated from the list at the discretion of the seller, with input from the M&A advisor.
Considerations on Go/No Go
When considering whether it’s healthy to go after potential strategic competitors, building a list and doing a simple talk-through of the various options is helpful, but asking the right questions is perhaps most important. When considering whether or not to even allow a competitor to begin knowing about your “for sale” sign in the yard, there are some pointed questions that might be helpful:
- What industry are you in? While you’ll of course know this question, the answer will speak volumes as to whether in matters in selling to a competitor. We’ll discuss more on this later.
- What is your size relative to the competition? Are you a small fish in a big pond or a big fish in a small pond. Would selling to the competition constitute a merger of equals or just another drop in the bucket?
- Do you own any IP that may make the acquisition a strategic no-brainer?
- Are there customers, contracts (including employee contracts) whose inclusion in the deal would make strategic competitors hot and heavy? Or, conversely, would giving away such information before or during due diligence be a full-fledged blunder or a form of corporate treason?
- Does the potential premium outweigh the risks of reaching out?
- What is your existing relationship with said competitors? Is the relationship one of mutual respect or unhealthy disdain? In short, would the potential buyer find more pleasure in screwing you than getting a deal done?
In some instances, the risk or working with the competition is ultra low. Your may provide the same products to a similar market segment, but perhaps there’s regional separation or product differences that make the fear of a competitor unwarranted. The buyer may be looking to horizontally or vertically integrate in which case there are great synergies perhaps in customers, but the overlap in products/services is likely to be significantly limited. If you sell commodity products, the risk can be greatly mitigated.
NDAs, Employees and Customers
In an acquisition by a competitor, information requests can quickly get out of control when they start asking for things like details on issued patents, names of employees (esp. in services or staffing companies), and even direct contacts within customer companies. These types of risks are some of the largest. Despite the best-worded NDAs or Confidentiality Agreements, the risk of getting in bed with a nefarious snake still remains. So, once you do decide to do direct outreach, it’s typically best to continue with the questions that will unearth the reasons behind information requests prior to LOIs and due diligence.
One Extreme Example
We had a not-too-distant client in the oil & gas sector who was so adamant that he not sell to a competitor that it slowed the deal process down by at least 9 months and almost entirely nixed the deal altogether. The worst part of the entire process was that the seller was in a complete commodity industry. In our minds, his risk of selling to a competitor was about as great as his risk of selling his product to a customer. In other words, it was extremely low. But, as part of our initial process of building, assessing and honing his potential buyer list for his company, he just laid waste to the batch of highly-strategic, highly-liquid and extremely acquisitive potential buyers because he considered them “competition.” In reality, most of what he considered “competition” also posed a problem because they didn’t currently share any of the same customers. In short, he shot himself in the foot from the outset.
In another instance, a strategic but competing buyer–acting friendly in the pre-LOI negotiations–attempted to strong-arm the seller once in no-shop due diligence in an attempt to get strategic information and significantly decrease the selling price, even far below what a financial buyer would have been willing to pay. While the transaction was eventually consummated, it came after unneeded hair loss and brain damage.
The Fine Line to the Double-Edged Sword
Advisors and bankers walk a fine line in pitching services to potential sellers. One of the risks we run is couched in either overselling our abilities and differentiators. We’ll often inform sellers, “you’re best bet on garnering a premium will be an acquisition from ‘strategic acquirers…’” But in the same breath, there needs to be a caveat: strategic buyers are often competitors and great care needs to be exercised in the approach and negotiation phase.
The opposite extreme can also prove brash. We’ve heard competing M&A firms inform clients that they never go after a competitor when selling a business. Caution is rightly warranted, but this advice was fool-hearty and brash given the client’s business and potential for selling quickly in a highly-liquid market sector with deep regional pockets.
Balance the Risk/Return Trade-offs of Selling to a Competitor
We’ve a current client who maintains an unshakable fear that even performing “blind” outreach to the competition will somehow collapse his well-built business. Somehow another M&A consultant–thinking it would help him get the opportunity filled him with a load of crock that you never, under any circumstances, sell to the competition. Certainly a large dose of caution is required when looking for buyers within a small competitive pool, but avoiding the competition may be a massive detriment to getting a strategic M&A deal done at all. He was fed this malarkey by another advisor hoping to showcase his prowess and win the deal engagement. In doing so, he created a monster which we had to deal with.So, now our task is to undue the false indoctrinated brainwashing of our client, which may prove highly difficult.
Let’s discuss when it’s okay and when it would be a bad idea to sell directly to a competitor. First, let’s discuss our client’s business. He sells a high-volume, low-margin commodity –a company which would be difficult to do detrimental harm to even if you tried. Even if all his buyers and suppliers outright knew he was for sale, I rightly doubt it would change their buying and selling habits. Like any commodity-based product, they’re more concerned with price than the name of the company to whom they right the check.
Commodity businesses are perhaps one of the best markets where selling to a competitor is not a bad idea at all. Where no differentiation exists, the risks are far lower.
On the other hand, here are some businesses with more differentiated models where selling to a competitor becomes much more tricky:
- Technology business with Intellectual Property
- Staffing companies where employment is in high demand. This can be particularly sensitive in software staffing.
- Customer-centric services companies
In short, any company or industry where information is king should think twice about selling out the competition. If the competitors show interest, certain care should be taken with confidential and privileged information. If the info being requested by a direct competitor does not have sway on determining value, then the seller should be particularly cagey about releasing such information. The big question is relevance:
Will the data they are asking for contribute to their ability to make a judgement on the business value or could it potentially aid them in causing harm to the business?
NDAs or Confidentiality Agreements aside, protecting the business is often more important than getting a deal done.Even in specialized industries, selling to a competitor, unless they’re completely cutthroat still may not kill the business, but treading lightly is still advised, given that there are built-in incentives to screw you by steeling customers or employees prior to your deal closing. The incentives for steeling customers and/or employees becomes even more intense, the closer the competitor is to your business geographically and customerly (not a word, but I think it should help to get the point across). The point is, there are risks and such risks could be very different depending on the industry. Some such risks in pitching your M&A deal to a competitor may put customers, employees, suppliers or products at risk or it may endanger all four. Typically owners know their businesses weak spots the best. Doing a thorough “what if” in worst case scenarios may prove a helpful exercise when prepping to sell the company.
Some of the best strategic acquirers willing to pay a premium for the business will likely be competitors. Hence, completely avoiding them could be the worst decision you make in the process of preparing your business for sale. Just be sure to exercise caution.
Conclusion
No two deals, owners or managers are the same. Every opportunity has a nuances that even the most experienced advisor may find challenging. Approaching the competition with your blind profile and an NDA may not be the best move for the long-term sustainability for the business. On the other hand, it may be the best decision you ever make. It depends. Determining the direction of how you deal with the competition when selling your business will require thoughtful insight and strategic pre-planning.
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