I have observed, in buying and selling businesses, an odd phenomenon. It is what I call, “The Third Buyer.” This refers to The Third Buyer becoming the successful buyer of a property or business.
Here is how this goes down. The owner of a business decides they are ready to sell. It is an almost universal truth that the owner/seller, overvalues their asset. It is often their baby and there is an emotional attachment.
An owner also perceives the risk of owning their business very differently than potential buyers of the same business. And well they should. A business owner knows the business and the risks are relatively low. The potential buyers do not know the business and the risks are markedly higher. Remember, the value of a business is the annuity stream of the business times a multiple. And the multiple is inversely proportional to the risk perceived by potential buyers. The higher the perceived risk, the lower the multiple.
In any case, there is often a gap—sometimes a wide gap—between what the seller wants and what the buyer is willing to pay. Sometimes the gap can be closed and many times it cannot.
Adding to the likelihood of there being a substantial gap is the nature of the process. Typically, when a potential buyer provides a Letter of Intent (LOI) to a seller, the price is pretty speculative. It is only after the LOI is signed that the potential buyer begins their Due Diligence process and is allowed to inspect the books and records. That process often leads to the potential buyer reducing the price they are willing to pay, based on what they have learned.
Meanwhile, the seller has gotten comfortable with the price in the LOI and often emotionally starts to let go of the business and looks forward to retirement. The downward price adjustment, and often it isn’t just price but other terms as well, leads to difficult negotiations. And all too often, the LOI is rescinded, no deal.
With much gnashing of teeth, the business owner puts the business back on the market. Eventually, the second potential buyer is chosen, an LOI is signed, and the process is repeated. If the owner/seller’s price they want for their business is too high, the second deal will fall apart as well.
Then, we come to the Third Buyer. When the business is put up for sale again, the owner, if they have listened to what the market is telling them, often becomes more realistic about the price they are willing to accept. This leads to the Third Buyer getting the business under contract and successfully buying it, often at a price not much different from what the first and second potential buyers offered. Of course, there are other factors involved too, not least of what is the grueling process of going through Due Diligence three times. Each time can take months.
In a case such as this, you don’t want to be the first or second potential buyer, but often you don’t know where you stand or what the process has been. In some cases, I’ve seen the Third Buyer being the same as the first buyer. That is, the first buyer rescinded their offer, a second buyer came through and softened up the owner, and then the first buyer came back in and became the Third Buyer and the successful buyer.
And that is my contribution to the Mergers & Acquisitions literature, The Third Buyer.
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