Corporate Finance
Feb 21, 2023
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This guide explains what financial intermediaries are in M&A deals. We cover what intermediaries do, different types of intermediaries, and explain the rationale behind using an intermediary in an M&A deal. Here are some key takeaways about financial intermediaries in M&A:
When a seller decides to put a business up for sale, what they are actually looking for are prospective buyers that will make an offer to buy their business. When a buyer goes about looking for target companies to buy, they are looking for businesses that fit their acquisition strategy and meet their search criteria.
From the seller’s perspective, approaching prospective buyers directly is an intimidating task that often places them in a weaker negotiation position from the start. From the buyer’s perspective, the M&A process is extremely time consuming and wasteful if not carefully and deliberately approached.
In mergers and acquisitions, the term intermediary refers to the professionals or firms that help facilitate a deal between the buyer and the seller.
To better understand the concept of an intermediary, first we’ll look at an example of a different type of intermediary—outside of mergers and acquisitions.
Real estate agents are an example of an intermediary that most people are familiar with. When a seller wants to put their house on the market, they can call a real estate agent to act as an intermediary to facilitate a transaction between the buyer and seller. They will help the seller price their house and get it out to the market. Real estate agents are also sought out by home buyers in their search for a house to buy. By working with a real estate agent, the seller doesn’t need to try and market and sell their house themselves and the buyer doesn’t need to knock on random doors or search through classified ads to find a house to buy.
Along the same lines as real estate agents, intermediaries in mergers and acquisitions bring qualified buyers together with interested sellers in exchange for fees and commissions.
In mergers and acquisitions, intermediaries normally foster and maintain relationships with multiple buyers at the same time, giving them the ability to bring businesses for sale to the attention of more than one buyer at any given time. Because of this, sellers often seek out intermediaries to help them sell their business.
Before we get into the different types of intermediaries in M&A deals, we will look at the different types of buyers in mergers and acquisitions.
For purposes of M&A strategy, buyers are typically categorized into two distinct groups—financial and strategic buyers. Here, we will look at a third category of buyer as well—individual investors. These three categories of buyers are distinct in that they make acquisitions with different intentions.
Strategic buyers are other businesses looking to make acquisitions to grow their business, reduce costs, or eliminate competition. For strategic buyers, acquisitions improve the core operations of their business and are considered a growth strategy (See Organic Vs Inorganic Growth).
Financial buyers are institutions (such as private equity firms) that are non-operators, looking to use financial leverage to make acquisitions and create value through equity rate of return. For financial buyers, acquisitions are made with the intention to grow the business through a capital investment and to sell it again down the road at a profit.
For clarification, we'll briefly address a hybrid strategy that financial buyers sometimes use. Some private equity groups structure their investment thesis in a way that mimics a strategic buyers motivations for M&A. Here, the private equity group would first buy a larger business, and then use the remainder of the money the fund has raised to buy other smaller companies that work as strategic buys for the larger company they bought first. This is often referred to as a platform/roll-up strategy.
You can learn more about the distinction between financial and strategic buyers, here.
Individual investors are a third category of buyer. Individual investors are individuals looking to buy businesses as an investment, or as an alternative to a job. Individual investors are a category of buyers that are often overlooked in M&A but are responsible for the purchase of a large number of the businesses sold each year.
The distinction is that these investors normally purchase small businesses, and they normally don’t purchase in great volume. For clarity, an extremely wealthy investor, looking to buy many businesses will almost certainly structure a company as an investment group or as a family office, and that’s not what we’re referring to here. In that case, that individual is a professional investor and would almost certainly operate with a strategy much more like a financial buyer than what we mean by an individual investor. Individual investors buy small businesses to replace the current owner/operators as an alternative to a job. Normally these individual investors are coming out of a successful career—often mid-life and are looking to buy a business as a second career. For purposes of distinguishing a buyer as an individual investor, we’re assuming they are in the market for a business doing less than $10 million in annual revenue.
Now that we understand these three categories of buyers, we’ll look at how intermediaries work with these various types of buyers to facilitate M&A deals.
In mergers and acquisitions, there are also three main categories that intermediaries fall into which facilitate deals between buyers and sellers—business brokers, boutique M&A firms, and investment banks.
To better understand the distinction between these three categories of intermediaries, we’ll go back to our real estate example to add some clarity here. There are different types of real estate and different intermediaries that help put buyers and sellers together. You would go through different channels to purchase a primary residence for you and your family than you would to purchase a 100-unit apartment complex as an investment, or to buy an entire real estate group that owns multiple apartment buildings, nationwide.
Business brokers, boutique M&A firms, and investment banks offer intermediary services helping facilitate different size transactions as well. In other words, they specialize in different things. These categories of intermediaries are largely determined by the size of the businesses they have expertise in working with and the corresponding relationships they foster with buyers of businesses at these varying sizes.
Here, we will look at each of these three different types of intermediaries. As a side note, it’s important to understand that these revenue ranges are not set in stone and there will be overlap between them. If your business is on the cusp of one of these revenue ranges, it may be beneficial for you to consider moving up or down the ladder. These revenue ranges are meaningful because competition is a huge element in M&A deals. From the seller’s perspective, getting more than one buyer to make an offer will drive the price up through the competition on the deal. Naturally, the intermediary you choose should have relationships with several buyers that can afford to make offers on businesses of the seller’s size. That is why these revenue ranges serve as meaningful guidelines here—and sellers will want to go with an intermediary that is best suited to bring multiple offers on a business of their size.
First, business brokers are intermediaries that specialize in facilitating the sale of small businesses. If you are trying to sell a business doing less than $5 million in revenue, a business broker is probably your best bet. The majority of the deals that business brokers do are under $1 million in transaction size. Business brokers foster and maintain relationships with the sort of buyers that purchase small businesses. These are almost always individual investors, but may also be smaller strategic buyers looking specifically for small businesses to acquire. So, business brokers are normally a good fit for a seller if they are looking to find a buyer for a small business. As we previously explained, individual investors buy small businesses to replace the current owner/operators as an alternative to a job. Normally these individual investors are coming out of a successful career—often mid-life and are looking to buy a business as a second career. Business brokers network with these types of buyers regularly and make it their business to always have a pipeline of buyers intent on making offers for small businesses.
Second, we have boutique M&A firms. Boutique M&A firms are commonly referred to as boutique investment banks. However, the term "M&A firm" is better for purposes of clarity because most boutique firms don't offer underwriting services like larger investment banks do. These intermediaries typically focus on businesses in the lower-middle market—businesses doing between $5 million and $100 million in revenue. If you have a business in that revenue range and are looking for a sale, it’s best to look for a boutique M&A firm to help you. Specialist M&A firms can get deals done on businesses up to $250 million in revenue if they have the connections to do so.
A distinction needs to be made between boutique M&A firms and the third category of intermediary—traditional investment banks. Boutique M&A firms are businesses that specialize in facilitating M&A deals—and usually, they focus on specific industries, sectors, revenue ranges, or geographic regions. Investment banks offer an array of services in addition to acting as an intermediary in merger and acquisition deals. Traditional investment banks typically aim their services at larger corporations and additionally assist with IPOs. To learn more about investment banks and their role in the M&A process, we recommend our guide: Intro To Investment Banking.
In the past, a business owner looking to sell had fewer options available to them than they do today. Whereas in the past you pretty much needed to go through an intermediary unless you were approached directly by a buyer—today there are websites, software, and networks with the intention of putting prospective buyers together with interested sellers.
These can be confusing to business owners and at first glance these options may seem more efficient than the idea of reaching out to a stranger and starting a relationship with an intermediary like an M&A firm.
This section will focus on giving some real-world practical advice for business owners looking to sell.
As an established M&A advisory firm, we strongly advise engaging with an intermediary, especially if this is your first time selling a business. It is important to avoid attempting to navigate this process alone.
Why?
Because professional buyers are good at M&A—and you probably aren’t. Intermediaries have a wealth of experience that will benefit you greatly and they can fill the gap between what you know about your business and what you don’t know about selling it.
Here are some good reasons for using an intermediary to help you sell your business:
1. Expertise — First and foremost, intermediaries have expertise in facilitating M&A deals. This is their core business and they have likely put together tons of deals that they can draw on for experience. They are aware of the tricks that professional buyers use to get an edge over sellers, and they will protect you from making costly mistakes along the way.
2. Competition — One of the biggest keys to maximizing the purchase price of your business is competition. When you can pull multiple offers (preferably from different types of buyers) you drive the price up because the buyers need to make better offers to compete for your business.
3. Speed — Intermediaries will help you to get a deal done more quickly. The M&A process often feels tedious and drawn out, especially if you have unrealistic expectations or no prior experience with M&A. Some deals are never finished, not because the buyer backed out, but because the time it took to finish was longer than the seller had stamina for. Intermediaries will do everything they can to advance a good deal to the next steps.
4. Realistic Valuation — Many business owners are uncertain about how to go about valuing their business. Intermediaries normally provide a lot of help with the valuation and assessment of a business. They can help sellers with a more accurate valuation range and help set expectations about what a business is reasonably worth to a buyer. They can help to ensure that a seller is not underpricing their business or undervaluing what it could be worth.
5. Reduced Risk of Not Getting Offers — In this guide, we used real estate agents as an example to explain intermediaries and how they work. In some senses M&A deals are much different than residential real estate deals. In real estate, maybe a homeowner wants to list their house for sale at a high price, just to see if they can get it. If they can’t, they can always take it off the market. This strategy could prove disastrous for a business owner in an M&A setting. M&A deals take time, cost money, and open a business up to the risk that word will get out they are looking to sell. Listing a business for sale preemptively may be a big negative for a business if they inadvertently turn off some buyers that may have been a good fit, just because they tried to rush their business to market.
6. Confidentiality — Confidentiality is a huge concern for sellers in the M&A process. Intermediaries know how the M&A process works and understand how to preserve a seller’s anonymity in the early stages of the deal. This ensures that the seller is protected from information about their business leaking out by more professional standards.
