If you’re wondering what will happen to your business when you retire, you’re not alone. According to a recent survey, the most pressing challenge facing small business owners is developing an exit strategy.
If your business has stable, significant revenue, a diverse client base, and consistent EBIT (earnings before interest and taxes) of between $500,000 and $3 million, you’re a successful Main Street business owner.
Many articles will tell you how difficult it is to sell a Main Street business. Some will even tell you it’s impossible. The process can be challenging, but it’s certainly not impossible. According to PitchBook, as of September 30, 39 percent of all deals this year were under $25 million in transaction size.
Here are seven types of buyers who actively pursue Main Street deals:
The most basic type of buyer is one private individual. She may be recently retired and looking for a way to spend her time, or she may be looking for a way to generate higher returns on investable resources.
The advantages of an individual buyer include the possibility that she may be interested in day-to-day management, does not have conflicts from a board or outside investors to whom she’s accountable, and will have a direct, vested interest in the company’s success. Depending on her background, she may also bring valuable expertise and relationships to the business.
But individual buyers also have downsides. Available capital is limited to her personal wealth, sometimes creating financial strain if the business were to temporarily struggle. Her risk tolerance may be overly limited, and your entity’s future will now be dependent on the health and capacity of the new owner. By definition, she won’t have a staff to help provide additional consulting or resources, and she may become distracted during personally challenging times.
According to Pepperdine Private Capital Markets’ Q1 2014 MarketPulse Report, individuals who had not previously owned a business purchased 40 percent and 36 percent of firms $1 million to $2 million and $2 million to $5 million in transaction size, respectively. Individuals who had previously owned a business purchased 20 percent of firms in the $1 million to $2 million sector, 21 percent in the $2 million to $5 million sector, and 13 percent of those in the $5 million to $50 million sector.
2. Family Offices
As the name implies, a family office manages the wealth of a single family. Recent trends indicate that family offices are increasingly investing in private businesses as an investment class.
The advantages of a family office are the availability of capital and, depending on how your business is best run, a lack of involvement from the new owner.
The disadvantages of a family office include their limited interest in the business as anything more than an investment and, depending on the deal structure, their requirements to operate the business in a particular manner.
3. Search Funds
Search funds are made up of one or two individuals (usually recent MBA graduates or entrepreneurs) who are being compensated by a pool of investors to seek out a viable deal over usually two years. Once the search team identifies a good deal, they must then go back to investors to raise the capital needed to purchase the business.
The advantage of a search fund is their ability to replace outgoing management that will focus solely on the business.
The disadvantages of a search fund — beyond the fact that they don’t have guaranteed capital — include an investor group with high expectations and a short time horizon and a leadership team that is inexperienced. The buyer group will be hands-on and usually directive in their approach.
Search fund buyers are great fits for more easy-to-run businesses, with outgoing management and ownership that is intertwined.
4. Private Equity Firms
More private equity firms are starting to create funds to target the lower middle market. A traditional private equity firm first raises money from investors (limited partners) to create a fund and then deploys the capital raised.
The advantages of PE are the availability of capital, the resources they’ll bring to bear on the business, which differ by firm, and expertise and experience of those involved in the deal.
The disadvantages of PE are extreme selectivity in their targets (meaning you’re less likely to fit their criteria), expectations on returns, the heavy use of debt to finance the deal, and a short holding period of almost always less than 10 years. This can cause decisions to be made that are against the business’s long-term best interest.
Additionally, PE firms don’t actively manage the day-to-day of a business, which may be preferable if your company already has capable non-owner management.
According to the MarketWatch Report, in Q1 of 2014, PE firms bought 10 percent of firms in the $1 million to $2 million sector, made no purchases in the $2 million to $5 million sector, and represented 67 percent of closed transactions in the $5 million to $50 million sector.
Although it can sting, a competitor may be an excellent option. They know your industry, have familiarity with your practices, and understand the risks and rewards of your business model without doing extensive research. Plus, transitional management is rarely a concern.
The disadvantages of strategic acquisition by competitors include unknown capital limitations on the buyer’s part, exposing sensitive information without a guarantee of purchase, and the risk that a competitor may buy to dramatically alter the nature of the business, including significant layoffs due to synergies.
Another type of strategic acquirer consists of the entities that supply to you and that you supply to. For suppliers, buying your company represents an opportunity to vertically integrate.
Like competitors, suppliers will have a good understanding of your industry. Unlike competitors, however, suppliers have a vested interest in seeing your offerings maintained.
Beyond unknown capital limitations, the primary disadvantage of strategic acquisition by supplier include the likelihood of a radical restructuring to absorb your offerings into their existing structure.
7. Nontraditional Entities
There are other entities that don’t perfectly match any of the descriptions above but also buy Main Street companies.
As an example, adventur.es uses excess cash from its existing portfolio to purchase companies, searching like a PE firm but without the pressures of limited partners or a need to divest a certain period of time.
Nontraditional entities may be harder to identify, and their advantages and disadvantages are unique to their structure.
Finding the right buyer is a process, but it’s possible. Reaching out to family offices, investment firms, and brokers are good first steps to gauge interest.
This post was originally published on Forbes.