Risks of Selling to a Competitor

For many owners, deciding to sell their business is one of the biggest decisions they’ll make in their lifetime. The company’s value represents the amassing of their life’s work. Successfully selling the business at a premium price is crucial for owners to finance their dreams or fund their retirement. Finding the right buyer or investor will help you obtain premium valuation, but that person could be a competitor.

A quick Google search for “Risks of Selling to a Competitor” returns a litany of articles containing advice and personal stories, both good and bad, from entrepreneurs who were faced with this issue. Owners are wise to be familiar with these risks, and mitigate them as much as possible. 

However, these risks must be weighed against the knowledge that oftentimes a competitor or strategic acquirer is the buyer willing to ascribe the highest valuation for the company. The reason for this is simple. Strategic buyers, buyers operating in the same industry and space, often can realize the most synergies from the acquisition. These synergies can including economies of scale, acquisition of talented employees and intellectual property, cross selling opportunities, and geographic expansion.

There are several key considerations that any seller and their representative should be taking to protect the existing operation and assets of the company, in the event a transaction doesn’t go through or the competitor doesn’t end up as the eventual buyer:

Send Blinded Teaser – In order to protect and mask a company’s identity when first approaching a strategic buyer, teasers are created that reveal enough about the business to enable your competition to know if they’re interested or not, but not enough to identify what company is being sold.

Execute a Non-Disclosure Agreement (NDA) – Ensure that any material shared will be used only for the purpose of evaluating a prospective transaction. NDA’s and Confidentiality Agreements protect the company from having its employees hired away, intellectual property replicated, customers poached, and suppliers undercut.

Share Information Two Ways – While your competitor isn’t for sale, it is important for them to share important information with you for multiple reasons. First, viewing their financials can confirm they have the financial ability to undertake the acquisition. Second, understanding their operations can validate that the operational synergies they’re hoping to achieve are realistic. Finally, through sharing material both directions, it ensures that the other company has “skin in the game” to uphold and adhere to the NDA.

Provide Requested Detail Gradually – There is no need to open up all company records the moment an NDA is executed. The seller will know better than anyone what they’re comfortable sharing at each stage of the process, and the advisor should completely honor and trust their intuition. Think of it as dating. You want to release the least sensitive information first to continue confirming interest and the buyer’s desire to acquire. You typically don’t get married after the first date.

Blind Sensitive Material – Vendor and customer lists, pricing sheets, and other competitively sensitive material can be sent over with key items redacted. Customer concentration is a big concern of all buyers; you can easily send your top ten list over without the explicit names associated with each amount.

Implement a Breakup Clause – As you get to the point where you are close to signing a Letter of Intent (LOI), consider including a binding breakup clause with the LOI that results in financial consequences to the buyer if they walk away from the deal without cause. This ensures they’re not entering into the no-shop diligence phase with the intention of just walking away after they’ve gathered intelligence.

Overall, the key consideration is risk mitigation.  An experienced advisor will ensure that the correct amount of information is shared to keep competitive buyers interested without exposing their client to any potential pitfalls or threats.

Does Your Company Have a Moat?

Moats are often water filled ditches around castles and other fortified structures creating obstacles for would be attackers. Moats make it difficult for those wanting to siege the protected structure, both thwarting attacks from the ground and preventing the practice of mining, digging tunnels under the castle to cause it to collapse.

Like the castles of old, your company’s market share and profitability is under constant attack from competitive forces.

Michael Porter, author of Competitive Advantage and several other stellar books, developed something called, “Five Force Analysis”, which says companies face competition from five forces:

– Rivalry Among Existing Competitors
– Possible Entry from New Competitors
– Bargaining Power of Suppliers
– Bargaining Power of Buyers, and
– The Threat of Substitutes

An effective moat gives you a hedge of protection and even competitive advantage against these outside forces.  Like the moats used to fortify a position, your business’s defense can come in all shapes and sizes, and will often depend upon your industry, business model and the weapons used by your competition.

When fending off other industry players, manufacturers of commodity products protect their market share and margins with economies of scale, a boutique retailer brand, or a technology company high switching costs for existing customers.  Not allowing suppliers to get the upper-hand can be accomplished through tactics like supplier diversity and the ability to substitute inputs, and keeping buyers from pinching you is easier when you have diverse customer base and product differentiation.

Competitive advantages, like the “moats” mentioned here will not only protect your company’s profitability, but will also allow you to advance your market share and grow.  Lastly, moats will increase the value of your hidden wallet, the equity value in your company.  Bottom line, buyers pay significantly more for companies with a meaningful competitive advantage. If you want to understand how to protect your company’s position and take ground from others, consider reading Porter’s book “Competitive Advantage”, if you want the cliff-notes version, read Porter’s article in the Harvard Business Review here.