An auction process is frequently used to sell middle market businesses (those with sales of $5,000,000 to $1,000,000,000). The primary reason for using an auction is to raise the selling price of the business. An auction is rarely used in the sale of smaller businesses. Would it be a good practice to use the auction process to auction a smaller business for sale?
The auction process I’m discussing is a private auction process. In the sale of some large,
well-known businesses – such as professional sports teams – the auction is made public. The auction is publicized to reach as many potential buyers as possible. In these sales, the public disclosure will not hurt the value of the business. In the sale of most privately owned businesses, the owner does not want public disclosure of a potential sale because it would hurt the business.
A private auction can be conducted in many different ways. Here are the usual steps in the process when used to sell middle market businesses:
- Identifying potential buyers. Because of the likely selling price of the business, the buyer is more likely to be a business entity than an individual buyer. The M&A advisor identifies all the potential buyers for the business.
- After identifying the buyers, contact will be made with all of the ones that might have an interest in buying the business. The identity of the business will be kept confidential. The buyers will be informed that an auction process is being used, the steps in the process, and when bids will be due.
- After executing confidentiality agreements and showing financial qualifications, the buyers are given another report about the business, disclosing its identity and giving more details about its business and finances. The buyer will then be asked to present an “indication of interest”. This is a range of the price that this buyer would pay.
- The buyers willing to offer the highest price range, and who are likely to present a final offer, will be given the opportunity to meet with the owners, see the business, and given additional information about the business.
- The chosen buyers present their final offer and the sellers negotiate with the best one to reach a final deal.
Note that this covers the basics and other steps, or processes, may be included.
There are several reasons that the auction process is used to sell larger businesses:
- By not putting a price on the business, you don’t put a cap on the price.
- There may be strategic buyers who are willing to pay much more than the financial value of the business.
- Buyers are knowledgeable and don’t need a selling price to develop their offer.
- There are many potential buyers so an auction process, which creates competition between them, can be used.
- It gives all buyers time to present an indication of interest and final bid which should result in a higher sale price.
Here are some reasons why the auction process isn’t used often to sell smaller businesses:
- Many buyers make offers based on the asking price and are not familiar with, or comfortable with, developing a price. They are worried about overpaying.
- Buyers are not used to an auction process, are not comfortable with it, and would not participate.
- Many businesses don’t have a strategic value, or have a small one, so attaining a much higher price by using an auction is limited.
- There are few buyers for the business. A successful auction needs to have several buyers participating.
Nonetheless, there are some small business sales that would meet the criteria. Here are a few:
- Liquor Stores – there are typically many buyers, who may already have bought another store, and are familiar with the sale prices.
- Printers – there are many potential buyers for a printer’s book of business and they will develop an offer.
- Security Alarm Companies – Are highly sought after because of their recurring revenues and long-term contracts.
Although the auction process may not be appropriate for most small business sales, it can be an effective way to sell some businesses. It can be a good way to handle a high level of buyer interest and get the best price for the seller.