Strategic Sale: Selling to a Buyer in the Same Industry

A strategic sale is the sale of a whole position to a buyer that already operates in the same industry. The buyer takes control, folds the business into its own and runs it. For the seller that means one counterparty, diligence run by somebody who already knows the market, and a competitor holding its commercial information while the transaction is still uncertain.

One fact sits under everything that follows, and it is worth holding on to before any process or any arithmetic arrives. The buyer's own business is inside the transaction. A fund buying a company is buying an asset it will hold and later sell to somebody else. A buyer already in the industry is buying something it intends to absorb, staff, rename and run alongside what it already has. The difference between holding an asset and absorbing one changes what the buyer asks to see, what it will do on the morning after the money moves, and what the seller risks by showing it anything at all. Every step below is a consequence of that one fact. Treat a sale to somebody in the same industry as an ordinary sale with a different name on the payment, and the sequence comes out right while the risks come out wrong.

Take the everyday version first. A woman runs a small tuition centre with sixty students, two rented rooms and three teachers. Two people want to buy it. One is a retired bank officer who wants somewhere to put savings and would keep her running the place exactly as she runs it now. The other is the bigger tuition centre two streets away. The bigger centre already teaches four hundred students and wants her sixty, so it will ask to see her fee list, her teachers' salaries and the name of every parent who pays her, and it will keep all of that in its head whether or not it ever pays her a rupee. If it buys, it also intends to close her two rooms and move her students into its own building. The same price on paper, and an entirely different transaction.

What makes a sale strategic, and what is it not?

A strategic saleThe sale of a whole position to a buyer that already runs a business in the same industry. is defined by who the buyer is, not by how large the price is and not by how the transaction is papered. The buyer already operates in the industry the target sits in, or in one close enough that the two businesses touch the same customers, the same suppliers or the same authority. The buyer is buying an operating business in order to operate it.

Three things are usually true of the position being sold, and all three matter for what follows. The seller is selling the whole of what it has rather than a slice of it. The buyer is taking controlEnough of a company to decide what it does, which is what a whole position usually carries., so it decides what the company does next without needing anybody else to agree. And because it is folded into the buyer's own operation, the company stops existing as a separate business at some point after the money moves. The third consequence is the easiest of the three to skip past, and it is the one the people inside the company feel first.

A definition is sharpened by what it excludes, so take the negatives now. A sale to another fund is not a strategic sale, whatever the price: that buyer is buying an asset to hold and sell again, and it has no operation to fold anything into. Selling shares through a public offering is not a strategic sale either. The shares go to many buyers and no single one of them takes control of anything. Selling an interest in the fund itself, rather than in the company, is a third transaction again. None of those three is the subject here. A strategic sale is one buyer, the whole position, and a buyer that will run what it has bought.

How does the transaction actually run, from first approach to cash?

Nine steps, in the same order almost every time. The order is not a convention somebody chose. Each step exists because the one before it left a question open, and the whole shape of the seller's bargaining position is decided by where in the nine it currently stands.

Step one is the approach. Somebody raises the possibility, and it can come from either side: the seller runs a process and writes to a list of possible buyers, or a buyer in the industry writes in unasked. Step two is the confidentiality undertakingA signed promise about what a prospective buyer may do with what it is shown.. The undertaking is signed before anything useful is shared, and it sets out what the bidder may do with what it sees. Step three is the information itself: management accounts, the customer list, the contracts, the salary schedule, the borrowings. Step four is the point where written numbers arrive, each one a non-binding offerA written price and structure that does not yet oblige the buyer to complete., a price and a shape the bidder is not yet obliged to honour.

Step five is exclusivityA period in which the seller agrees to negotiate with one bidder and nobody else., and it is the hinge of the whole sequence. Step six is diligence proper. The bidder brings accountants, lawyers and its own operating people through the business. Step seven is signature. Step eight is the period in which the conditions attached to that signature are worked through. Step nine is completionThe moment shares and money actually change hands., the day shares and money actually change hands. The seller has somewhere else to go for the first four steps and nowhere else to go for the last five, and that is the single most useful thing to know about the sequence.

A longer process is not automatically the better one, and a seller need not always run one. The count of alternatives is simply a real quantity, it moves, and it moves in one direction only. Everything a seller negotiates after step five is negotiated by a party whose count has already gone to one.

What does a seller give up the moment it grants exclusivity?

Its alternative, and nothing else. One alternative sounds small until the alternative is named properly: the only thing that made the first price a price rather than a suggestion. A bidder that knows another bidder is reading the same accounts is negotiating against a number it cannot see. A bidder that knows it is the only one left is negotiating against nothing.

Exclusivity is usually asked for honestly and for a defensible reason. Diligence on an operating business costs the bidder real money: accountants, lawyers, environmental and technical specialists, its own operating staff pulled off their jobs for weeks. A bidder that spends all of that and then loses to somebody who spent nothing has funded a competitor's homework. So the bidder asks the seller to stop talking to anybody else for a defined period. The seller usually agrees, because refusing means the bidder may not start at all.

The cost of exclusivity is not the period it runs for; it is the point in the sequence at which it is granted. Granted after several written offers have arrived, it costs the seller a delay and a known price it can return to if the bidder walks. Granted before any written offer exists, it costs the seller the entire comparison. There is nothing to return to, and the bidder is free to revise its thinking downwards during diligence knowing the seller has no second chair to look at. The downward revision has a name in the trade, and the name matters less than the mechanism: the number moves after the alternatives are gone, not before.

Here is the household version, and it lands harder than the corporate one. A man is selling a second-hand two-wheeler. Three people have seen it and one has offered a number out loud. A fourth asks him to promise not to show it to anybody for two weeks while he arranges money and has a mechanic look at it. With that one spoken offer written down, the promise costs two weeks. With nothing written down and the other three turned away, in two weeks the mechanic finds a scratch, the number drops, and the three others have bought something else.

What does a buyer already in the industry read closely, and what does it barely open?

The buyer's own operation now shows up inside the process. A buyer that already runs the same kind of business is not trying to learn the industry. The buyer is trying to learn this company, and specifically the parts of this company that will collide with what it already has.

Four things get read line by line. The customer contracts come first, and the buyer wants to know which of them survive a change of control and which of them are with customers it already serves. The people come next. A buyer that already employs people doing the same jobs needs to know who is contracted for how long and on what terms. Then the systems: two billing platforms, two sets of records and two ways of booking revenue have to become one. And last the liabilities. A buyer that will run the business inherits every dispute, every tax position and every promise made to a supplier.

One thing gets barely opened. The market study, the industry outlook, the section of the seller's own presentation explaining how large the market is and how fast it is growing. A buyer already in that market does not need a stranger to describe it, and reading a seller's description of a market the buyer serves every day tells the buyer nothing it did not know at breakfast. A seller who spends four weeks preparing that section for a buyer of this kind has spent four weeks well only if a different kind of bidder is also in the process.

There is a second consequence and it runs the other way. Because this buyer knows the industry, it also knows which questions to ask that a stranger would not think of. The buyer knows that a particular customer in this market pays late. The buyer knows which supplier contract in this market carries an unusual clause. And the buyer knows what staff in these roles are actually paid, so a salary schedule that looks reasonable to an outsider can look like an understaffing problem to somebody who employs forty of the same people. A seller preparing for this buyer prepares for sharper questions on a narrower list, not for gentler questions.

What does it cost to show the inside of a business to a competitor?

Something real, and it is paid at step three, long before anybody knows whether the transaction will happen. No other kind of sale carries that cost, and the cost is the reason a seller thinks harder about who to let in than about what to charge them.

Take the list the buyer asks for. Every customer by name and by what each one pays. The discount given to the largest account and the date that discount was last renegotiated. The staff salaries. The supplier that gives the best terms, and the reason it does. Where the margin actually sits inside the business, as opposed to where the presentation says it sits. A fund reading all of that learns about an asset it might buy. A buyer already in the industry reads the same file and learns about a rival it competes with on Monday.

The confidentiality undertaking is the seller's protection, and precision about its reach matters. The undertaking can restrict use: the information may be used only to consider this transaction. The undertaking can require the copies back. The undertaking can name what happens if those promises are broken. No undertaking anywhere can make a competitor forget what it read, and a competitor that walks away still competes tomorrow with everything it learned yesterday.

Forgetting cannot be enforced, so an experienced seller stages the information rather than opening everything at once. Ranges before exact figures. Customers by category before customers by name. The most commercially sensitive material held back until the bidder has put a number in writing and is close to signature. The staging is not distrust and it is not a negotiating trick. Staging matches the depth of what is shown to the seriousness of what has been promised, so the cost of a collapse is smaller the earlier the collapse comes.

What is actually being sold, beyond the shares?

The shares are the item everybody names and they are the least complicated thing in the transaction. Shares transfer by a form and a register entry. A business is a bundle of promises made to other people, and several of those promises say something about what happens if the shareholder changes. Everything attached to the shares is what makes a strategic sale slow.

Six things move on completion day. The shares themselves. Control of the board, so directors resign and new directors are appointed at a meeting minuted that day. The customer contracts, some of which name a change of control and give the customer a right when one happens. The borrowings, together with any security given for them. The leases on whatever premises the business runs from. And the people. Their employment usually moves with the business without anybody signing anything, which is exactly why it surprises them.

Five of those six can carry somebody else's signature, and that consent list, rather than the price, is what decides how long the transaction takes. A seller who has read every customer contract before starting knows which consents it needs. A seller who has not will discover them during diligence, in front of the buyer, at the worst possible moment to learn that the largest customer can walk.

What has to turn true between signature and completion?

A signature is not a payment. A signature is a promise to complete if a list of things happens, and that list has a name: the conditions precedentThe things that must happen between signature and completion before the money moves.. Until every one of them is satisfied, the seller has a signed agreement and no cash. The distance between signature and cash is the single most common misreading of a transaction announcement, including by people who work near the subject: the day the agreement is signed is the day the news appears, and it is not the day anybody is paid.

The list is drawn from the consents named a moment ago plus anything an authority requires. Each item is either true or not true. There is no partial credit and no averaging. Completion is simply the day the last item on the list turns true, and if one item never turns true the signature stands and no money moves.

Which approvals sit outside both parties altogether?

Some of the conditions on that list are inside the parties' control. The company's own board can be convened. A lender can be telephoned. A landlord can be visited. Others belong to an authority that answers to its own procedure and its own timetable, so they sit inside nobody's control and neither the seller nor the buyer can speed them up.

The conditions attaching to a share transfer, to a company's filings and to a change in who controls a business are set by the authorities named below, and they are amended from time to time. A threshold that held last year may not hold this year. The authority is named, the current text sits at its own site, and any remembered figure is a thing to check rather than a thing to use.

What happens to the business on the morning after completion?

The company stops being a separate business. Not immediately in every case and not all at once, but the direction holds, and the folding-in is the part of a strategic sale that gets left out of every summary of one. IntegrationFolding the bought business into the buyer's existing operation. is the whole reason this buyer paid what it paid, so the buyer has every reason to get on with it.

Two finance departments become one. Two sets of accounts become one set. The smaller company's name may survive on a signboard for a while and then it may not. Roles that exist twice stop existing twice. The office that made sense when the business was standing alone may not make sense eleven kilometres from an office the buyer already runs.

Integration is a real consequence for real people, and an account of the transaction that leaves it unnamed has covered half of it. The seller is a fund, and for the fund the transaction ends when the money arrives. For the two hundred people who worked in the company, the transaction is the beginning of something rather than the end of it. Whether that is good or bad is a separate question. A sale to a buyer in the same industry has this consequence built into it, a sale to a fund usually does not, and anybody reading a transaction needs to know which of the two it is.

There is a further practical point for the seller, and it is unglamorous. Because the buyer intends to integrate, it will ask for things a fund would never ask for: a period during which the seller's senior people stay, an agreement not to set up in competition, a transitional arrangement under which some service the seller provided continues for a few months. Those requests are not aggression. Somebody who has to run the business the following week needs exactly those things.

What did the worked sale produce, and when did investors see the cash?

Holding 1 of Nilgiri Growth Partners Fund II, an invented fund, is Sahyadri Diagnostics Private Limited, an invented company. Every figure below belongs to that fund and to nothing else, and every one of them is stated as at that fund's record date, the end of its Year 9 Quarter 2. The fund keeps time on its own clock, counted from the day it closed to new money, so a date here is written as a year and a quarter of that clock and never as a calendar date.

The fund entered at Year 1 Q3 with Rs 55,00,00,000, and it matters what that money bought: it bought existing shares from the founding shareholders, so not one rupee of it reached the company itself. At Year 4 Q1 the fund put in a further Rs 15,00,00,000 as a follow-on, taking the cost of the holding to Rs 70,00,00,000. At Year 7 Q2 the whole position was sold to a buyer already operating in the same industry for Rs 2,03,00,00,000.

A figure that cannot be rebuilt is a figure that has to be trusted, so here is the arithmetic worked rather than asserted. Rs 2,03,00,00,000 divided by Rs 70,00,00,000 is 2.90, so this holding of Nilgiri Growth Partners Fund II returned 2.90 times its cost on the record of that fund at the end of its Year 9 Quarter 2. Rs 2,03,00,00,000 less Rs 70,00,00,000 is Rs 1,33,00,00,000 of profit. Both figures are an outcome and not a verdict: 2.90 times is what the division produced, it is not evidence that this route is the good one, and it says nothing whatever about any other transaction.

A single multiple hides the last two rows, so look at those two before anything else. Two payments went into this company at two different times and both left on the same day. The first was in the ground for 5.75 years. The second was in the ground for 3.25 years, a little over half as long. The 2.90 times is reported across both of them as though the money had one age, and it did not.

How much of this fund's realised cash came out of this one transaction?

Nearly half of it, and this is the most important single fact about the record being worked here. Nilgiri Growth Partners Fund II, invented, has realised Rs 4,38,00,00,000 in cash across its whole life to the end of its Year 9 Quarter 2. Of that total, Rs 2,03,00,00,000 came from this one sale. Divide the two: 203 divided by 438 is 0.463, so holding 1 produced 46.3 per cent of every rupee this invented fund has realised to that record date. 46.3 per cent of realised cash and 46.3 per cent of anything else are different statements, so the denominator has to be named whenever the figure is quoted.

Four of the nine holdings have produced realised cash at all. Holding 3 produced Rs 1,50,00,00,000, holding 2 produced Rs 63,00,00,000, and holding 9 produced Rs 22,00,00,000 from a part sale. The other five have produced nothing yet: four are still held and one was written off in full. Nine holdings, and one of them accounts for very nearly half the cash. Such concentration is the ordinary shape of a private portfolio rather than an unusual one.

Why can the Rs 1,33,00,00,000 not be split into its causes?

Because the record does not support the explanation, and writing one anyway would mean inventing figures that look exactly like real ones. The temptation to split a return into neat causes is the strongest in the subject, so go slowly over the next few lines.

Of the Rs 1,33,00,00,000 of profit, this fund's record attributes exactly Rs 28,00,00,000. The Rs 28,00,00,000 is the gap between what the buyer in the same industry paid and the best number reached by a bidder with no operation in the industry, and both the arithmetic of that gap and the reason behind it are covered separately. Subtract the gap and Rs 1,05,00,00,000 is left over. The remaining Rs 1,05,00,00,000 has no attributed cause, and saying so plainly is worth more than filling the space with three plausible numbers.

There is a real and long-established way of splitting a private equity return into parts: how much came from the business earning more, how much from a buyer paying a higher multiple for the same earnings, and how much from borrowings being repaid out of the company's own cash. The split is a genuine method, it is taught, and it is done elsewhere. The split also needs the company's earnings at entry, its earnings at exit, the multiple paid at each end and the movement in its borrowings across 5.75 years, and this record locks none of those. Three numbers adding neatly to Rs 1,05,00,00,000 would be three inventions with a correct total, and a correct total is the most convincing kind of wrong.

So take the honest version. Rs 28,00,00,000 has a stated cause. Rs 1,05,00,00,000 does not, on this record. A visible gap teaches more than a complete picture assembled out of plausible guesses. Noticing which parts of a return are attributed and which are simply asserted works on any transaction, not only on this one.

What did this exit do to the fee the remaining investors pay?

The exit cut the fee on the day it completed, and nobody had to renegotiate anything. Almost every account of an exit leaves that consequence out, and the consequence is arithmetic rather than opinion.

How the management fee of this invented fund is set, and why the thing it is charged on changes partway through the fund's life, is covered separately. Take it here as given. From the start of this fund's Year 6, the fee is charged at 2.00 per cent a year on the acquisition cost of the holdings not yet realised, measured at the start of each year. So an exit removes that holding's cost from the basis on the next measurement date.

Work it through. At the start of Fund II's Year 7, two holdings had already gone and the cost still held was Rs 3,20,00,00,000, so the charge for that year was Rs 6,40,00,000. Holding 1 was sold during Year 7, taking its Rs 70,00,00,000 of cost with it. At the start of Year 8 the cost still held was Rs 2,50,00,00,000 and the charge for that year was Rs 5,00,00,000. The fee fell by Rs 1,40,00,000. That is 2.00 per cent of Rs 70,00,00,000, and the Rs 70,00,00,000 that left is the whole of the difference between the two bases.

Notice what that means for somebody reading a private fund's numbers. An exit is not only a payment to investors. An exit is also a reduction in what the investors who remain will be charged next year, and the size of that reduction is set by the cost of what left rather than by the price it fetched. A holding sold for a great deal and a holding written off entirely remove exactly the same amount from a cost-based fee basis if they cost the same to buy.

What does a reader of a transaction like this check from outside?

Far more people read transactions than run them, so reading one from outside is the practical end of the subject. An analyst covering a listed acquirer, a lender deciding whether to keep funding a business that has just changed hands, an investor in a fund reading its quarterly pack, and an employee of the company being sold are all reading the same event from four different seats. Each of the four seats looks for something different.

An analyst reads the buyer's side first. What did the buyer pay, what did it say it will save by combining the two operations, and how long did it say those savings will take? The number that matters is not the price. The number that matters is the cost the buyer says it can remove. The buyer funds that part of the price out of its own operation rather than out of the business it bought. An analyst who takes a saving as delivered on the day it is announced has taken a plan for a result.

A lender to the company being sold reads the consent list. Its loan may say something about a change of control. If it does, the lender has a decision to make and a moment of real leverage in which to make it, and that moment falls between signature and completion and nowhere else. A lender who notices after completion has noticed too late.

An investor in the selling fund reads three things in order: whether the cash has actually arrived or only the agreement has been signed, when the cash reaches its own account rather than the fund's, and what the exit did to the fee it will be charged next year. On this invented fund all three had clear answers. Cash reached the fund at Year 7 Q2, reached investors at Year 7 Q3, and the following year's charge fell from Rs 6,40,00,000 to Rs 5,00,00,000.

And somebody who works in the company reads something none of the others do. A sale to a fund usually means the same job in the same building with a new shareholder, while a sale to a buyer in the same industry means the business is being folded into another one, and the difference between those two sentences is the whole of what a strategic sale is. Somebody meeting either transaction can then tell which of the two is in front of them.