Choosing the Approach for Your Search
Deal flow is the foundation of a successful search. Buyers who build processes to efficiently and affordably access deals that fit their investment theses are able to win in the long run. Buyers access deal flow in two main ways. The first is the brokered search method, where buyers analyze businesses that are currently for sale and represented by a sell-side advisor. The second is the proprietary search method, where buyers identify interesting businesses and approach the owners to inquire about a sale, even if that owner had not previously considered selling the business.
Each of these methods is viable, and each has its strong proponents in the small business M&A world. In our view, a thoughtful searcher should pursue any and all techniques to find the ideal business to buy. This means going with a blended approach. In this article, we will outline the strengths and weaknesses of each deal flow strategy, highlighting opportunities for beginner and veteran searchers to make the most of both brokered and proprietary search.
The Pros and Cons of Brokered Deals
Searching with a focus on brokered deals involves identifying businesses that are currently for sale and best line up with a buyer’s investment thesis. In this case, “for sale” means the business owner is actively (and often publicly) looking to sell and has employed assistance to facilitate the deal. Sellers in this position are often hoping to retire, have a new opportunity they would rather pursue, or have experienced an acute change in circumstances due to a divorce or health scare. They work with a sell-side advisor to help source and vet buyers as well as provide assistance throughout the negotiation process. Sell-side assistance can take the form of an investment bank for a larger deal or a business broker (whose role functions like a hybrid of an investment banker and a real estate agent).
The support of a sell-side advisor is important because sellers often enter M&A negotiations at a significant disadvantage: while they are experts in the operation of their specific business, business owners are typically less knowledgeable about a business sale than a prospective buyer. The broker is there to help level the playing field, providing logistical, strategic, and emotional support to the seller. Sellers that work with a good broker often have at least semi-reasonable pricing expectations and are more likely to have key pieces of information already prepared, such as financial statements and asset valuations, than business owners that are not actively looking to sell. From a mindset perspective, business owners that actively engage brokers and put their companies up for sale are often more emotionally ready to actually close a deal and have the support of their broker when negotiations get tough (as they frequently do). Due to all of these factors, businesses represented by brokers are significantly more likely to sell and encompass a majority of deals sourced by self-funded searchers (according to a 2022 survey conducted by the Search Invest Group).
However, there are key downsides to limiting your search to businesses that are actively listed for sale. First of all, there is competition – the searcher community is talented, and high-quality deals are likely to have multiple interested buyers. This can drive prices up for buyers that end up in bidding wars. It can also make it difficult for less well-capitalized buyers to get noticed when it comes to promising deals where the broker needs to filter through many interested buyers. The second downside is variation in broker and deal quality – while many brokers add value to the transaction, there are some that can make transactions more difficult. In particular, brokers that filter buyers out on the basis of their age, experience, race, or gender harm our industry. In other cases, lower-quality brokers may make unreasonable promises to their sellers when it comes to purchase price or the access they need to provide to buyers, making it more difficult for buyers to negotiate a fair enterprise value for the transaction. Finally, it can be challenging to sort through thousands of businesses for sale on existing platforms, with sourcing requiring substantial effort from buyers to filter out uninteresting brokered deals and build relationships with the right brokers. At Private Market Labs, we’re hard at work trying to make this process easier.
On balance, we believe that brokered search should be a core part of any buyer’s deal sourcing process. We’ve written extensively about how to work effectively with brokers in the past. Check out this article and this conversation with a broker.
Leveraging a Proprietary Search for Deals
Proprietary search involves identifying companies that fit a buyer’s investment thesis and then inquiring about whether the owner wants to sell. In this case, the business owners may not have contemplated an exit, or perhaps they’ve thought about it but haven’t done any of the necessary pre-work. This means that the business owners approached by searchers on a proprietary basis are less well-prepared, financially, logistically, and emotionally, than business owners that have already secured sell-side support from a broker. A typical proprietary search process looks similar to a traditional B2B sales pipeline. Searchers analyze large datasets from publicly available sources (like the PPP loan database) or private sources like large third-party data providers. They will often hire assistance and employ big data analysis techniques to identify potential leads out of hundreds of thousands of companies. Searchers will then execute an outreach campaign, which can include emails and cold phone calls, along with more creative approaches such as sending handwritten cards and small gifts to get the business owner’s attention. If a lead is potentially interested in selling, the searcher is responsible for guiding the business owner through the acquisition process, requesting documents, and making sure they have the appropriate support through the process.
The benefit of a proprietary search is that it can be more targeted and less competitive than searching for brokered listings. Buyers will often maximize their outcomes by picking the exact company they want to purchase and building a positive relationship with a seller, such that they’re viewed as a natural successor to the business. By being deliberate, thoughtful, strategic, and transparent, buyers can achieve strong results through a proprietary process.
There are also downsides to this approach: first and foremost is the cost (both in dollars and in time). Because proprietary search involves searching for companies that aren’t currently for sale, it can take a long time to find the right target that’s willing to consider your offer. Additionally, the B2B sales process can cost close to $4,500 per month according to estimates from searchers who have implemented this method successfully. For buyers who don’t have salaries that can pay them to search, this can be cost-prohibitive. Additionally, because business owners identified using this method are not necessarily prepared to sell, the deal is less likely to close. Issues can arise during due diligence around the businesses’ internal bookkeeping. It’s also possible that the seller gets cold feet, backing out of a sale process when it comes time to actually part with the business they’ve worked so hard to build. Finally, while some buyers can get below-market prices on proprietary deals, many sellers have unrealistic expectations for the value of their businesses. These expectations go unchecked when the business owner doesn’t have the experienced advice of a broker. In general, while the proprietary method works really well when it works, businesses engaged through this process are materially less-likely to close than brokered deals, adding substantially to the time and cost issues mentioned above.
At Private Market Labs, we advise buyers to pursue a hybrid approach – looking at both brokered deals and proprietary deal flow. With strategic thinking and proper application of resources, buyers can maximize their outcomes by spending time with both search types. Some traditional advice in the search fund space is that buyers should spend 80% of their time on proprietary search and 20% on brokered search. Based on our experience, we believe the ideal mix is somewhere closer to 50-50, but ultimately depends on each buyer’s individual budget and preferences.