Trade Sale

What is a trade sale?

Trade sale (sale to a strategic buyer) describes the sale of a company or a majority stake to an operating company that integrates the business into its own activities. Typical buyers are competitors, providers of adjacent products, customers, suppliers or foreign corporate groups that want to open up a market. The term is not used uniformly: some market participants call any sale to a corporate buyer by this name, including one to a financial investor. In the vehicle trade, "trade sale" means something different, namely a sale to dealers rather than to private customers.

For founders and investors of a growth company, the trade sale is in practice the usual route to an exit. Legally, in Germany it is implemented overwhelmingly as a share deal, that is, as a purchase of the shares, more rarely as an asset deal, in which individual assets pass. Those involved are the selling shareholders, the management, the buyer with its specialist departments and, on both sides, advisers. The legal framework is set by the company purchase agreement. It is preceded by a letter of intent and due diligence, the thorough review of the company by the buyer.

Motives of strategic buyers

A strategic buyer measures the target company by its own earnings and in addition by what it contributes to its existing business. The most important motives are:

• Technology and product: acquiring a solution that would take longer or cost more to develop in-house.
• Customers and markets: access to customer groups, regions or sales channels that the buyer cannot reach alone.
• Team: gaining skilled staff, in the limiting case as an acqui-hire, where mainly the team is bought.
• Cost reduction: combining purchasing, infrastructure and administration.
• Market position: strengthening against competitors, also to prevent a competitor from acquiring the target company.

These motives give rise to synergies, that is, value contributions that arise only from combining both companies. In a trade sale they are the strongest argument for a higher price. A buyer that can capture cost or revenue synergies is able to pay more than a buyer that looks at the company only on its own. Whether it does so depends on competition among the bidders.

Trade sale compared with a financial investor and an IPO

Sale to a financial investor

A financial investor, for example a private equity fund, acquires the company as a holding for a limited time. It plans to resell after a few years, often finances the purchase price partly with debt and gives the management a stake. Its price results from the targeted return and from financeability. It has synergies only if it combines the target company with an existing holding (buy-and-build). Unlike a strategic buyer, it generally expects the founders and management to stay in the company and to take a stake again in the acquiring company (reinvestment).

Stock market listing (IPO)

In a stock market listing, shares are placed with a large number of investors through the capital market. The existing shareholders usually sell only part, are subject to lock-up periods and afterwards bear the price risk. The company remains independent but needs a legal form suitable for listing, such as an AG (German stock corporation) or an SE (European company), and is subject to ongoing disclosure obligations. A trade sale, by contrast, brings about a complete change of control and, as a rule, a far-reaching exit at a fixed point in time. Larger companies sometimes prepare both routes in parallel (dual track) in order to be able to choose until the last moment.

Process and consideration

A trade sale usually follows a structured auction process. It begins with a list of possible buyers (long list) and an anonymous first approach with a short profile (teaser). After a confidentiality agreement, interested parties receive a detailed information memorandum and submit non-binding first offers. Management presentations, due diligence, binding offers, negotiation of the purchase agreement, signing and closing follow. With a few selected strategic buyers, an exclusive process can also make sense, though it lacks the price pressure of competition.

Payment is predominantly in cash at closing. In addition there are a performance-related part of the purchase price (earn-out), a retention as security for warranty claims, shares of the buyer as consideration and retention bonuses for key people. For payment in shares, the value of the consideration depends on the development of the buyer. Whether such a share exchange is possible on a tax-neutral basis is governed by the German Reorganisation Tax Act (Umwandlungssteuergesetz). It in principle presupposes a buyer with its seat in the EU or the EEA; for other foreign buyers, the individual case must be examined.

Merger control and investment screening

Because buyer and target company often operate in the same market, merger control carries particular weight in a trade sale. A transaction must be notified to the Federal Cartel Office (Bundeskartellamt) if the parties reach the turnover thresholds of the German Act against Restraints of Competition (GWB). For target companies with low turnover, even a high purchase price can trigger the notification obligation (transaction value threshold); for larger transactions, the European Commission is responsible. Until clearance, the transaction must not be completed (standstill obligation).

Foreign acquirers, above all from states outside the EU, are subject, depending on the industry and the size of the stake, also to investment screening under the German Foreign Trade and Payments Act (AWG) and the Foreign Trade and Payments Ordinance (AWV). Competitively sensitive information such as prices, terms and customer data is made accessible before closing only to a clean team, a tightly limited circle of persons on the buyer side.

Worked example: synergies in the purchase price of a trade sale

A software company achieves EBITDA (earnings before interest, taxes, depreciation and amortisation) of EUR 2 million. A financial investor values it on a stand-alone basis at eight times EBITDA. A strategic buyer expects cost synergies of EUR 1 million per year and one-off integration costs of EUR 1.5 million. The target company's net debt, that is, its financial debt less cash, is EUR 1.6 million. For simplicity, the synergies are valued at the same multiple and not discounted.

• Stand-alone enterprise value (enterprise value): 8 × EUR 2 million = EUR 16 million
• Value of the cost synergies: 8 × EUR 1 million = EUR 8 million
• Net value after integration costs: 8 minus 1.5 = EUR 6.5 million
• Upper price limit of the strategic buyer: 16 + 6.5 = EUR 22.5 million enterprise value
• If the buyer passes on 40% of the synergies to the seller in the competitive auction: 16 + 0.4 × 6.5 = 16 + 2.6 = EUR 18.6 million enterprise value
• Purchase price for the shares: 18.6 minus 1.6 = EUR 17.0 million, compared with 16 minus 1.6 = EUR 14.4 million for the financial investor

The seller thus achieves EUR 2.6 million or around 18% more than with the financial investor. Synergies do not lead to a high price by themselves, however: the buyer gives up only the share that competition among the bidders demands. If there is no second serious interested party, it can base its offer on the stand-alone value and keep the entire synergy value for itself.

Distinctions: trade sale, MBO, merger and secondary sale

• Management buy-out: the buyer is the company's own management team, usually together with a financial investor and a bank. Synergies play no role in the price.
• Merger: combination through a merger in which the shareholders of the target company receive shares in the acquiring entity. Economically this often corresponds to a trade sale against shares.
• Secondary sale: in the venture capital market, the sale of individual shares to a new investor without a change of control; the company remains independent. For private equity funds, the term also covers the resale to another financial investor (secondary buyout), a common alternative to a trade sale when a fund exits.

Common mistakes

• Only one buyer in discussions. Without competition, the value of the synergies stays with the buyer. Even a preferred interested party negotiates differently when alternatives exist.
• Buyer's synergies not quantified by the seller. Anyone who does not know the value of the combination for the buyer cannot assess the buyer's price room.
• Sensitive data to competitors too early. Customer lists, prices and terms belong in a late phase and in a clean team. If the sale fails, the competitor otherwise holds knowledge that it should not have had.
• Integration plans not asked about. If an earn-out depends on targets that the buyer itself influences through integration, the management needs contractual protections for this phase.
• Merger control checked too late. The notification obligation and review period determine the closing date. A late finding shifts the timetable and burdens the negotiation.
• Customer reaction underestimated. Customers that are themselves in competition with the buyer use change-of-control clauses or switch providers.

Frequently asked questions

Does a strategic buyer always pay more than a financial investor?

No. It can pay more if it can capture synergies, but does so only under competitive pressure. Financial investors with a suitable existing holding or favourable financing sometimes bid more than a strategic buyer.

Must all shareholders agree to a trade sale?

Not if the shareholders' agreement contains a drag-along obligation. The agreed majority can then oblige the other shareholders to sell their shares on the same terms. Without such a clause, each shareholder decides for themselves about their shares.

Do the founders stay in the company after a trade sale?

Often for a transition period. Buyers secure the transfer of knowledge through managing director or adviser contracts, retention bonuses and earn-out arrangements. A post-contractual non-compete for the sellers is generally added.

What happens to virtual employee shares in a trade sale?

They are generally settled at closing under the plan terms. The payments are usually treated in the purchase price calculation as debt-like items and reduce the shareholders' proceeds.

Can a trade sale be prepared in parallel with an IPO?

Yes, as a dual track. The effort is high because both processes must be fully prepared. This variant is therefore considered mainly for larger companies.

The Roemer Capital view

In a trade sale, Roemer Capital starts with the question of for which buyers the company has the greatest strategic value. Roemer Capital maps the buyer groups on a long list and quantifies the possible synergies for the most important candidates. Teaser, information memorandum and data room are prepared so that competition among several bidders can arise.

A company sale in Roemer Capital's mandates typically takes 6 to 12 months. During this time, Roemer Capital protects confidentiality towards competitors through staged information releases and agrees with the law firm when which data goes into a clean team. Roemer Capital conducts the price negotiation on the basis of the synergy calculation, not only the stand-alone value.