As you sell your company or raise funding, understanding the key differences between strategic and financial buyers can help you understand their decision-making processes. Clarifying what each type of buyer is seeking can help you decide which fits your situation best.
As a quick refresher, potential buyers / investors fall into two primary categories:
These are operating companies that provide products or services and are often competitors, suppliers or customers of your firm. They can also be unrelated to your company but looking to grow in your market to diversify their revenue sources. Their goal is to identify companies whose products or services can synergistically integrate with their existing P/L to create incremental long-term shareholder value.
These include private equity firms (also known as “financial sponsors”), venture capital firms, hedge funds, family investment offices and ultra high net worth individuals (UHNWs). These firms and executives are in the business of making investments in companies and realizing a return on their investments. Their goal is to identify private companies with attractive future growth opportunities and durable competitive advantages, invest capital, and realize a return on their investment with a sale or an IPO.
Because these buyers have fundamentally different goals, the way they will approach your business in a M&A sale process can differ in many material ways. There are five primary ways they differ:
Evaluation of Your Business
Strategic buyers evaluate acquisitions largely in the context of how the business will “tie in” with their existing company and business units. For example, as part of their analysis, strategic acquirers will ask questions like:
- Are the products sold to their customers?
- Does your company serve a new customer segment for them?
- Are there manufacturing economies of scale we can realize?
- Is there intellectual property or trade secrets that you’ve developed that they want to own or prevent a competitor from owning?
Conversely, financial buyers won’t be integrating your business into a larger company, so they generally evaluate an opportunity as a stand-alone entity. In addition, they often buy businesses partially with debt which causes them to scrutinize the business’ capacity to generate cash flow to service a debt load. Financial buyers are also focused on understanding how to quickly increase the long-term value of the company to ensure an acceptable return on their investment.
While both buyer groups will carefully evaluate your business, strategic buyers focus heavily on synergies and integration capabilities whereas financial buyers look at standalone cash-generating capability and the capacity for earnings growth.
One note of caution is that all buyers cannot be nearly categorized. Sometimes “strategics” are just looking to boost their earnings and end up acting like financials. Other times, “financials” already own a company in your space and are looking to make strategic add-ons, so they’ll evaluate your business more like a strategic. By understanding the motivations of the buyer, you can understand how they’re determining your business value.
Determining the Investment Merits of the Industry
While this might seem obvious, strategic buyers usually are more “up to speed” on your industry, its competitive landscape and current trends. As such, they will spend less time deciding on the attractiveness of the overall industry and more time on how your business fits in with their corporate strategy. Conversely, financial buyers are typically going to spend a lot of time building a comprehensive macro view of the industry and a micro view of your company within the industry. It is not uncommon for financial buyers to hire outside consulting firms to assist in this analysis. With this analysis, financial buyers might ultimately determine they do not want invest in any company in a given industry. Presumably, this risk is not present with a strategic buyer if they are already operating in the industry.
As the seller, the risk of having a sale process fail due to “industry attractiveness” factors is reduced by ensuring that you are soliciting strategic buyers.
Strength of Back-Office Infrastructure
Strategic buyers are going to focus less on the strength of the target company’s existing “back-office” infrastructure (IT, HR, Payables, Legal, etc) as these functions will often be eliminated during the post-transaction integration phase. Since financial buyers will need this back-end infrastructure to endure, they will scrutinize it during the due diligence process and often seek to strengthen the infrastructure post-acquisition.
As such, you’ll likely want to de-emphasize the importance and/or value of your back-office infrastructure in discussions with a strategic, whereas it’s important to be prepared for thorough evaluation of these functions when having discussions with a financial buyer.
The Impact of the Investment Horizon
Strategic buyers intend to own an acquired business indefinitely, often fully integrating the company into their existing business. Financial buyers typically have an investment time horizon of four to seven years. When they acquire and subsequently exit the business, especially in the context of the overall business cycle, will have an important impact on the return on their invested capital.
For example, if your business is purchased at the peak of a business cycle for 8X EBITDA and the buyer can only sell it for 6X EBITDA 5 years later, it’s tough to make an attractive return. As such, financial buyers are going to be more sensitive to business cycle risk than strategic buyers, and they will be thinking about various exit strategies for your company before making the final decision to invest in / buy your company.
Financial buyers are in the business of making acquisitions. It it one of their core competencies to execute deals in a timely fashion. Strategic buyers may not have a dedicated M&A team, may be encumbered by slow-moving boards of directors, bureaucratic committees, territorial division managers, necessity to check acquisition against internal projects, etc.
From our experience, combine these factors and the process with strategic buyers can often take longer than with financial buyers. No matter what, be prepared for a 6-12 month process BEFORE you decide to sell.