There are two kinds of buyers: financial buyers and strategic buyers. Financial buyers, often called ‘financial sponsors’ or just ‘sponsors’, include any company that invests as a business: private equity funds, family offices, commercial lenders, mezzanine funds, independent investors, and other capital providers. Strategic buyers include effectively everything else: the industrials business buying an original equipment manufacturer, the media company buying a software provider, and so on.
However, the primary tradeoff is that financial sponsors are usually unable to pay as much for a business as strategic buyers can (details on why below).
The question: do we limit our sellside deal processes to strategic acquirers or is there a sizable benefit to including financial sponsors?
There are two core reasons why financial sponsors tend to be unable to pay as much as strategic acquirers.
First, sponsors are under pressure to hit a target return % on they money they invest — which puts a restraint on their entry price into every investment. They’re not obligated to meet these return targets, but their ability to do so makes a dramatic difference for (a) the amount of carry received upon exit, (b) future management fees and (c) whether future funds can even be raised. The three main drivers of returns are entry price, exit price, and leverage. Consequently, buyers are rightfully focused on pricing for a certain internal rate of return (IRR) during the acquisition process.
Secondly, sponsors usually* can’t benefit from the operational synergies that frequently result from strategic deals. Synergies occur when two companies perform stronger financially than they do individually. This generally results from cost reduction, joint talent and technology, or cross-market revenue growth. For this reason, synergies almost always accompany strategic acquisitions and are often a driving force behind how much a buyer is willing to pay. For financial sponsors however, unless the deal is an add-on to an existing portfolio company, they structurally can’t benefit from operational synergies. The absence of these sizable benefits puts a ceiling on how much the business is worth to them, and correspondingly, their upfront offer.
Despite these limitations however, experience shows that it is actually almost always a good idea to include financial sponsors in your buyer list. Here are the primary benefits.
First, having financial sponsors in your sellside process helps with deal discipline and pacing. Anyone who has ever tried to sell a business will tell you that there are about 1,000 roadblocks that you’ll have to hurdle to actually close a deal. Between buyers needing more time, being unable to make decisions, wanting more information, and unexpected hiccups, even the most veteran M&A bankers have an exceptionally tough time running an expedient process.
However financial sponsors, as the name denotes, are in the business of sponsoring business growth. Because of this, they’re veterans when it comes to sellside deals and will typically go through dozens of processes a year.
As a result, sponsors tend to have an excellent grasp of structure and pacing: knowing what the standard transaction looks like, exactly what the next step is, and when you should be there. They know how a normal NDA looks, when to submit it, what needs to be in the data room, and how to structure an LOI.
Moreover with multiple parallel deal processes running, investments that the sponsor has to exit in the next few months, capital that must be put to use within a tight time frame, and their own timing restraints, having these guys on your buyer list will help keep the process on track and moving forward.
Secondly, involving financial sponsors in your sellside process typically improves deal certainly. Because sponsors are generally driven by a return targets, the amount that they’re willing to pay will be predominantly based on the exit price, forecasted performance, and the IRR that they need to hit. They will then use these restrictions to solve for the entry price.
Consequently, while they generally pay less than strategics, sponsors are often happy to come to the table at some price level.
Indeed Eliot Peters, Managing Director at RA Capital Advisors** adds that he will include financial sponsors on his buyer lists “no matter what.” Not only does it help with deal discipline, but “it gives you deal certainty, because they’re always there at a price.” To have someone like that in your process gives you a sometimes weak but nonetheless covetable safety net, or insurance, which is something that anyone trying to sell a company could only hope to have.
It’s easy to find financial buyers for your company on the Axial network. Screen your potential buyers by firm type (e.g., private equity firm, venture capital, corporation, etc.) by navigating to your matched buyers list. See exhibit A. In the righthand panel, expand the company type menu and place a check mark next to the specific types of buyers with which you’re interested in connecting.
Exhibit A: How to Screen Your Buyers by Type
Start Building Your Buyer List
*This applies unless the acquisition is an add-on to an existing portfolio business. In that case, the combined company is much more likely to realize either cost synergies or revenue synergies. The financial sponsor will then incorporate these bottomline savings or topline gains into their valuation of the business and will be able to pay a commensurately higher price.
**Registered broker-dealer and member of FINRA/SIPC