by Dimitri Steinberg

As one considers a potential sale of a business, determining who are the most likely buyers will become a critical issue for the seller and the seller's financial advisors to address and consider. Identifying the best buyers for a business from an early stage will greatly improve the odds of a successful deal process, resulting in the target company being sold at an attractive purchase price from the seller's perspective.

​

Most sellers have a number of objectives in mind when planning their exit, including:

​

• Maintaining confidentiality

• Controlling the due diligence process

• Minimizing disruption to existing operations

• Maximizing the financial return to themselves and their fellow investors

​​

The type of buyer can have a meaningful impact on all of these objectives

As part of that exercise, the terms "Financial buyers" and "Strategic buyers" are likely to arise along with a number of questions, including:

​

• What is a Financial buyer?

• What is a Strategic buyer?

• How are Financial buyers and Strategic buyers different and/or similar?

• What are the motivations of Financial and Strategic buyers?

• Who will pay the higher price for a business - a Strategic or Financial buyer?

• How should a sale process by structured if the buyer is more likely to be Financial or Strategic?

• Is the owner of the existing business more likely to remain involved post acquisition depending on whether it is a Financial buyer or Strategic buyer?

• Who's the better buyer for a business?

Characteristics of Financial Buyers

A Financial Buyer is exclusively motivated by the opportunity to make a profit by buying a business, operating it for a finite period of time during which they work to improve the business' profitability and ultimately exiting either via a sale or initial public offering (IPO), presumably for more than they paid. In short, Financial buyers are interested in the cash flows a business generates and the gain to be made on the eventual exit.

​

While the most common types of financial buyers in M&A are private equity funds that specialize in leveraged buyouts, there are a number of different types of Financial buyers. including:

​

• Traditional Private Equity funds

• Growth Equity Firms

• Search Funds

• Family Offices

• Pension Funds

• Holding Company

Financial buyers such as private equity firms generally operate as partnerships that invest the interests of a group of limited partners (LPs) in a number of discrete, individual investments with the expectation of generating attractive, risk-adjusted returns.

​

Acquisitions made by Financial buyers are often called Leveraged Buyouts ("LBOs") as these are transactions where a substantial portion of the purchase price used in acquiring businesses is financed with the use of debt.

Characteristics of Strategic buyers

Strategic buyers look to identify companies in an area which fits into the Strategic buyer's own long-term plans. A target company or operating business may offer the Strategic buyer one or more of the following:

​

• Access to new customers

• Complementary products or services

• Entry into new geographic regions

• Valuable technologies

• Critical human capital

In short, a Strategic buyer will look at another existing business as an opportunity to expand "inorganically" - i.e., via acquisition, as opposed to "organically" - i.e., via internal growth. In addition, while Strategic buyers are motivated by the financial returns and cash flows that will come from an acquisition, they are typically less concerned with the value the target might attract in a future sale as that is not generally their intention.

A subset of Strategic buyer is the Financial buyer portfolio company. This is an existing portfolio company that is already owned by a Financial buyer which is looking to make follow on acquisitions. This hybrid buyer will share many of the same motivations and characteristics of the traditional Strategic buyer, but with the addition of some of the characteristics of a Financial buyer.

Investment Time Horizon and Planned Exit Strategies

Financial buyers, typically private equity firms, have a finite time horizon for their investments. Whether this is a 2-3 year or 8-10 year horizon, it will have an end point. Financial buyers also always buy a business with a planned exit strategy. Most typically, they will plan to sell the business at some point in the future, after having made whatever operational improvements they can to maximize the business' cash flows. They may sell it to another Financial buyer or to a Strategic buyer. Financial buyers may also "recap" the business while they own it. That means that they may place additional leverage on the business if market conditions and operational performance allow so as to pay themselves a dividend. An alternative to selling the business is to take it public in an Initial Public Offering ("IPO").

In contrast, Strategic buyers have an infinite investment horizon and do not generally have any intention to sell the business they've bought, but will instead integrate it into their existing operations so as to realize synergistic benefits of the combination.

Investment Criteria and Valuation Approach

Financial buyers are 100% driven by expected financial returns. They will value the business based on a projection of stand alone cash flows discounted to the present. They will be constrained by their calculated returns assuming a specific purchase price, use of leverage and assumed exit valuation levels. In contrast, Strategic buyers will generally have a more holistic perspective on an acquisition, driven by the long-term strategic benefits that may be achieved from the deal in terms of addressing their own needs (technology, talent, critical mass economies of scale, etc.).

Use of Leverage

Financial buyers will generally employ substantially greater amounts of leverage (debt) to finance an acquisition. They are looking to maximize their returns to equity and, all things being equal, increasing leverage will offer the opportunity to have much greater returns on equity. In the early days of LBOs, debt was used to finance up to and in excess of 90% of the purchase price! Today, the amount of debt employed by Financial buyers will not generally approach those levels, but may well be in the 50-60% of total consideration levels.

In contrast, Strategic buyers may or may not employ any leverage at all. The decision on using leverage will come down to a number of issues, including the Strategic buyer's stated intentions regarding their own debt levels (for instance, they may have a policy of maintaining an investment grade debt rating, which would impact their ability to employ debt to finance a transaction), the relative size of the acquisition (smaller deals are much less likely to require the Strategic buyer to use leverage) and cash flows of the target (a business with strong cash flows will make it easier and more justifiable for the Strategic buyer to employ leverage)

Deal Structure Flexibility

Because Financial buyers are not typically integrating the business into another operation, they generally have much greater flexibility in how they can structure a potential transaction. For example, they could acquire less than 100% of the business if the owner wants to retain a stake. They can offer to acquire the remaining interest at some point in the future on a set of predetermined terms. They can easily incorporate seller financing if the owner wants to convert their equity in the business into a debt instrument or offer other "bells and whistles" to address a number of seller potential goals.

In contrast, Strategic buyers generally intend to integrate the business into their own operations. They are also typically constrained as large corporate entities. As a result, they are much less likely to be able to offer the range of creative deal structuring options that a Financial buyer can.

How should a Sale process be structured to reflect whether the business is more likely to be acquired by a Financial buyer or Strategic buyer?

There are a number of fundamental nuanced differences in terms of how Financial vs Strategic buyers behave in the context of a sale process. Broadly speaking, however, Financial buyers are in the business of buying businesses. That's what they do and therefore it's a core competence which they are good at doing. In contrast, while some Strategic buyers have made doing M&A a part of their DNA, many have not.

What that means is that if you want to focus and depend on Financial buyers, you can plan to run a much stricter M&A process with tighter deadlines and explicit conditions. Financial buyers are much better suited to meeting these types of conditions. In contrast, Strategic buyers, which are generally not in the business of buying businesses may not be able to meet short time frames and tight deadlines, so if you attempt to impose them, they may drop out of the M&A process. As such, it may make sense for a Strategic focused buyer list process to be more flexible with looser timelines.

Post Acquisition Role for Seller

In most cases, there will be roles for the seller (if he or she desires) irrespective of the buyer. However, the nature of the role can vary. For example, in most cases, a financial buyer will look to retain the management team of the target company - at least initially. The Financial buyer may be able to plug in some level of management, but in general, Financial buyers would much prefer the existing management team stay with the business to run it. What they will do, however, is introduce a potentially new set of operational goals and benchmarks for management to perform against.

A Strategic buyer may have a different perspective. Depending upon the way in which they plan to integrate the business, the roles for the existing management team may be unchanged or completely different. A CEO of the target company may remain as the business unit head or alternatively move into a more focused role (eg, Head of Sales, Product, Tech, etc.).

Do Financial buyers or Strategic buyers pay higher purchase prices for businesses?

Generally, Strategic acquirers should be able to pay the highest price for a number or reasons that Financial buyers cannot duplicate, including:

​

• Synergistic benefits - a Strategic buyer may be able to achieve revenue synergies in a number of ways, including selling existing products and services to a broader audience, selling new products and services to its existing customer base or leveraging the combined business to sell new products and services to new customers.

• Cost savings - Similarly, given the Strategic buyer's existing business and operations, they are likely able to achieve savings from things such as creating economies of scale in purchasing and operations once the acquired business is integrated into the larger company.

• Competitive Dynamics - The integration of the two companies may change the competitive balance in the industry allowing improved pricing and terms.

• Non financial motivations - strategic buyers are much more likely to ascribe non financial values to an acquisition target as potential buyers than Financial buyers may

While Financial buyers generally cannot rely on any of the above, they may, depending upon market conditions, be willing and able to employ much higher levels of leverage to finance a transaction. This may have the effect of counterbalancing some degree of the advantages that Strategic buyers generally enjoy.

Who's the best buyer for a business?

It call comes down to the seller's goals. While PE firm or other Financial buyer typically offer greater deal flexibility and the opportunity to remain in their pre-existing role, Strategic buyers may be able to may more for the business and offer management greater career opportunities. At the end of the day, it comes down to individual priorities and the specific deal terms that can be negotiated on a case by case basis.