5 Major differences between strategic and financial buyers
This guest post is written by Mike Gasparro of AxialMarket. You can also view the post on AxialMarket’s blog.
According to the PriceWaterhouseCoopers study “Strategic deals and ‘mergers of productivity’ to drive M&A in 2010“, strategic buyers will remain a major factor in the M&A market in 2010. As such, if you’re a serious seller this year, understanding the goals of strategic buyers and how they differ from financial buyers is critical. In this post, we explore the key differences between strategic and financial buyers and how it impacts their acquisition decision-making process.
As a quick refresher, potential buyers / investors fall into two primary categories:
- Strategic Buyers — 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.
- Financial Buyers — These include private equity firms (also know 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. Below are five of the biggest differences we’ve witnessed:
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, they 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. As such, they scrutinize the business’ capacity to generate cash flow to service a debt load and determine how to quickly increase the long-term value of the company to ensure an acceptable return on their investment.
In the end, both buyer groups will carefully evaluate your business; however, strategic buyers focus heavily on synergies and integration capabilities whereas financial buyers look at standalone cash-generating capability and the capacity for earnings growth.
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 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. Financial buyers typically have an investment time horizon of four to seven years. When they acquire and subsequently exit the business and how that pertains to the overall business cycle will have an important impact on the return on their invested capital (for example, if you buy a business at the peak of a business cycle for 8X EBITDA and 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.
Transaction Efficiency
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, 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.
There is more to be said about the many important differences between strategic and financial buyers, but these are the basics. Any questions, as always please feel free to ask them in the comments or contact us directly if you want to take it offline.
Well spotted about the different approaches to the back office. I have an additional question regarding all of these differences, if I may. What would the difference be if your strategic buyer is a PE portfolio company? What about when PE firms trade portfolio companies?
Thank you in advance.
-Georgi
georgiatanasov
15 Aug 10 at 07:56
Mike,
Interesting topic, thanks for starting it.
From our perspective we have always felt some PE's would fare well if that acted more like strategic buyers. I know this is a sensitive subject and may even be a bit controversial. Let me elaborate:
Many PE's have evolved by taking advantage of opportunistic situations. They may not have platforms or compelling ways to grow the business or add much value to it. The model may be as simple as buy low, sell higher (hopefully). I worked for one for years whose mantra was a “a shameless pursuit of a dollar for a dime”. That worked well for a long time. Times may be changing.
Strategic buyers as you clearly articulated, have synergy opportunity that provides value that may not be easily obtained by others. Historically they may have paid more in recognotion of this. Not always the case though in today's environment.
We are most commonly enagaged by strategic buyers to help them duirng the integration due diligence, planning and execution phases of the transaction. Together we work to maximize the value of the synergy opportunities and minimize the risk. ROI is enhanced significantly when this is done right.
My comment about PE's acting more like strategic buyers simply means that those that move beyond opportunistic rationale for buying and consider synergy will put themselves in a position to maximixe the value of their investment. Platforms are increasingly more common and and for good reasons. Focusing on sectors that you can become well versed in and looking for ways to leverage synergy seem to be key components in adding value and achieving results. Yet, even many PE's with platforms we talk to don't look at integration with the same passion as some strategics.
We have always thought the work we do for strategic buyers could easily be applied to financial acquisitions under circumstances where the PE believed that synergy can drive value and that proper integration may be a key to achievng it. Yet, from our eyes only a minority of PE's consider external help for integration (when there is something to integrate) and instead rely on less than objective perspectives of their business to integrate who may not have a lot of experience at it. That seems to be taking inordinant risk.
History has shown us that many deals fail to reach financial or organizational objectives and that the systemic root for that failure is inability to integrate properly. The M&A world could contribute to turning around the economy if every deal done going forward was a resounding success.
I am interested in the PE perspective on this topic and invite constructive criticism of my thoughts and analogy.
Joe Huguelet
19 Aug 10 at 15:46