Trade Deal vs Private Equity Deal
For businesses considering their options for accelerated growth, they tend to gravitate towards proposals that contain a financial and strategic component. With this in mind, the most compelling expansion deals are usually from trade investors and private equity firms. In this post, I’m going to compare these offerings in a formulaic manner.
Trade Deal
So let’s assume:
- $X = The value of financial capital in a deal
- $aX = The value of strategic support in a deal
The value of strategic support is a multiple of financial capital because the whole purpose of the investment is to multiply the initial investment. Note: the “a” only represents the strategic value-add, not the realised cash multiple for the investor because there are other influences that drive the final result.
Therefore, the value of a financial+strategic deal ($Y) is:
- $Y = $X + $aX
When a business faces making a decision between a trade deal (JV, strategic investment, etc) and a private equity deal, they’re often deciding between the following two scenarios:
- Trade Deal: $Y = $X + $aX
- PE Deal: $Z = ($X - some) + ($aX + some)
In simpler terms, a trade buyer will usually offer a higher upfront valuation, while a private equity firm will offer greater strategic value. My thinking for this is that a trade buyer has greater immediate synergies and is often the more natural buyer of the business; hence, it may pay more. Whereas, a private equity firm has more experience in value creation AND it has more aligned interests; hence, it offers greater strategic value. I say more aligned interests because there’s the risk that the trade buyer wants to invest in the business as a defensive move and they actually don’t want the business to grow. This is a significant risk compared to a private equity investor who almost undoubtedly just wants to see growth.
With all of that said (and this is hardly an exact science), the question for the business owner is whether the additional upfront value from a trade buyer (trade deal) is worth more than the additional strategic value offered by the private equity firm. This is where the deal becomes self-selecting. If the business owner sincerely believes in the potential growth of the business, then they’d really choose the deal with the higher strategic value: the private equity deal.
