Private equity (financial buyers) vs. strategic buyers, which one is right for you?
Updated: May 17
It's a daunting task when thinking about selling your business. To complicate matters, there are different types of buyers too. So when the time comes, which one do you sell to?
While there are more than two types of buyers for your company, this article will focus on the two main buyers: strategic buyers and financial buyers (PE acquirers). We'll explain the differences between the two types of firms, the differences in their approach to M&A, and help you better understand which one is best for you.
How do they differ?
The main difference between these two types of buyers is their approach to M&A. Strategic buyers are usually more focused on long-term growth and success. Acquisitions are a way of plugging gaps in their business and helping them grow.
Financial buyers see M&A as an investment. They are primarily motivated by shorter-term (3 - 5 years) gains as private equity buyers will typically sell the business in a 3-5 year window post-acquisition. Private equity firms usually look for companies with a strong revenue stream and cash flow positive. They're also interested in companies with a good management team in place and offer growth potential.
On the other hand, strategic buyers are looking for businesses that have synergy with their own company and can plug a gap or offer a competitive advantage in the market. They're also interested in companies with a good market position and a strong brand.
However, both types of firms can provide valuable resources and operational expertise to help your business succeed.
Determine your goals
Once you've decided to sell your business, the first step is to have an exit plan for what comes next. Some owners typically sell as they may be looking to retire and want to cash in on their years of hard work. In contrast, others see an acquisition as a way of taking their business/products to the next level with the backing of a buyer. Under those circumstances, an owner may wish to remain involved in the business working with an acquirer to help them achieve their acquisition goals.
Understanding your motivations is essential to helping you identify the right buyer.
So, which type of buyer is right for you?
Sadly there is no one-size-fits-all. It entirely depends on your goals and objectives. For example, suppose you're looking to sell your company quickly and stay on to take the business to the next level. In that case, a financial buyer is most likely your best bet. However, suppose you're interested in the best valuation but will to accept you may longer be running things. In that case, a strategic buyer is probably a better option.
Of course, there are pros and cons to both types of prospective buyers.
Strategic buyers are typically more interested in the long-term success of your company, but they will most likely want to run and operate your business themselves. While financial buyers may be more motivated by short-term profits/growth, they could also provide the capital and resources needed to take your business to the next level.
Ultimately, your goals and aspirations will define which type of buyer is the best fit for you and your company.
What is a strategic buyer?
A strategic buyer is a company that purchases another company to grow or expand its operations. Strategic buyers are usually in the same or similar industry as the company they're acquiring. They're looking to add new products, customers, technology, market share or talent to their business to grow, stay competitive or become a market leader. A strategic buyer will most likely integrate an acquired company and
In a nutshell, strategic buyers are looking for a target company that will help them maintain or enhance their current business model, while also ensuring strong returns on investment.
Note that strategic buyers may be portfolio businesses of private equity groups.
What is a financial buyer?
A private equity firm is a company that invests in other companies to achieve a return on investment. PE firms usually have a lot of money to invest. They're looking for profitable companies which can be even more successful if they receive some financial help. They're usually not interested in companies that don't have a lot of growth potential.
PE firms draw the necessary funding for acquisitions from a central fund. Their tenure as the owner is linked to the fund's maturity; therefore, it is not unusual for an acquired firm to be re-sold within 3 - 5 years. In addition, financial buyers will often make the acquisition with the exit goals in mind. Therefore a PE firm's objective is to acquire and transform the business to maximise its return on investment.
There is usually an opportunity for existing management to stay on and help achieve the next growth phase. Private equity firms may incentivise management to achieve those goals. Additionally, they can provide the capital needed to grow the business and bolster management teams. They often have the resources and expertise to help the company succeed.
What are portfolio companies?
Private equity firms typically invest and own a portfolio of companies. This can be a mix of public and private companies, varying in size and industry.
Once a PE firm has invested in a company, they may treat it as a standalone investment or provide further financial and strategic support to help the company grow as an acquisition platform. An M & A roll-up strategy is a type of acquisition in which a company buys several smaller companies to create a larger, more powerful entity. Done well, this is an attractive option for companies looking to expand their business rapidly and achieve economies of scale.
Who pays more?
It depends on the buyer's goals and what's important to them regarding payouts. For example, a strategic buyer will usually pay a higher price since they're in it for the long term. Therefore, they will look for synergistic benefits such as operational synergies and increased earnings.
On the other hand, private equity firms typically pay less upfront. Still, they are often willing to invest more in the long run, thanks to the potential for a future sale of retained assets.
M&A deal structuring is the process of negotiating and finalising the terms of a business sale. This includes negotiating the price, defining the terms of the agreement, and drafting the contract. Therefore, it's essential to understand all the terms involved to avoid any misunderstandings down the line.
Strategic buyers typically aim to own the target company outright. Therefore deals are usually structured as an outright purchase, e.g. all of the money paid on signing the agreement or with some deferred element. For example, a percentage is paid upfront, and the rest is paid within a 2-year window based on achieving some defined criteria.
Financial buyers are often more flexible with their deal structures. As well as outright ownership and earn-outs, they are more receptive to a partial sale. For example, buying a controlling stake in the business and working with the owner to achieve the investment goals jointly.
The deal structuring process can be complex, so it's essential to work with a team of experienced professionals who can help you navigate these waters. Your financial advisor and M&A team will work with you to negotiate the best possible deal for your company. They'll also help you manage any potential roadblocks that may come up during the sale process.
It's also important to remember that the buyer and seller may have different expectations post-sale. However, the buyer and seller typically work together to ensure a smooth transition. During this period, the buyer will want to learn as much as possible about the company's operations.
Post-closing can be anti-climatic as the M&A process stops and business as usual resumes. However, management should prepare for what can be a very tedious process of integration and business planning. Buyers will focus on firming up their plans and integrating the business to achieve future growth (organic) and operational excellence. Additionally, suppose the acquirer is looking to consolidate further businesses. In that case, identifying additional complementary acquisition targets may start soon post-closing. Many private equity backed businesses are acquisition machines acquiring 4+ businesses a year.
When selling a business, it's vital to have an exit plan in place. This plan outlines how and when you'll exit the company and what you hope to achieve through the sale. Again, it's vital to have a clear strategy in place to maximise the value of your business and achieve your desired outcome.
What do you hope to achieve through the sale? First, get a proper valuation of your business to align your expectations with reality. Also, the earlier you identify a gap between your valuation and what you want, you will have time to bridge it by developing growth opportunities.
Looping back to the start of this article, what are your own plans post-transaction? Will you retire, will you remain involved, and if so, are you willing to continue to work as hard. Answering these questions honestly will help you decide on whom to sell to.
Your plans and expectations are the best barometers for deciding which is the best buyer. Both a financial buyer and a strategic buyer offer two very different propositions in terms of purchase. Therefore, think about what you want for yourself, your employees, and your business to help you better decide which offer to accept.
Each type of buyer has its pros and cons, and therefore don't be afraid to ask what their post-acquisition plans are so you can see which aligns best with your plans. Don't expect full disclosure from the buyer, but most will share the big picture strategy.
About Lighthouse Advisory Partners
If you're not sure which way to go, financial buyer / strategic buyer, we can help. Our team of M&A experts has a wealth of experience working with strategic and financial buyers. We'll work with you to understand your goals and objectives and then help you find the right buyer for your business. Contact us today to learn more.