For example, in the 1990s many private equity firms developed a practice of buying companies and operating them more “efficiently” by cutting staff or other expenses or hamstringing the leadership from making necessary business decisions that owners previously made independently. As a result, business owners learned about this practice and developed a hesitancy—if not a resistance—to selling their businesses to private equity.
Today, that model of gaining efficiency by aggressively cutting back or fundamentally changing the business has shifted. The current model is much more hands off, and the more prominent and successful private equity buyers largely recognize the value of their target businesses and avoid dictating changes that might hamper growth or morale.
One M&A concept that has remained constant has been the way we differentiate the types of buyers that a seller can expect to engage with in a selling process. Generally, those consist of two categories:
- Strategic – Prospective buyers that operate within the same industry or vertical as the target (selling) company, such as a competitor or supplier.
- Financial – Private equity companies and family offices are two of the most recognizable parties, sometimes new entrants into the industry and sometime experienced acquirers.
The outcome of a sell-side process differs depending on the type of buyer that is either being pursued or ultimately brings the most compelling offer to a seller. Below are some of the key differences that a seller will notice with either type of buyer.
Operational Setup
Private equity companies are, by design, structured and equipped to buy and sell portfolio companies, but strategic buyers focus more on operations. Some of the reasons for the difference is in the strategies that private equity companies employ to earn a return (via M&A), which is different from those businesses that are more focused on organic growth.
Companies that are natural acquirers may never have executed another similar transaction, so that operator would not need anyone on staff with M&A expertise. In that case, it can be important to purposefully position the company from a marketing standpoint, as well as ensure the right people are contacted in the solicitation and decision-making stages of the process.
Speed of Execution
Related to their operational setup, the time it takes a strategic suitor to evaluate an opportunity is often much greater than the equivalent review time that a private equity or family office needs.
A lag in evaluation, or even execution, of a decision to buy a company can impact the seller’s preferred timeline. If the owner’s objective is to sell quickly or for the company to be evaluated by multiple parties simultaneously, it can become a challenge when a strategic buyer is not able to organize at the same speed as a financial participant. The determination of which parties to approach should be informed by a transaction advisor’s experience with both types of buyers in concert with the seller’s preferences.
Valuation
The lack of speed of execution can often come into play in the value strategic buyers are sometimes able to assign to the target company that is for sale. When there are “strategic” reasons a buyer may be interested in a company, such as operational or geographical efficiencies, the inherent value in the selling company to that particular buyer may be large enough to allow the strategic buyer to value the company much higher than a new entrant into the industry.
When a strategic sale is more advantageous, as in the above scenario, it can be worthwhile to allow the strategic buyer the additional time necessary to evaluate the opportunity. In fact, the evaluation of synergies can be more complicated. The important consideration is the overall approach and timeline necessary to execute on the selling strategy.
The Bottom Line
Financial buyers typically view acquisitions of companies as an investment, often with significant leverage employed as part of the transaction. As a result, the best targets for those buyers are stable and growing businesses with upside over the coming three to five years, which is the most common hold period for private equity firms.
Strategic buyers are most interested in targets that, when combined with their operations, create additional value (1+1=3). In that scenario, selling companies often become absorbed into the larger acquirer over time, and the strategy is not for there to be a specified hold period at which time the company will be divested. Instead, the two may become long-term partners, or even indistinguishable as separate entities.
Financial-backed Strategic Acquirers
There are exceptions to the above generalizations. One emerging theme, as private equity funding has increased significantly over the previous 10 years, is the blending of strategic and financial buyers into a hybrid category: Financial-backed Strategic Buyers.
When a private equity firm makes its initial entry into an industry, it will create what is known as a “platform investment,” an operating company that the financial buyer owns. That platform company is the strategic operator backed by a financial investor. Those platforms most often continue to be acquisitive, seeking to solicit “add-on investments,” or smaller strategic targets, to build the platform over the three-to-five-year hold period. However, these platforms are actively seeking acquisition targets that can bring additional efficiencies or synergistic benefit.
Financial, strategic, and financial-backed strategic buyers represent some of the many examples of the complexities of M&A. Understanding these and other ever-evolving facets of the transaction environment is critical to the eventual success of any owner seeking to plan for, or exit, a business.
At HORNE Capital, we include all types of buyers and considerations in our strategy for helping business owners evaluate the best approach to preparing for and selling their companies. When we work with our clients in advance of a transaction, we can control the timeline and leverage of the sale by incorporating our experience into the strategic plan, which results in a better experience and outcome for business owners.
