In the world of M&A, buyers tend to fall into two distinct categories: strategic and financial.  We believe it is important to understand the differences among these buyer groups so you know what to expect and who to approach about a potential sale.  

1. Strategic Buyers

Strategic buyers are companies that operate in the same industry or perhaps a related or adjacent one. They might also be a supplier or customer of yours that is looking to expand vertically within the supply chain. These buyers tend to acquire for a variety of reasons: growth opportunities, new product lines, and bigger scale to improve efficiencies. They might also be seeking to obtain skilled people that are in demand, intellectual property, technology, production capabilities, processes, customers, and suppliers.

Strategic buyers frequently pay higher multiples because there are often sales synergies and/or administrative redundancies that can be eliminated after the two companies are combined. For example, two combined companies can generate more bottom-line profit than each can separately due to cross-selling opportunities and/or elimination of redundant back office functions. This makes the combined enterprise more valuable than as standalone operations.

Because these buyers could be direct competitors, a seller should strongly evaluate if releasing proprietary company information to these suitors raises confidentiality concerns. The parties will sign non-disclosure agreements, but nevertheless, giving up trade secrets or having word leak out that a sale is imminent could negatively impact the seller’s business. Also, after a deal is consummated, a strategic buyer may dramatically change operations and/or consider employee layoffs to streamline operations. The potential upside of a higher multiple should always be weighed against some of the potential negatives.  

2. Financial Buyers

Conversely, a “financial” buyer is usually a private equity (“PE”) firm that has established a fund with committed capital to be used for acquisitions. These funds have defined criteria for the types of deals they will pursue. PE firms raise capital from high-net-worth individuals and institutions such as pension funds and endowments. These firms typically have a track record of successful deals, which enables them to raise such capital.

It is often relatively easy to learn about these firms, as they typically post information about their deals, firm personnel, and investment criteria right on their websites. Some of these firms are more operationally focused and “hands-on” with their investments, while others are less involved in day-to-day matters. Many PE firms have specific industry expertise, knowledge, connections, and resources that can be highly beneficial to a seller’s business.

It is also important to note that most PE firms would ask that existing management remains in place, particularly if the seller’s business is the first investment in a particular sector. In most situations, PE firms are not equipped to run the business, so a partnership with strong management teams is critical. If a seller wishes for continuity in operations (in terms of personnel), a financial buyer might be more appealing.

A seller might receive unsolicited offers from such PE firms, or they might be introduced to them with the help of an M&A advisor. We believe the best approach is to meet several such groups in order to ensure that deal terms are favorable and that goals and culture are aligned. 

More About Private Equity Firms

• PE firms will look at acquisitions in terms of returns on capital. They may take a harder look at ways they can improve operations, reduce costs, professionalize the business, improve sales functions, and seek new growth avenues (including add-on acquisitions).
• They are “fund-driven,” which means they are held accountable for investment performance by their outside investors (limited partners).
• PE firms may have a shorter time horizon than strategic buyers because their funds usually have a defined lifespan, after which capital must be returned to investors. On average, most PE firms hold their investments for 5 years.
• In order to return capital, PE firms must exit their investments via IPO, recapitalization, and/or a sale of the business.

As you consider a transaction, you will likely come across many PE firms because they are active buyers in the middle market. 

Independent/Fundless Sponsors

Over the past decade, there has also been an emerging subset of PE firms that are known as “independent” or “fundless” sponsors. These firms do not have a fund, nor do they have committed capital. Rather, they depend upon their relationships and connections with capital sources, which they approach to raise money when they find attractive deal opportunities. This could be somewhat risky if a sponsor does not have sufficient access to capital, so we recommend learning more about them and their funding sources early in the process.

• Independent/fundless sponsors essentially raise money deal-by-deal, and they may structure transactions differently depending on the requirements of the capital provider(s).
• These sponsors tend to be smaller, but they have more flexibility with their deals because they are not constrained by a fund’s specific criteria.
• They may or may not have specific industry skills and knowledge.