Entrepreneurs who sell their businesses generally run across two main types of acquirers: strategic buyers and financial buyers. As you approach the M&A process, it can be helpful to understand the general expectations and requirements of each; and to consider which type of buyer might present the best fit, given your business and your personal and financial goals.
Strategic buyers are companies already in your industry, either as a direct competitor, client, distributor, or other participant in the value chain.
Strategic buyers are generally looking for an acquisition to help expand their sales, customer base, geographic reach, product offering, or talent pool -- with the expectation that an acquisition will be faster or less expensive than organic growth. Strategic buyers may also look to reduce expenses by integrating some aspects of the acquired company into their existing operations. In most cases, strategic buyers want to acquire 100% of the company or its assets. Although Fortune 500 companies spring to mind when thinking of a strategic buyer, most industries have a very large base of mid-sized companies that actively seek acquisitions of smaller, lower middle market companies. This is especially true for consumer products companies.
Financial buyers, including private equity groups, venture capital firms and family offices, acquire companies to generate a financial return on their investment. They usually buy with the intention of using their capital and know-how to increase the size and value of the company, and reselling to a strategic acquirer or another financial buyer. They generally hope to keep the existing management team and organizational structure in place to continue to operate the business. The financial buyer usually purchases a majority of the company, leaving a percentage of equity with the seller as an incentive to grow the business and share in the upside in the second exit. Private equity firms sometimes refer to this as "A second bite of the apple."
Most larger financial buyers raise capital to fund acquisitions in advance of identifying acquisition targets, however some financial buyers are “fundless” or “independent” sponsors, who plan to raise capital from investors once they identify a specific acquisition opportunity. Over the past couple of years we have seen a tremendous increase in the number of financial buyers looking to make acquisitions of lower middle-market companies.
In today’s changing marketplace, some buyers are hybrids of strategic and financial buyers. A private equity firm might have other similar investments in their portfolio that can provide synergies through marketing, distribution or other activities, as well as a support network to share management experiences and strategies. On the other hand, a strategic buyer may look like a financial buyer if they plan to have an acquired company operate independently to move into a new market, capitalize on brand recognition, social, or environmental ethos, or shift their existing operating model.
There are varying schools of thought as to whether the highest valuations and best terms can be obtained from strategic or financial buyers. A strategic buyer may be able to make an acquired company more profitable by cutting expenses, or may have a deep balance sheet to easily make an all-cash acquisition. Financial buyers may have limited time frames in which to invest their committed capital, which can create a sense of urgency to make acquisitions. However, the best buyer for your company is usually the one that sees the greatest fit and highest future potential, and that can be either a strategic or financial buyer.
Depending on the size and type of your company, individual buyers or search funds might also be potential buyers. An experienced, high-net worth individual buyer, such as a former entrepreneur, an experienced corporate executive, or a former private equity manager may bring strong experience and personal capital to the acquisition, can move quickly and independently, and may provide flexibility regarding your role and equity participation moving forward. Search funds are typically spearheaded by recent MBA graduates with a desire to acquire and run a lower middle-market business. Just like financial buyers, some search funds are funded, while others plan to line up financing once they identify the right opportunity. If you are approached by a search fund, be sure to find out if they have any capital to buy your business.
As you approach the M&A process, it’s important to thoughtfully consider your personal goals, and how they match up with the potential buyers in the marketplace. To optimize transaction value, some entrepreneurs may want to approach all types of buyers during the M&A process. In other cases, a seller may want to identify a category of buyers which will best help achieve their financial and non-financial goals. For example, if your intent is to sell for retirement or to explore other options in life, a strategic buyer may be an ideal fit. On the other hand, if you want to surround yourself with a smart team and participate in a second exit, a financial buyer may be more attractive. But in either case, understanding the types of buyers and how they match up to your desired exit strategy will help you achieve a more successful exit.