Strategic vs Financial Business Sales

Thinking of selling? Your choices are Strategic vs Financial Business sales, and understanding the mindset of different types of buyers is critical.
Strategic vs Financial Business Sales

You may be considering a sale of your business as you read this or already planning for a future transaction. Your choices are Strategic or Financial Business buyers, and understanding the mindset of different types of buyers is critical to your preparation and decision-making processes. Understanding the motivations and goals of each type of buyer, you can better prioritize which buyers fit your situation, allowing you to focus on finding the right relationships.

Many different kinds of buyers might be well suited to acquire the business. Potential buyers and investors generally fall into one of two categories:

Strategic vs Financial Business Sales

Strategic Acquisition

These are privately held or public operating companies that provide products or services to the market in a certain sector or industry. Generally, they are direct competitors, customers, or suppliers of your business. They can also be indirect competitors, in close adjacencies, or perhaps contextually related to your company and they may be looking to grow in new directions.

Strategic buyers can identify companies whose products or services can integrate well with their existing business – imagine that the worth of two companies’ combined is larger than the sum of the separate individual parts (i.e., 1+1 =3).

According to Pepperdine’s “2020 Private Capital Markets Report”:

  • About 51% of closed business sales transactions in 2020 involved strategic buyers.
  • Strategic buyers making deals in 2020 saw a net increase of 28% on 2019.
  • Strategic buyers making deals in 2021 is expected to increase by 17% over 2020.

Financial Buyers

A financial buyer invests in private or public companies, but on behalf of a larger shareholder/investor group. Financial buyers will work to improve the company’s operational and financial performance throughout a predetermined time and eventually sell the business to create returns for its investors.

This type of buyer is generally a private equity firm, investment fund, family offices, etc. They offer a wide range of options for business owners from reinvestment to a complete and final exit.

A supportive financial buyer can help a company that has a strong owner or management team by offering finance for any acquisitions and growth and cost reduction.

It has to be said that once a financial buyer owns a portfolio company in a specific industry, they can easily move to be a strategic buyer as they look to complete add-on transactions and achieve growth through M&A.

Primary Differences between Strategic and Financial Acquisition

It is important to have an understanding of the end goals of both strategic and financial acquirers to understand how their approaches differ and why. Generally speaking, there are five ways in which their considerations differ:

  • Valuation of the business.
  • The investment merits of the industry.
  • The strength of infrastructure.
  • Impact of the investment horizon.
  • Transaction efficiencies.

Each of these differences highlights its importance as to why one buyer category is more desired than the other.

How each evaluates your business

Perhaps the most consequential difference between strategic and financial acquirers is how they will evaluate your business. Strategic buyers tend to focus heavily on synergies and integration capabilities, while financial buyers look at standalone cash-generating capability and the business’s capacity for earnings growth.

A Strategic buyer will generally incorporate the business into a larger one so they have to make considerations on how the new acquisition will work with the existing company.

As an example, strategic buyers will typically ask questions such as:

  • Are there manufacturing economies of scale we can realize?
  • Does your company serve a new customer segment for them?
  • Are your products sold to their customers, are you a competitor?
  • Are there intellectual property or trade secrets that you’ve developed that they want to own or prevent any other competitor from owning?

Conversely, financial buyers generally evaluate an opportunity as a stand-alone entity, simply because it won’t be integrated into a larger company. Financial buyers’ focus is on the business’s ability to grow very quickly in a short, predetermined period. Financial buyers often buy businesses partially with debt, causing them to scrutinize, very closely, the business’s capacity to generate cash flow to service a debt load.

One note of caution; not all acquirers will fit neatly into these two categories. It could happen that ‘strategics’ may just be looking to boost their earnings and move into the financials category. On the other hand, ‘financials’ already own a company in your space and are looking to make strategic add-ons, so they’ll evaluate your business more like a strategic

It is essential to recognize the motivations of the buyer, helping you to understand how they’re determining your business’ value.

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How they intend to own an acquired business

Yet another important difference between strategic and financial acquirers is an understanding of how long they intend to own an acquired business. Strategic buyers will plan to keep a newly purchased business indefinitely, most likely they will integrate the company into their existing business. Financial buyers are likely to have an investment period of only 5 to 7 years.

This infinite versus a predetermined and finite holding period will have an impact on how much a buyer is willing to pay for a particular business.
The time that a financial acquirer buys into and exits the business will have an important impact on the return on the capital invested.

Any financial acquirer will be more sensitive to business cycle risk than a strategic acquirer, always thinking about several exit strategies before making a final decision to invest in or buy a company.

They differ on the investment merits of each industry

The industry within which the company exists will have varying importance for the type of buyer attracted to it.

Since strategic acquirers are usually tied to a particular industry, by nature of their core product/services, they will spend a great deal of time focusing on how your business can integrate with their overall corporate strategy. These strategic buyers are looking to make an acquisition that can quickly impact the bottom line.

Financial buyers tend to specialize in the whole picture: both your business and therefore the industry within which it operates. Since financial buyers are often not wedded to one industry, they have to make their minds up both on the attractiveness of a selected business and also the attractiveness of the broader industry in its entirety.

Financial buyers will sometimes hire a third-party firm to help within the valuation. For industries that are highly regulated, unpredictable, or discretionary, pursuing relationships with a strategic buyer can help mitigate the risks related to an industry.

Each views back-office infrastructure differently

A typical strategic acquisition will focus less on the strength of their target company’s “back-office” infrastructure as many of those functions which are duplicated in their company are going to be eliminated during the post-transaction integration phase.

Financial buyers don’t have these functions already in situ, they’ll need this back-end infrastructure to remain. They’ll scrutinize it to the nth degree during the due diligence process, often seeking to strengthen the infrastructure post-acquisition.

It is better to de-emphasize the importance and/or value of your back-office infrastructure during discussions with a strategic buyer, whereas it’s important to be prepared for a radical evaluation of those functions with a financial buyer.

In Conclusion

As a business owner moves through the sale process, it’s important to stay in mind the first goals established for the sale transaction. Understanding the various approaches taken by financial buyers and strategic buyers can help a selling business owner set realistic expectations for every stage of the sale process and ultimately settle on the proper partner to fulfill the objectives within the sale.

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