When companies are bought or merged, there are two kinds of possible buyers: Strategic or Financial. Both want to buy businesses, but they have different reasons and strategies.
Understanding how they are different is important for business owners and their advisors working on these transactions. Let's look at what makes these two types of buyers unique and how they impact the M& A world.
Defining Strategic Buyers
Strategic buyers are typically established firms in a particular industry sector, and their M&A activity tends to be driven by strategic motives aimed at growing and improving present operations. They aspire to expand market reach or attain competitive advantages. These buyers pursue vertical or horizontal synergies with the target company. Horizontal synergies could involve leveraging complementary technologies, accessing new distribution channels, or diversifying product offerings. Vertical synergies could include acquiring customers or suppliers. Their current operations and target company's capabilities align for enhanced business advantages.
The Motivation Behind Strategic Buyers
Acquiring a business is no small matter for strategic buyers. They are always looking for companies that match their growth strategy. These acquisitions bring more than just financial gains, they bolster the buyer's future. Strategic buyers view such acquisitions as investments in staying competitive. Acquisitions must be directly tied to the company's long-term business strategy. Opportunity for growth motivates a strategic buyer, and generally strategics will pay more than pure financial buyers.
Key Characteristics of Strategic Buyers
Strategic buyers typically have deep industry knowledge. They understand what makes their business successful. This expertise lets them look for specific attributes in the companies they wish to buy. The acquisition must fit their strategic growth plan.
Strategic buyers want to integrate the companies they acquire into their businesses. They want to combine operations to create efficiencies and accelerate growth of the combined companies.
Strategic buyers focus on long-term value creation, not just quick profits. Their growth plans include acquiring companies with the goals of becoming market leaders through steady expansion.
Exploring Financial Buyers
Financial buyers are private equity groups, family offices, investment firms, or high net worth individuals. Their main goal? To earn high returns on investments by increasing revenue and earnings. Unlike strategic buyers, they may not already have an investment in the target company's industry. To Increase the value of their investment, they utilize financial engineering, operational enhancements, and strategic repositioning. In many instances the financial buyer will purchase a “platform” in an industry, followed by “add-ons” to the platform, to gain significant increases in revenue and earnings. As they become a seller, the significant increase in earnings ( EBITDA ) can command a higher multiple of earnings than was paid for the first investment. This financial technique is referred to as “multiple expansion.” The financial buyer’s focus is making the target company more valuable when the investment period is over and it’s time to monetize their investment.
The Motivation Behind Financial Buyers
What motivates Financial Buyers to invest? They seek businesses that are underperforming, underpriced, or have significant growth opportunities that have not been realized. Their goal is to boost the business's net worth through smart management decisions. This can be achieved by cutting costs, streamlining operations, increasing sales or finding new ways to increase profits. Financial buyers are driven by the prospect of significantly increasing a company's overall value.
Key Characteristics of Financial Buyers
Financial buyers will employ leverage as a tool to increase gains on investments. They can restructure debts, refinance a company’s financial obligations, and utilize tax reductions to increase returns. Financial buyers understand financial techniques and strategies.
While lacking specific industry knowledge, financial buyers often improve operations through management experience. They initiate changes and enhancements to raise profits and efficiency. However, operational guidance is their strength.
Financial buyers always think about their exit steps when acquiring companies. They plan to eventually sell investments to other investors or offer public stock sales (IPOs). Yet their end goal involves favorable valuations to generate returns from ownership stakes.
Conclusion
Companies who are ready to divest or merge seeking a capital partner can attract both strategic and financial buyers. Strategic buyers try to achieve continuous growth through both vertical and horizontal acquisitions in their specific industry. Financial buyers look to increase revenue and earnings, utilizing financial tools and operational smarts, aiming to increase the value of the acquired company. In today’s market, financial buyers have also become “hybrid” buyers as they complete strategic acquisitions to accelerate growth of revenue and earnings of their portfolio companies. Understanding motives and styles of buyers helps stakeholders navigate M&A wisely. Each buyer type has strengths for achieving goals to increase the value of the business.