When the critical time comes to sell a business, ownership sometimes doesn’t know which potential buyers to entertain and may end up consuming a considerable amount of time with the wrong buyer.
The myriad options available to them when contemplating their exit strategy can be confusing at times, leaving the owner unable to decide when to sell and who to sell the business to. Understanding what avenues are available helps owners decide which one provides the best fit for the business, beyond the standard deal terms and pricing.
Other than the business founder’s children or next generation inheriting the business or a management team approaching the owner to take over the business, there are two types of buyers in the mergers and acquisitions (M&A) marketplace.
Types of buyers
First are strategic buyers. These buyers are companies that either operate in the same industry or otherwise operate in a horizontal or vertical industry. They can be a larger competitor, a supplier, or a customer of the target company.
The second type, financial buyers, typically are private equity firms, family offices, or wealthy families who gained significant fortunes from selling a business in the past. They can also be a group of investors who collectively pooled their resources to invest in a portfolio of companies.
Broadly speaking, strategic buyers acquire businesses because of the potential synergies that they can derive from a target company not only immediately after acquisition, but also during the many years to come. For that reason, they augment the possibility of maximizing the enterprise value for the owner.
Financial buyers, especially private equity firms whose main goal is to buy the target company and sell for profit over a three- to seven-year horizon, are known to buy companies expediently and with higher certainty. This is because these buyers don’t need to take into account synergies that add more layers of complexity to the transaction.
Key differences between these two types of buyers exist, and understanding these differences will help owners understand, and eventually make a quicker decision, about which buyers to pursue.
Synergies. For strategic buyers, the combined performance of both companies, and their ability to generate value, is greater than the sum of their performance as separate entities. Strategic buyers have various motivations for buying a business. These can be as varied as expanding the breadth of products and services, expanding geographically, or finding a unique product or a niche market. Presumably, if integration runs smoothly, the cliché “bigger is better” can’t be truer than in this situation.
A bigger company has a stronger presence in the marketplace and better bargaining power with suppliers and customers. Oftentimes there are cross-pollination of expertise and ability to cross-sell products and services between their customers, assuming there are no significant overlaps.
Furthermore, when a target company is integrated into a larger company with better systems and processes, it allows the former team to function more efficiently.
Financial buyers, on the other hand, will own and manage the only target company, although tremendous value can be created by investing more equity into the business and hiring more people.
Valuation. Strategic buyers typically pay more for the business because they look at how bringing the target company into the fold can improve performance and generate efficiencies. They can also eliminate redundancies in administration, such as HR, finance, accounting, and IT functions, and reduce associated operating expenses.
Except in situations where a private equity firm already has a company in their portfolio that is similar to the target company, financial buyers do not gain synergies as a result of the acquisition. Their only motivation is the ROI from a single company, so they are therefore reluctant to pay a premium based on future earnings.
They rely upon the company’s historical earnings or past EBITDA multiplied by a standard industry multiple. There are hardly any variances between the offers from two private equity firms.
Speed of Closing. Strategic buyers need to consider future synergies and several possible scenarios after the target company is acquired.
For example, cultural integration, retention of a talented management team, products and services mix, accounting, tax, and legal matters can be very challenging to ascertain. All are important considerations that will determine if the acquisition will be successful or end up being a massive failure.
The M&A process for financial buyers is less complicated because they are dealing with only one company and uncertainties about the outcome are minimal. Executing the process from the time the owner accepts the offer can take anywhere from two to four months, whereas M&A with a strategic buyer can take six months to one year or longer depending on the size of the company.