The terms “Financial Buyer” and/or “Strategic Buyer” frequently arise in discussions about investment banking activities, particularly when discussing the sale of a business. This article describes some of the characteristics of each type of buyer, and briefly discusses potential situations in which one might be more appropriate than the other.
Financial buyers can generally be classified as investors interested in the return they can achieve by buying a business. They are interested in the cash flow generated by a business and the future exit opportunities from the business. They are typically individuals or companies with money to invest, and who are willing to look at many different types of businesses or industries. Their goals may include growing cash flow through revenue enhancement, expense reductions, or creating economies of scale by acquiring other similar companies. Their exit plans may include an IPO (initial public offering), where the business is “taken public” (hopefully at a higher multiple of earnings than paid at acquisitions), or selling the company at a future date.
Financial buyers will carefully scrutinize the financial statements of the company. Most are looking for a well-managed company with a history of consistent earnings, and preferably, earnings growth. The transactions of financial buyers are often leveraged. It is common to see financial buyers use as much as 80% or more debt to finance an acquisition. By using high leverage, the financial buyer is effectively partnering with someone who is willing to accept a level of return (a lending rate, perhaps augmented by “kickers” to augment returns) that is generally lower than that required by financial buyers.
In layman’s terms, financial buyers are buying exactly what the company has to offer. They are buying the expected future earnings of the company as they are perceived to exist at the time of the acquisition. While financial buyers may see the potential for expanding cash flow beyond what the company has achieved on its own, they are generally not willing to pay for that potential. They are much more likely to keep the current personnel in place than strategic buyers. However, if their intent is to grow the business and eventually sell to a strategic buyer, the retention of personnel may be temporary.
Strategic buyers are interested in a company’s fit into their own long-term business plans. Their interest in acquiring a company may include vertical expansion (toward the customer or supplier), horizontal expansion (into new geographic markets or product lines), eliminating competition, or enhancing some of its own key weaknesses (technology, marketing, distribution, research and development, etc.).
Strategic buyers are often willing and able to pay more for a company than financial buyers. There are two main reasons for this. First, strategic buyers may be able to realize synergistic benefits almost immediately due to economies of scale that may exist through the combined purchasing power of the new entity and the elimination of duplicate functions. The better the fit (i.e., the more realizable the synergies are), the more they will want the business and the greater the premium they will pay. Second, strategic buyers are generally larger companies with better access to capital. They often have another currency available to them in the form of stock. Strategic buyers often offer stock, cash, or a combination of the two in payment of the purchase price.
In short, the strategic buyer is buying the company in light of how it will enhance their existing operations. They are often willing to pay for readily realizable synergies, and many times will pay for speculative synergies, particularly if the target company is being marketed to other competitors (through some type of “auction”). Strategic buyers are much less likely to retain all of the current personnel.
Believe it, or not, the answer to the question “which is right?” is not always as cut and dry as it might seem. Whether a strategic buyer or a financial buyer is right for a specific company depends largely on the seller’s goals in selling the business. Listed below are different scenarios discussing the seller’s goal and the type of buyer most appropriate.
This brief discussion is in no way intended to try to address all of the circumstances that may need to be considered in the prospective sale of a business. If you are a business owner who is considering the sale of your business please contact us at Mercer Capital to confidentially discuss your specific situation.
Reprinted from Mercer Capital’s Transaction Advisor – Vol. 2, No. 2, 1999.