It has been written by Samidha Hegde, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions from LawSikho. It has been edited by Ruchika Mohapatra (Associate, LawSikho).

It has been published by Rachit Garg.

Introduction

There are various types of buyers in the market. They can typically be categorized as “Strategic Buyers” and “Financial Buyers”. Both Strategic and Financial Buyers buy equity in companies but this is where the similarities end. There are many fundamental differences between Strategic and Financial Buyers.

When you want to sell a business, it is important to find buyers keeping in mind the goal of the transaction; buyers who align with the long term objectives of the seller, buyers who pay more etc. The seller should take into account all these factors and market their business to the optimal buyers to accomplish the goal of the transaction.

Who are strategic and financial buyers?

Strategic Buyers are companies that operate a similar business or in the same industry as that of the Seller and hence they have the benefit of knowing the industry closely and they don’t tend to diversify or risk buying a company outside of their industry which limits the options available to them. Strategic Buyers can be suppliers, customers or competitors that are looking to expand their business. They tend to acquire for reasons like- growth opportunities, eliminating competitors, removing their existing weakness, improving efficiencies, and enhancing business.

Strategic Buyers are often willing to pay more than financial buyers because they instantly realize synergistic benefits and the underlying profit that can be generated when the businesses are combined, which could not otherwise be possible for the Strategic Buyers on their own. Another reason why Strategic buyers are willing to pay more is that they tend to be well-positioned and have easier access to capital and can make purchases easily in stock or cash. [1]

Financial buyers

Financial Buyers are often Private Equity Firms, Venture Capitalists or Individuals with high net worth. These types of buyers are engaged in the business of investments and have committed capital which is used for acquisitions; they view acquisitions as investments and expect to generate a satisfactory return.

Financial Buyers are usually open to investing in different industries even if that is diverse from existing operations this provides them with several options to choose from [2] and they can conduct extensive financial analysis and a good network of bankers, advisors and lawyers which helps them to swiftly identify potential targets.  However, most Financial Buyers don’t have an existing management in place and are not equipped to run the business therefore they look to buy businesses with strong management. Financial Buyers are ideal if the Seller intends to manage the business after the sale. [3]

Different approaches used for evaluation by strategic and financial buyers

Since Strategic and Financial Buyers have different motivations behind the transaction, one of the key differences between Strategic and Financial Buyers lies in the way they evaluate the business.

What do strategic buyers look for in a business?

• Strategic Buyers are largely focused on synergies and integration capabilities; they spend a great deal of time evaluating the acquisition based on how well the Seller’s business will integrate into the acquirer’s existing operations and business units. 

• Strategic Buyers consider how dependent the business is upon the Owner/Seller. How strong is the management? Can the management remain in place and run the business in the absence of the Owner? Can the business survive without the Seller/Owner? A general rule of thumb is that no more than 10% of the sales of your business should be dependent on the efforts and connections of any one person—particularly the owner. The less dependent the business is on the Seller, the higher the value. [4] 

• Strategic Buyers don’t pay much regard to target company’s existing infrastructure, because generally the acquirer company already has them in place and therefore many back office functions like- HR, IT, Legal etc. of the target company will be eliminated in order to cut cost.

• Strategic Buyers commonly buy 100% of a company; post-transaction they do not allow the Sellers or other investors to control all or any part of the acquired company. [5]

• Strategic Buyers long-term plan is to hold on to the business indefinitely post-acquisition and completely integrate the business into their own business to realize synergies.

What do financial buyers look for in a business?

• Financial Buyers do not aspire to integrate the business into a larger company; they view the business as an independent entity and are mainly interested in the cash flow generated by the business.

• Financial Buyers do not recognize the synergistic benefits and make the acquisition based on expected future earnings and cash flow; hence they thoroughly examine the financial statements of the company and ensure that the company exhibits a record of consistent earnings.

• Most often Financial Buyers don’t have a team or necessary back-office infrastructure to run the day to day operations, they seek to buy companies that are well managed and therefore many a times the senior management or the Seller of the target company is required to stay and continue the business or at least remain involved for a while post-acquisition. Alternatively, the Buyer may even look for new management before the investment. [6]

• Financial Buyers often have an exit plan while entering the acquisition. They follow the principle “buy, improve and sell” [7] and consequently exit the investment typically within 5-7 years of time.

Who pays more between strategic buyers and  financial buyers?

Generally Strategic Buyers are willing to bid more than Financial Buyers because of their ability to quickly capitalize on synergies. “Synergies” also include the intrinsic benefit of possibly eliminating a competitor or gaining new customers, removing redundancies and eliminating duplicate roles, this creates extra cash to pay to the Seller. 

Even though Facebook acquired WhatsApp for $19 billion, it had first offered a similar company (Snapchat) $3 billion for the same deal; this shows that the more synergies a strategic buyer can find between their company and Seller’s company, the more they are willing to pay. [10]

However, in recent trends, Financial Buyers have upped the amount they are willing to pay in order to remain competitive with Strategic Buyers. If the recurring earnings and EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) are higher than 20% then they will readily offer a significant amount of cash.

So it is better not to always assume that Financial Buyers tend to offer less, they may sometimes be willing to offer much more and a quicker exit and so it is important to keep an open mind and consider both the types of Buyers.

How to choose between strategic and financial buyers?

There is no straightforward answer to which type of buyer is the best for your business, it all depends on the Seller’s goals. One thing is certain that regardless of the type of Buyer the Business is bound to change post the transaction. Certain factors need to be considered to help determine the right type of buyer-

• Seller wants maximum price possible:  If the Seller’s only goal is obtain the highest price possible without any concern about what happens to the business, employees or the property then an open auction is the most fitting choice. In this case, Strategic Buyers will be the most suitable type of Buyers as they are more likely to offer a higher amount.

• The Seller wants a higher price but has certain concerns: If the Seller wants a high price but also wants to protect certain aspects of the business per say, employees, culture or all the infrastructure that the Seller has built etc. A Strategic Buyer may still be the best fit however; the Seller may need to make some concessions in the price. Despite this the Seller may get a high price but not the highest possible price.

• The Seller wants to cash out but would like to remain involved in the business: In these cases, a Financial Buyer might be the most appropriate type of Buyer because Strategic Buyers already tend to have the expertise to run the business and are not likely to continue with the top-level management of the Seller’s Company or in other words eliminate duplicate roles while Financial Buyers lack this expertise and require Seller to stay and manage the business. And Sometimes the Seller has a significant amount of the deal structure tied up in earn-outs and in these cases the Seller may want to remain as long as possible to attain the earn-outs. [11]

Conclusion

Both Strategic and Financial Buyers offer advantages and disadvantages. Whether to choose a Strategic Buyer or a Financial Buyer is a decision unique to each firm. Sellers should carefully consider the types of Buyers and their intentions before entering the transaction. It is obvious that Seller wants to get the best possible price, but there are other factors and considerations that come into play depending on the buyer who’s sitting across the table and therefore it is advisable that Seller engage in a large number of both Strategic and Financial Buyers and see what they are willing to offer and assess the benefits and hazards that will ensue as a result of the deal with each type of Buyer.

References

1. https://www.lutz.us/buyers-strategic-vs-financial/ 
2. https://rosebiz.com/financial-vs-strategic-buyers-which-one-is-right-for-you/ 
3. https://www.middlemarketcenter.org/expert-perspectives/4-key-differences-between-financial-and-strategic-buyers 
4. https://www.keglerbrown.com/publications/strategic-buyer-vs-financial-buyer/ 

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