Types of M&A Buyers: Strategic, Financial and Hybrid
By: Jack Schanze
A vast, motivated and diverse buyer universe is what helps set the stage for a highly competitive M&A process. And in the M&A arena, increased competition almost always brings increased value.
So, who comprises this competitive universe?
- Strategic buyers
- Financial buyers
- Hybrid: Sponsor-Backed Strategic buyers
There are pros and cons to each buyer type and depending on the objectives of a potential sale, the seller may prefer one over the others. It is important for the seller to understand the basic approach and attributes of each buyer category to be able to make an informed decision on selecting the right partner for the future.
Strategic buyers are typically public corporations or large private companies that operate in the same or a closely related industry as the seller or have a subsidiary operating in the space. Strategic buyers can be foreign or domestic, public or private, in a horizontal or vertical space, or a competitor, supplier or customer. Regardless of their standing, all strategic buyers are seeking to expand or improve their offerings and realize synergies with the target company.
Pros: Strategics usually have an incumbent understanding of the product/service that the seller is offering and of the customers that constitute the marketplace in which these products/services are sold. This eliminates the need for a complete education of the seller’s offerings, which helps accelerate the transaction process and gives the buyer the ideal vantage point to understand what drives value in the seller’s business. Strategic buyers also realize cost-saving synergies – duplicative assets, expenses, and other overhead that would no longer be needed in a post-acquisition environment – that can justify a higher purchase price.
Cons: Unlike financial buyers, strategic counterparties usually do not have a specific mandate to acquire companies, so they are not always actively looking to make acquisitions. Also dissimilar to financial buyers, strategics can lack experience in executing transactions. A first-time buyer trying to execute a transaction with a first-time seller can lead to unforeseen challenges and places an increased importance on the intermediaries advising on the deal. Additionally, in order for a strategic buyer to realize synergies, there is typically some reorganization that takes place such as eliminating redundant positions, facilities or other overhead. Strategic buyers could pose a threat for sellers wanting to preserve the existing structure and culture of the business, especially personnel.
Financial buyers, otherwise referred to as financial sponsors, are usually private equity firms, family offices or venture capital firms that are looking to acquire companies as an investment. Financial buyers exist specifically to acquire businesses, grow those businesses, and either take perpetual distributions from those businesses’ cash flow or to sell those businesses at a later time for a higher price than what they originally paid – all to achieve a financial return on the investment.
Pros: Financial sponsors’ core purpose is to buy businesses to generate financial returns and to repay their investors, so they have created a marketplace where there is always an appetite for acquisitions. This can create heightened competition for the seller’s assets and can result in receiving a higher valuation. Additionally, sponsors will pay a premium multiple for a “platform” acquisition – platform meaning the first business acquired to execute on a “buy-and-build” strategy (covered further in the sponsor-backed strategic section below). Sponsors usually have strong experience and expertise in successfully executing acquisitions, giving sellers a greater certainty of closing compared to a potentially inexperienced strategic buyer. Finally, financial buyers can grant incumbent ownership the opportunity to “roll” or retain existing equity in the company, allowing for participation in future upside of the business and a “second bite of the apple” when the sponsor resells the business at a later time.
Cons: Since financial sponsors view an acquisition purely as a financial investment, choices made in a post-acquisition environment put financial consequences at the forefront of all decision-making. This can lead to organizational realignment and other planning decisions that disrupt the legacy culture of the entity. Sponsors’ focus on financial returns could also hinder their ability to justify a purchase price that a strategic buyer may be able to justify. Financial buyers have a targeted internal rate of return on the investment, and the higher the purchase price the more challenging it can be to realize this rate of return. Additionally, sponsors typically utilize large amounts of debt to fund the purchase price, and in order to obtain a reasonable financing package from the third-party lenders the sponsor must prove it is paying a rational price and the seller must prove it has sufficient and reliable cash flow.
Sponsor-Backed Strategic buyers are strategic buyers that are majority/fully-owned by a financial sponsor. Sponsor-backed strategics are a hybrid of the two aforementioned buyer types and bring a unique blend of pros and cons to the buyer landscape. This buyer type is almost always created when a pure financial buyer acquires a business, the “platform company”, and then mandates additional strategic “bolt-on” acquisitions to scale the platform and achieve more rapid growth. This is known as the “buy-and-build” strategy that is deployed by many well-regarded private equity firms across the globe and allows the platform to simultaneously achieve growth both organically and through acquisition.
Pros: Sponsor-backed strategic buyers bring the existing industry knowledge of the platform company and parlay that with both the transaction experience and the appetite for acquisitions possessed by financial buyers. This allows for a motivated buyer with experience in executing deals to understand the value proposition of sellers and quickly and effectively scale the platform by making acquisitions.
Cons: The main downfall to sponsor-backed strategics is simply that the volume of this buyer type is more limited compared to the previous two buyer types. In order for the buyer type to be applicable, a financial sponsor must make a “platform” acquisition of a comparable company, and also have a mandate to make additional “bolt-on” acquisitions of like companies. Based on these contingent criteria, this buyer type can be few and far between in certain lines of business. Additionally, as a sponsor-backed strategic executes its “buy-and-build” strategy, acquisition multiples can be discounted for “bolt-on” deals. So, while this hybrid buyer often still realizes the same synergies that would allow a pure strategic buyer to pay a premium, those are often offset by the nature of the sponsor’s desire to pay a “bolt-on” multiple.
In conclusion, each buyer type provides a unique set of pros and cons. This requires the seller to consider its transaction objectives before choosing its acquirer, and in order to do so, must first understand the characteristics that each buyer brings to the table. Utilizing the guidance and expertise of an M&A advisor allows sellers to better recognize which buyer type(s) aligns best with its goals in a transaction. Additionally, each respective buyer brings a nuanced set of attributes to a potential acquisition and allowing an M&A advisor to run a full sale process gives definitive insight to the post-sale environment and increased optionality in ultimately choosing an acquirer. Learn more about the value of an M&A Advisor.