Takeaway: Knowing the key differences in the way these two groups think can help improve your chances of a successful outcome.
I work with business owners who need to raise capital or want to sell their companies. Most are unprepared to do either. There are many reasons for this, but three of the most important ones are: They lack a well-thought-out business plan, they do not know whether to raise debt or equity, or they do not understand which kind of buyer or investor to reach out to — either a strategic buyer or a financial buyer.
Knowing the key differences in how these two groups think can help improve your chances of a successful outcome.
Strategic buyers and investors are operating companies that sell products or services. Some may be your competitors, suppliers or customers. Others could be unrelated to your company’s specific business, but are looking to grow in your market space to diversify their revenue sources.
Financial buyers and investors are private equity firms, venture capital firms, hedge funds, family investment offices and ultra-high net worth individuals. These firms and individuals make investments in companies expecting a significant return on their investments. They identify privately owned companies with solid growth records, consistent earnings, strong management teams, attractive future growth opportunities and sustainable competitive advantages.
Strategic and financial buyers have fundamentally different goals. Therefore, the way they approach a business purchase or investment can differ significantly.
Here are six major ways that these two groups differ when considering a potential purchase or investment:
- Strategic buyers evaluate acquisitions largely in the context of how the business will “fit in” with their existing companies and business units. For example, as part of their due diligence and analysis, strategic acquirers will focus on to whom products or services are sold. They will examine market segments, economies of scale in your manufacturing processes and your intellectual property that could give them a competitive advantage.
- Conversely, financial buyers won’t be integrating your business into a larger company, so they generally evaluate an opportunity as a stand-alone business. In addition, they often buy businesses with debt, which causes them to scrutinize the business’ capacity to generate cash flow to service the debt and to ensure that the company can generate an acceptable return on investment. While both buyer groups will carefully evaluate your business, strategic buyers focus heavily on synergies and integration capabilities whereas financial buyers focus heavily on stand-alone cash-generating capability and earnings growth capacity.
- Strategic buyers are usually more up to speed on your industry, its competitive landscape and current trends. They will spend less time deciding on the attractiveness of the overall industry and more time on how your business fits in with their corporate strategy. Conversely, financial buyers typically build a comprehensive macro view of the industry and a micro view of your company within the industry. This macro view analysis might ultimately determine that they do not want to invest in any company in a given industry. This risk is usually not present with a strategic buyer that is already operating in the industry.
- Strategic buyers focus less on the strength of your company’s existing “back-office” infrastructure as these functions will often be eliminated during the post-transaction integration phase. Since financial buyers will need this back-office infrastructure to endure post-transaction, they will scrutinize it during the due diligence process and often seek to strengthen such infrastructure post-acquisition.
- Strategic buyers often intend to own an acquired business indefinitely. Therefore, they fully integrate the company into their existing business. Financial buyers typically have an investment time horizon from four to seven years, at which point they seek to sell or exit the acquired business. Financial buyers will be more sensitive to business cycle risk than strategic buyers. Financial buyers will be thinking about various exit strategies well before investing in or buying your company.
- Financial buyers are in the business of making acquisitions. It is one of their core competencies to execute deals in a timely and efficient fashion. Strategic buyers may not have a dedicated M&A team. Therefore, a strategic buyer may be encumbered by slow-moving boards of directors, bureaucratic committees, and conflicts with senior management.
From my experience, the factors and processes that strategic buyers employ can often take longer than with financial buyers. Regardless of which buyer category you choose, be prepared for a six- to 12-month thorough preparation process before you decide to sell.
Gary Miller is the managing director of the Consulting Division of SDR Ventures, a Denver-based investment banking firm. Gary specializes in strategic business planning and providing advice regarding M&A, exit planning and capital formation. Gary often speaks at conferences on M&A matters.