Selling your business to private equity (“PE“) is very different to selling to a strategic buyer. They each approach deals in different ways, so you need to understand these differences and respond accordingly so as to secure the best deal.
As a general proposition, there are usually two types of buyers for a mid-market business:
A financial buyer — one who seeks to get a return on the investment made in the company and looks for businesses with growth opportunities and defensible competitive advantages. The return sought is an attractive return on investment and a profit on the sale of the company in a trade sale or IPO. PE companies are often financial buyers.
A strategic buyer — one who seeks out companies that have products or services that are complementary to their own, customer bases that they would like to own or IP they would like to own. They intend to integrate those businesses into their own business to create long term shareholder value. Growth oriented companies in the same or similar industry segment are often strategic buyers.
The difference is that a strategic buyer may agree to pay more, or may buy into an unprofitable company, if it believes it can leverage those assets or synergistically integrate them into its own business. A financial buyer, on the other hand, will usually be assessing the business as a stand-alone entity. If it is using debt to acquire the business, the free cash flow is very important.
There are times when a PE firm has bought into a company is using it to acquire other companies strategically, but for the purposes of this analysis, we will assume that the PE firm is always a financial buyer.
Understanding the difference between PE companies and strategic buyers helps you frame your approach differently to each for the maximum chance of concluding a satisfactory deal.
Deal Flow
A strategic buyer usually sources deals from within its sub-sector and relies on its knowledge of its own industry to keep track of potential targets. A PE company, on the other hand, relies on external analysis of sectors and companies, usually in conjunction with a network of advisors, bankers and other professionals.
At first blush, you would think that strategic buyers within an industry would have the upper hand. The difficulty is, though, that the assessment of the targets by strategic buyers is often done largely in-house. This may lead to a blinkered view. The other difficulty is that if the buyer is already in an industry, there may be a cognitive bias in the decision to acquire another company in that same industry. An example might be the video store chain that seeks salvation by acquiring more video stores instead of questioning the fundamentals of its own industry. Of course, if you are a seller, this may well work in your favour.
What tends to happen in PE companies, on the other hand, is that because they are coming from outside an industry, they pride themselves on rigorous processes to analyse targets and their extensive networks to approach targets. They also rely on hiring domain experts to analyse these targets.
So actually, there may be few differences between the two approaches, except for this one: the time it takes for each of them to decide. What tends to happen is that strategic buyers are so busy running their own businesses that they take longer to make decisions on acquisitions. PE firms, on the other hand, are in the business of buying and selling companies, so their decision making process tends to be faster. Corporate advisors often say that if you offer your firm to a PE company, a least you get the dignity of a quick “no.”
Due Diligence
Once each of these types of buyer is past the terms sheet, heads of agreement or memorandum of understanding phase, they start to display different tendencies in the next phase of due diligence.
Strategic buyers often do not dwell on an analysis of the industry (because they are usually in the same industry) or detailed market segmentation (for the same reason). Their due diligence is focused more on the value of the assets, the team being acquired and possible integration synergies between the target business and its own. The danger here is if the target operates in a different geography, a different segment or is using a different technology. The assumption of prior knowledge in these situations may not be useful to the acquirer — or may even be harmful.
PE firms, on the other hand, assess the target internally as well as externally. There is a lot of work done in researching the market the target operates in and how conducive it is to growth. This is in additional to diligence on cash flows, management and assets.
The difference between the two types of buyers here is that it usually takes longer for a PE company to do the due diligence. This may not always be the case, though. Modern PE firms have due diligence as a core competency, so they may actually be faster than strategic purchasers that do not regularly undertake acquisitions and may not have such highly developed due diligence structures and procedures.
So if you want to maximise the opportunity with each different buyer:
For PE companies: prepare detailed market information in advance of the due diligence process.
For strategic buyers: provide a structured environment for due diligence and do what you can to project manage the process with them.
Financing the Acquisition
Strategic buyers often finance smaller acquisitions internally through cash flow. When it comes to larger acquisitions, strategic buyers seem to rely largely on either:
Debt sourced from tier one or tier two lenders, or
Equity as full or part consideration.
Financing this way usually makes sense for strategic buyers because they can see how the target can be integrated into their own operations and where the back office savings or other savings can be made.
PE firms, on the other hand, use debt, but in a much more leveraged way. They rely heavily on cash flow forecasts and on the target’s ability to repay this debt. In a competition between a strategic buyer and a PE firm, then, it may be that the strategic buyer can organise finance more quickly than a PE firm, although the PE firm will usually get a higher internal rate of return because of the leverage.
The race to organise finance, however, is not always won by the strategic buyer. The reason is that strategic buyers usually don’t do as many deals as PE firms, and so they may be as efficient in arranging finance, although it should be easier for them, especially if they are doing it internally.
Conclusion
Understanding the differences between PE firms and strategic buyers helps you as a seller to frame your approach to each of them differently. It also helps you understand why they seem more preoccupied with some aspects of your business more than others. Finally, even though you may have your heart set on selling to a strategic buyer, you need to understand that often these buyers are simply not as practiced at doing deals as PE firms and you may therefore be disappointed with various aspects of their approach.
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