In Part II of our saga, our outdoor-loving business owner took a look at how strategic and financial buyers perceive and derive value from purchasing a business to consider which kind of buyer would make a higher offer for her business.
In this final installment, our business owner is considering other factors that might be important in her decision-making process.
Part III. Which Kind of Buyer is Best - A Strategic Buyer or a Financial Buyer?
Now that our outdoor-loving business owner has considered how a strategic buyer and a financial buyer are likely to value her business, she needs to consider what other differences between the two buyers must go into her deliberations.
Which type of buyer should the outdoor-loving owner choose?
The answer of course will depend upon the seller’s own goals and priorities, how well the owner has prepared for the sale, whether the seller has successfully courted multiple suitors, and ultimately the options presented by the market. Even outside of the question of valuation, however, both types of buyers come with their respective advantages and disadvantages which should all be part of our seller’s considerations.
Due Diligence Review
While it is true that a strategic buyer will be able to conduct its due diligence review much quicker than a financial buyer, there are obvious downsides to giving a market competitor or potential market competitor access to your most sensitive business and strategic information. The fact that a strategic buyer is more familiar with the seller’s industry makes the prospect of engaging in premature due diligence disclosures relating to the seller’s business a risky one.
Of course, a well-structured confidentiality and non-compete agreement will provide certain protections and legal recourse. But if the deal falls through (and a majority do), you still will have given your company’s most sensitive secrets to a competitor who is not likely to forget what they have learned no matter how ironclad your confidentiality and non-disclosure agreement.
In contrast to the speed at which a strategic buyer will drive a transaction, the due diligence process by a private equity or other financial buyer tends to be much longer and involve multiple rounds of diligence and bring-down inquiries. Private equity buyers often hire outside consulting firms to evaluate a potential strategic acquisition, and the time the consulting firm takes to evaluate the possible investment often drags out the negotiation and sales process for many months. This is because the nature of a financial buyer’s due diligence review is entirely different from a strategic buyer’s.
Because the financial buyer must operate the seller’s business for at least some period, it will make sure it is buying a solid business, one it can operate smoothly for this interim period before it arranges its divestiture of the business. The financial buyer will therefore not only carefully analyze the financial statements of a company it is considering buying, but it will also carefully examine the management, salespersons, and other employees of its potential strategic acquisition.
One reason the financial buyer’s due diligence period tends to last longer than the strategic buyer’s is that the financial buyer is looking for institutional ways in which to increase the value of the acquired business. If the financial buyer concludes that the seller is well-run and fits its investment strategy, then it will decide how it will manage, and possibly improve its strategic investment, and it will devise a business strategy that it hopes will increase the target company’s valuation over time.
This analysis can have as much or more to do with external factors as it can with a due diligence review of the target business and its operations, so a seller should plan on a significantly drawn-out due diligence period from a financial buyer. A private equity buyer wants to know if the competitive advantages extolled by the seller are really those which are most highly valued by the market, and if not, how they can be modified to capture unrealized market value.
Post-Closing Obligations of the Seller (and its Employees)
If the seller can attract a strategic buyer to the closing table, then the seller will probably be able to spend more time outdoors and do so sooner than if the buyer sells to a financial buyer. This is because the strategic buyer is typically a competitor, supplier, or customer from inside the seller’s industry who already has a plan for using the assets and business of the acquired company to enhance its own business. While the strategic buyer may prefer to have an owner stick around to ensure a smooth transition to the new ownership for a short period, the long-term presence of the owner would only hinder the strategic buyer’s plans for transforming the acquired company to fit with its existing business model and/or culture. So the seller’s transition period, if any, is likely to be quite short.
Likewise, a strategic buyer will often not plan on retaining any of the seller’s management on a long-term basis. While this may be perfect for our seller’s outdoor plans, it may not be as optimal for a son or daughter or for other long-term employees who work for the company. While the substance and priorities of a “seller’s legacy” are different for every seller, a seller should be aware that a strategic buyer, almost by definition, will implement value-capturing changes quickly and aggressively without much consideration of the previous owner’s priorities for the business.
Service industries are often an exception to this general rule. Where the ultimate value of the business resides in its employee base and client relationships, an acquirer – whether strategic or financial - will be much keener on keeping the management and key employees in place. And if this is best achieved by keeping the former owner around for a period of years, then that will likely be part of the acquisition discussion and negotiations.
A financial buyer, on the other hand, is much more likely than a strategic buyer to need the owner’s help running the company after it makes its acquisition and for a longer period. This is because a financial buyer is far less likely to know the “ins and outs” of the industry. A financial buyer enters into negotiations with the seller primarily because it sees an opportunity for growth and profit on an investment, rather than to run the seller’s business.
Unless the financial buyer is tucking the acquired company into a portfolio of like companies, maintaining operating continuity and stability of the acquired company is probably fundamental to the financial buyer’s acquisition and profitability model. This means that it is far more likely that a financial buyer will require the post-closing services of the owner and/or other key employees to run and manage the operations side of the business, even if the financial buyer makes other institutional changes.
Our outdoor-loving seller may be able to negotiate limited hours and will not bear the same degree of responsibility for the company, but will probably need to postpone full retirement for a period following the sale of the family business to a financial buyer.
Variations
Of course, the market offers all kinds of options and variations to the nimble seller and potential purchasers come in all variations. Thus a seller’s best potential buyer may combine the attributes of a financial buyer with the attributes of a strategic buyer.
A financial buyer may acquire a company that operates in the same or a similar market as other assets it already owns or plans to acquire. It may buy the target company so that it can combine its new strategic acquisition with one or more companies it already owns.
It is still a financial investor, driven by the need to eventually implement its exit strategy to realize its profit model. But when entering into these “add-on” or “tuck-in” acquisitions it is looking for synergies in much the same way that a strategic buyer does and its valuation and post-closing expectations may differ accordingly.
Another possibility is that the financial buyer would make its strategic acquisition although it does not—yet—own any similar or related companies. As this implies, the private equity firm would, in this case, intend to later acquire other similar or related companies. Such an acquirer may seem to be a standard financial buyer on the surface, but in reality, such a buyer may be driven by very different motivations and may be willing to pay a premium for a key acquisition for its overall investment portfolio in much the same way as would a strategic buyer.
Conclusion
Ultimately it would be wise for our intrepid outdoorsman to consider carefully the various options for selling the family business before dropping a down payment on the family yacht. Sellers will want to decide which type of buyer they would most want to attract and design an exit strategy around those preferences. Early and well-informed planning is key to a successful exit strategy and the right legal and financial advisors are invaluable allies in the process.
Armed with the right advisors, sellers will need to consider how quickly they want to sell, their risk tolerance, whether and to what degree they are vested in the post-closing operation of the business, and how much, if at all, they want to participate in running the business after they sell. All these considerations will put sellers in the position of controlling how much and how soon they get to enjoy the great outdoors.
In any event, it pays to have an experienced attorney and perhaps a good investment banker to help assess potential purchasers and negotiate the best purchase price potentially available from any given potential purchaser – advisors that understand that “competition is key”.
Ask your attorney what deliberate measures you should be taking to proactively control the marketing and sale of your business or reach out to Rose Law Firm with the same question. Our focus is to protect and maximize the value you have created in your business, regardless of the transaction or legal matter that you find yourself faced with.
