Rose Law Firm represents many middle and lower-middle market businesses that are actively preparing for third-party sales. This is the first of a three-part series of articles addressing the distinctions between strategic and financial buyers and how a business owner can maximize the offer amount from one or more suitable purchasers.  

Part I.  Two Kinds of Buyers:  Financial Buyers and Strategic Buyers 

There may come a time when the owner of a successful small to midsize business decides it is time to move on and, among other things, spend more time enjoying the great outdoors.  As a result, this business owner may decide to sell his or her company.  Ignoring options for transitioning the business to a family member or a key employee, this owner can sell the business to essentially one of two different kinds of buyers: a financial buyer who is approaching the transaction as a financial investment in an asset with growth and profit potential, or a strategic buyer who is looking to add the value proposition of the target company into its own business portfolio.  

The Primary Difference that Distinguishes Strategic Buyers from Financial Buyers is How Each Derives Value from the Acquisition of a Business: 

A financial buyer will, generally speaking, operate the company for a period of years with the intention to resell it at a profit.  A strategic buyer, on the other hand, will in some way incorporate the business it is buying into its own ongoing and likely larger business.  

Strategic Buyers 

A strategic buyer is an active player in the same or similar industry as the seller and is looking at the seller’s business as a near-term way to enhance the value, size, or efficiency of its own operating business.  In some way, the acquisition will give the potential strategic buyer the opportunity to expand its business, either horizontally or vertically.

Horizontal expansion opportunities for a strategic buyer may be the ability to enter into a new geographical or niche market, the ability to expand its offerings to related products or services, the ability to offer a competitive advantage over its competitors, or may simply be the opportunity to eliminate a competitor from the field.  

Vertical expansion opportunities for a strategic buyer could include acquisition of the buyer’s supplier or expansion of some element of its supply and/or delivery chain.  Other vertical expansion opportunities stem from the buyer’s ability to bring outsourced goods or services in-house, such as marketing, accounting, or research and development functions that increase the acquiror’s control over its own operations and production, and ultimately over its bottom line. 

While the strategic value for each potential purchaser is unique to the purchaser’s own circumstances and there may be plans for the acquired business that are never shared with the seller, determining what the value proposition is for the purchaser is generally fairly straightforward.  The better the seller can anticipate a strategic purchaser’s need for the business, the more the seller can emphasize the elements of the business that are of most value to the purchaser. 

Financial Buyers 

A financial buyer, on the other hand, is a financial player (typically a private equity fund) that is looking at ownership of the seller’s business as a way to generate profit on a resale, whether in a subsequent private or public offering.  Since a financial buyer is not an industry player, it will generally only realize its intended value proposition from its acquisition upon the resale of the business for a profit over its original purchase price.  A financial buyer is therefore taking a longer-term view of the value proposition of the acquisition, notwithstanding that it usually does not intend to be a long-term owner of the acquired business.  

A financial buyer or private equity firm tends to look at the investment (the acquired business) at an institutional level, rather than at an operating level - and the corresponding changes to the business model of the acquired company will generally be institutional in nature and may require some anticipated amount of capital investment.  The most basic institutional changes are cost-cutting, efficiency, and economies of scale measures, but may also be achieved by aggregating similar businesses or services, packaging the business with other related resources or services, and/or expanding the market or market offerings of the business.  

For this reason, it is quite common for a financial buyer to want someone to focus on the industry-specific operations of the acquired company while the buyer is strategizing on a larger scale.  Since a financial buyer or private equity fund will not know the specifics of operating the business, the financial buyer will need assistance operating the business.  Who better to help it run the company than our outdoor-loving business owner who will probably still be spending some time in the office as the “former” owner. 

Financial Buyers - Value Realization Upon Exit 

Since a financial buyer is anticipating a resale from the beginning, financial and private equity buyers generally already have an exit strategy developed before purchasing a business, and usually before even considering purchasing a business.  As such, these strategic buyers often have a history of similar transactions (and a corresponding reputation).  And whether the financial buyer specializes in private or public resales, a seller can generally derive the purchaser’s exit plan (and value proposition) with a certain degree of informed certainty. 

A financial buyer who is staging the acquired business for another private resale to a strategic buyer or another financial buyer is generally going to be projecting future profit margins differently than a financial buyer who is staging the company for an initial public offering.  

Knowing how the buyer values your company is always an advantage to the seller in the negotiating process.  Beyond that, knowing a financial purchaser’s exit strategy may present various benefits to the seller and sometimes significant financial opportunities as well.  Depending upon the intended exit strategy, there may be additional financial incentives and perhaps even an equity position for a seller who is willing to get on board with a financial purchaser and build out the value of the company for the acquiror’s own exit event.  For this and other reasons, it is valuable to know the financial buyer’s most likely exit strategy. 

In Part II of our series, our outdoor-loving business owner will want to know whether a financial buyer or a strategic buyer will offer a better purchase price for her business.

If you are the owner of a small to midsize business and have questions about the best way to stage your business for a future sale, call  Rose Law Firm. 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.