Strategic vs Financial Buyers – What’s the difference?
The world of mergers and acquisitions (M&A) is dominated by two distinct buyer types: Strategic and Financial. Each brings a different set of motivations and implications which typically lead to varying outcomes and deal characteristics for the seller.
Overview of buyer types
Strategic acquirers
A strategic acquirer is a company, often in the same or related industry, looking to buy a business to enhance its own operations or competitive positioning.
These organisations are often established businesses seeking to unlock synergies which add value to their bottom line, whether through product lines, customer base, geographical expansion, technology, risk reduction, or moving across the value chain.
Mature strategic acquirers might have an established M&A strategy, which adapts over time as they consolidate. They are primarily focused on fit and synergy, valuing how your business complements their existing operations.
Financial acquirers
Financial acquirers include private equity firms, family offices, venture capital funds and institutional investors. When it comes to established small and medium sized enterprises (SMEs) in the UK, private equity firms are the most common financial acquirers of those listed.
In contrast to strategic acquirers, financial acquirers are investment focused. They do not have existing operations to which they intend to integrate your business. Instead, their interest lies in the financial returns generated by your business through acquiring, growing, and eventually exiting their investment within a defined time frame.
As a result, these acquirers are attracted to businesses with:
- Strong cash flows and profitability
- Potential for growth or operational improvement
- Strong market positioning and external growth drivers
- Potential bolt-on acquisitions
- Favourable deal structures or leverage opportunity
Key deal differences between buyer types
Having established that these two buyer types have distinct motivations and profiles, it feels obvious that there would be varying implications in whether you sell your business to a strategic acquirer or a financial acquirer.
Whilst there are exceptions to every rule, we typically see the most distinction when it comes to acquisition criteria, valuation approaches, deal structures, post-acquisition involvement, cultural fit and integration, and investment horizon.
Acquisition criteria
Strategic acquirers are focused on fit and synergy, valuing how an acquisition might integrate into their existing operations, often adding scale, enhancing profitability, de-risking their operations, or strengthening their market position.
Financial acquirers are focused on return on investment (ROI). The financial profile of the business, including cashflows, profitability, and risk-adjusted returns, is a key focus in evaluating an investment opportunity.
Strong market drivers with the opportunity to improve the business and add scale both organically and through acquisitions are critical. As financial acquirers do not have existing operations into which the business will be integrated, they often require the business to have established incumbent management teams, who are willing to commit to the business post-sale.
Valuation and price considerations
It is not surprising that strategic buyers often pay higher multiples because they factor in synergies and cost savings post-acquisition.
Whilst it is possible to close the gap through a competitive process, financial buyers are typically more disciplined with their business valuations, given their core focus is to maximise ROI. They also rely on more traditional valuation methodologies, whereas a strategic buyer might be more driven by internal drivers.
Deal structures
Whilst 100% cash upfront deals are rare in both cases, strategic buyers are more likely to offer all cash consideration, even if part of this is deferred.
Private equity typically offer vendor rollovers, where the seller or the incumbent management team retains a minority stake, such as to align the interests of the investor and directors going forward.
As a result, financial acquirers are more likely to implement various management incentive schemes. This can comprise of sweet equity or performance related bonuses.
That being said, we are increasingly seeing the option for vendor rollovers with strategic acquirers, although this is often accompanied by detailed exit options. Private equity transactions will rely on their exit of the business before you are able to realise your remaining interest. This can help close the valuation gap, as provided the business performs well, you are likely to exit at a high valuation. A smaller piece of a bigger pie.
Private equity transactions are often highly leveraged. These buyers typically rely more on debt financing, meaning the acquired business may face a heavier debt burden post-transaction. The ability of the business to service this debt should be a key consideration for sellers who are retaining a stake in the business.
Post-acquisition involvement
Typically, strategic buyers can phase out involved shareholders over a shorter period, and, where necessary, more easily recruit into vacant leadership positions if required.
Exiting shareholders are often retained for a short period of time for knowledge transfer, but are rarely involved long-term unless filling a unique role.
Financial buyers rely heavily on the existing leadership, especially if they are key to the business’s success. If seeking to exit with a financial acquirer, appropriate succession planning is critical, or a strategic buyer might be more suited.
Cultural fit and integration
Naturally, with no existing operations, financial acquirers tend to keep operations intact, focusing on value creation and strategic guidance rather than integration.
Strategic acquirers, on the other hand, often require deep integration. Employees may face policy shifts, branding changes, and system changes over the medium term, although this differs by acquirer.
Investment horizon
Private equity often adopts investment horizons of 3-5 years. As a result, the business is likely to enter a period of rapid growth followed by a change in ownership within that time frame.
It is rare for strategic acquirers to plan on selling a business unit following an acquisition unless it begins to underperform or no longer aligns with their strategy. As a result for the post part, SMEs sold to strategic buyers often find a home for life, whether they are fully integrated or operating as separate business unit.
How to approach each buyer type
If you are speaking with a strategic buyer, highlight the strategic value you can add, such as customer contracts, routes to market, product lines or market share. Showcase how your business complements their existing operations. Be ready to ask questions on how they foresee the business fitting in with their organisation, and what this means for employees and integration.
If you are speaking with a financial acquirer, ensure your financial information is buyer-ready and prepare a longer-term business plan with detailed financial forecasts. Clarify your future role, and if you want to exit quickly, implement robust succession planning to develop a high-quality management team. Emphasise the scalability of your business and the operational improvements that can immediately add value.
Final thoughts:
Whether you are seeking a financial or strategic buyer, understanding their differing motivations and implications on deal terms, valuation and post-transaction outcomes will help inform your negotiations. And, regardless of the type of deal you are after, a competitive process can profoundly improve valuation, deal structure and ease negotiations.