What is the Difference Between a Strategic Buyer and a Financial Buyer?
What is the difference between a Strategic and a Financial Buyer?
Understanding your exit options is one of the most crucial elements of the exit planning process. As far as potential buyers, there are several different possibilities. We will give you a quick overview of each buyer profile below:
Private Equity Buyer
What makes a good strategic buyer? The strategic buyer can generally be described as a business that through the purchase of your business will gain a strategic advantage. This buyer could be a direct competitor who is looking to expand market share. It could be a company that is looking to enter a new geographical market, or it could be a company that would benefit from up/cross-selling products/services to their existing portfolio of businesses. Sometimes a strategic buyer could be interested in your company to secure a better supply chain, and increase profit margins in their existing business.
These types of buyers are much rarer in the marketplace, as they have a much higher standard of acquisition protocols.
A strategic buyer has the potential of purchasing your business for top Fair Market Value (FMV) or well above FMV, because they see how much your business will add to the service, revenue, (negate expenses), and add to the bottom line of their own business.
Take a business that specializes in payroll. A successful PEO/HR business making $5M could be looking at your payroll business that makes 500k because their strategy is to grow through acquisition. They may make a move to acquire 3-4 500k businesses and pay top dollar for successful businesses in order to grow their own business. In the long run, these acquisitions will benefit them greatly.
Alternatively, a successful HVAC company could acquire their supplier of a/c units so they don't have to pay an up-charge for the unit, thus passing that on to their customers, and giving their customers lower prices for a better product compared to their competitors in the marketplace.
Ultimately, the strategic buyer is asking the question,
"How will your business exponentially improve my business?"
The pool of "financial buyers" are much more vast than the strategic buyer. In smaller markets, the financial buyer is looking for a business that can produce income for them. Private Equity can start to be interested here as well. Brokers have a huge pool of "prospective acquirers" that are looking for owner INdependent businesses that they will pay a premium for in order to get an ROI. There is a "blend" of buyers and sellers between individual buyers and financial buyers at the bottom of the pyramid.
If we separate out individual buyers from financial buyers, then we would have to define financial buyers more as “Private Equity Firms”. Those companies usually look at companies that are making no less than $1M in EBITDA, which is only about 4% of businesses. So statistically the vast majority of business owners, PE Firms are unlikely buyers.
The individual buyer is usually a successful corporate executive who is looking to be the owner/operator of their own business. They usually bring a specific set of skills to the table that qualifies them to run and grow your particular business. They pay fair market value for what your business is worth so as to not have to start completely from scratch. For most small business owners in the United States, the individual buyer is the most likely purchaser.
Many individual buyers will analyze the pros and cons of buying your business versus a franchise in your industry.
*If your business is in this category, you will get the lowest multiple available for the industry.
Private Equity Buyer
A Private Equity buyer is a special type of buyer, that is (most of the time) considered a financial buyer of bigger businesses. Generally, a private equity firm will purchase a business that is a "right fit" for its standard and portfolio. They will work to scale that business, and either flip it for a profit or keep the business in their portfolio, acting as an advisory board and benefiting from the business's margins.
A PE firm has a goal of making x% of profit from any business they invest in. This percentage is usually determined ahead of time as a firm standard. They will traditionally use a Discounted Cash Flow (DCF) method of valuing a business, although it is common they will assign a bigger than Fair Market Value (FMV) multiple for the right-fit businesses.
PE firms can also be a Strategic Buyer. In this scenario, they will have a business in their portfolio that will benefit from merging another business with it. They will then purchase that business, work to merge the two businesses, and scale the merged business for a greater profit.
Another likely buyer may come from someone within your existing business. It could be an individual or a small group of people (e.g. existing management team). These buyers are uniquely qualified to continue the legacy of your business. Sometimes more creativity is required to structure such a deal, but it happens every day. Especially if you have some years left before an eventual exit, don’t underestimate the potential of this type of buyer.
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