EDGEMONT CAPITAL BLOG

Strategic Buyer or Private Equity?

How should you choose a deal partner? It all depends on your objectives. Let’s consider two options:

1. Strategic buyers are companies already in similar areas of business. They seek to enhance their current model to reap financial rewards. This also includes portfolio companies operating as acquisition platforms to private equity firms.

2. Financial buyers are mostly private equity firms. They include companies with experience in a similar industry. Their goal is for the company to be a standalone investment with opportunities for growth and increased cash flow. They may also attempt to convert the company to an acquisition platform.

Financial executives must juggle several issues during a sale, so it’s vital to evaluate the differing goals of different types of buyers and then make an intelligent assessment to determine which will be best for the company. Determining the company owners’ goals and their understanding of a successful transaction can lay the groundwork for a successful relationship. Knowing the objectives of prospective buyers can help further align and reconcile the collective goals of both parties involved in the transaction.

Characteristics of Strategic Buyers Compared to Private Equity
Don’t oversell. A proper valuation reduces risk. Strategic buyers plan to pay top dollar to realize synergies in their existing operations. They may also offer a higher price in exchange for stock, but that’s a risky undertaking.

By contrast, private equity firms tend to offer a lower initial price, but with greater opportunities for long-term gain if the owner retains a portion of the company and the business sells.

The deal structure must meet the buyer’s needs. Strategic buyers typically acquire 100% of the target company. Private equity firms and other financial buyers often offer all-cash structures with flexibility that meets different needs of the ownership. They can cash out some owners and allow some to leave equity in the business.

Financial leverage is key. Private equity is comfortable with higher debt in the capital structure of a purchase than strategic buyers. This can lead to an over-leveraged business that reduces the reinvestment value of operating cash flow. Financial executives at the target company should carefully analyze debt load to make a well informed decision.

At closing, a strategic buyer’s industry expertise can reduce the length and complexity of due diligence. Financial buyers may lack this expertise and instead opt to bring in consultants. This can draw out the process. Nevertheless, this expertise can identify and solve common problems, preventing post-closing disputes.

It’s important to learn a buyer’s investment criteria. Don’t shy away from difficult questions. Carefully review buyers’ investment criteria, particularly when partnering with private equity firms. It’s equally important to look at a buyer’s previous transactions. Every transaction includes a lot of positive talk, but target company owners must look at the whole picture. It’s key to uncover issues that can disrupt the deal before the transaction closes.

Sellers must ensure their strategy and vision is aligned with the buyer’s. Strategic buyers often already have their own plans. It’s up to the company to explain its vision and goals for success. Likewise, company culture, employees, and legacy can be an issue. If it’s important to minimize disruptions and ensure the company culture, a private equity firm might be the best choice. Strategic buyers, by contrast, will look to minimize costs and streamline operations, often through downsizing.

Consider which party will take the lead on control and governance as seller typically makes early decisions that determine this relationship. Strong negotiation skills are key. When companies wish to sell 100%, a transaction with a strategic buyer will be more straightforward. Private equity, by contrast, may be open to other options. Financial executives should help the company sort through the options and address control and governance issues arising from various options. In most cases, a pending sale will necessitate a more formal governance process, including regular board meetings.

Buyers must tell sellers about their long-term financial and operating objectives. It’s best to let management run daily operations and the due diligence process will reveal the extent to which current management remains in control.

Finally, it’s important to consider the exit plan. Private equity often exits by selling to a strategic buyer. The second option is to sell to another private equity company. So even if the first transaction is with a financial buyer, the target company and managers will typically sell their ownership shares to a strategic buyer.