Financial vs. Strategic Buyers: Understanding the Difference
Why is a potential buyer interested in your business?
The answer is important, but the type of buyer depends on what is the right fit based upon the seller’s goals. Some buyers are willing to pay a premium for your business based upon future potential or a strategic fit. Finding the right buyer depends on various scenarios and what is most important to the seller.
Some purchasers are financial buyers.
The goal of a financial buyer is to earn a specific rate of return on an investment.
Financial buyers achieve a return on investment by following these steps:
- Evaluate and purchase: Find a company that generates an attractive level of earnings and cash flows.
- Manage: Operate the business and generate earnings, which are used to recover the cost of the investment. Once the entire investment cost has been recovered, the buyer will start to earn a positive return on the purchase.
- Exit opportunity: Sell the business to another firm that is interested in the track record of earnings and cash flows. An eventual sale generates the biggest return for the investor. The exit may be an initial public offering or another private sale.
Financial buyers invest using a timeline. Private equity firms, for example, prefer to invest, manage, and exit a business in five to seven years.
These companies raise investment dollars from wealthy individuals, and institutional investors, such as pension funds. The firms invest in private businesses, in order to influence company management and increase earnings.
High net worth individuals may also operate independently as financial buyers.
Selecting and managing businesses
Financial buyers focus on the financial performance of a company, and not on the firm’s industry.
Buyers are looking for a history of consistent earnings and cash flows, and purchasers may implement changes to improve results. If the firm can reduce expenses, and collect cash faster, the company will be more valuable.
Financial buyers are more likely to keep an experienced management team in place. The buyer may also retain the seller during a transition period, in order to maintain client relationships.
Note, however, that financial buyers are not interested in paying a premium for growth potential. These purchasers are willing to pay for a flow of earnings, based on current sales and operations. While growth enhances the value of the company, it is not the primary focus for a financial investor.
Strategic buyers have a different focus.
These buyers purchase companies in order to grow an existing revenue source or to diversify into new products and markets.
Strategic buyers have a long-term focus and are willing to make substantial changes to the acquired firm over time. The seller may be a competitor, a supplier, or a large customer. A strategic buyer is willing to pay a premium for a business that can help the combined firm increase profits.
Business expansion can take several forms:
- Vertical expansion: The seller’s business allows the buyer to control another step in the delivery of a product or service. If a sporting goods manufacturer buys a company that supplies leather material, the purchase is a vertical expansion strategy.
- Horizontal expansion: If you expand horizontally, you add new products, or sell products in new markets. If the sporting goods company purchases warehouses to store and market goods in a new geographic region, the expansion is horizontal.
A strategic purchase can produce a number of benefits.
Strategic buyers buy competitors to eliminate competition and to grow market share. They also purchase firms that help them to eliminate a weakness. If distribution in the Northeast is a weakness for the sporting goods company, buying warehouses can eliminate the weakness.
Purchasers can also benefit from economies of scale. Assume that a retailer buys a competitor and grows from five stores to eight. The retailer can negotiate better prices with suppliers because the expanded company must buy inventory for more stores.
Buyers may purchase specific assets from a company, rather than the entire business. A manufacturer can purchase machinery and equipment and expand production. If a seller has intellectual property, such as a patent, the buyer can benefit from purchasing and using the patent.
Strategic buyers are more likely to make changes to staff and operations when a business is purchased.
A buyer may make significant changes to the purchased business. The seller’s firm may be combined with an existing company, and back office functions may be eliminated, such as accounting, customer support, and sales.
A strategic buyer may also change the direction of the seller’s business, and the buyer may eliminate senior management positions.
To understand how a strategic purchase works in practice, consider Amazon’s purchase of Whole Foods.
Amazon and Whole Foods
In June of 2016, Amazon purchased Whole Foods in a $13.7 billion acquisition. This was a strategic purchase that enabled Amazon to add 473 physical store locations to its existing online retail business.
Since the purchase, Amazon had made a number of changes.
Whole Foods has cut prices, in an effort to compete with Walmart and Trader Joe’s. A number of Whole Foods products are now available on the Amazon website, and Amazon is using Whole Foods marketing efforts to promote Amazon Prime.
The purchase has enabled Amazon to expand into physical store locations using a popular retail brand.
How does the buyer’s approach impact your business sale?
Understanding the Buyer
A business sale may be the most important financial decision you will ever make. To understand how the buyer views your firm, work with the experts at Raincatcher.
The professionals at Raincatcher have years of experience advising business owners. They understand your industry, and they care about how you are positioned in the market. Raincatcher’s staff will assess the buyer’s interest and determine if the purchase is strategic or financial so they find the right buyer for your company.
When you hire an expert, you can make a more informed decision about a business sale. Work with Raincatcher, so you can sell your business and have peace of mind.
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