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Strategic Buyer

Step-by-Step Guide to Understanding the Strategic Buyer vs. Financial Buyer Concept

Last Updated February 20, 2024

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Strategic Buyer

What are the Characteristics of Strategic Buyers in M&A?

A strategic buyer refers to a company – i.e. a non-financial acquirer – that attempts to purchase another company.

Because strategic buyers are often in the same or a related industry as the acquisition target, the strategic can benefit from synergies.

Synergies represent the estimated cost savings or incremental revenue arising from a merger or acquisition, which are regularly used by buyers to rationalize higher purchase price premiums.

  • Revenue Synergies → The merged company can generate more future cash flows from the increased reach in terms of customers (i.e. end markets) and greater opportunities for upselling, cross-selling, and product bundling.
  • Cost Synergies → The merged company can implement measures related to cost-cutting, consolidating overlapping functions (e.g. research and development, “R&D”), and eliminating redundancies.

A sale to a strategic buyer tends to be the least time-consuming while fetching higher valuations, since strategics can afford to offer a higher control premium given the potential synergies.

Revenue synergies are usually less likely to materialize, while cost synergies tend to be realized more easily.

For example, shutting down redundant job functions and reducing headcount can have a near-instant positive impact on a combined company’s profit margins.

M&A Industry Consolidation Strategy

Often, the highest control premiums (%) are paid in consolidation plays, where a strategic acquirer with plenty of cash on hand decides to acquire its competitors.

The reduced competition in the market can make these sorts of acquisitions very profitable and can contribute to a meaningful competitive advantage for the acquirer over the rest of the market.

For instance, the post-consolidation company’s branding improves from the strategic acquisition, with increased pricing power by virtue of being positioned favorably as the market leader.

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Strategic vs. Financial Buyer: What is the Difference?

Strategic buyers represent companies operating in overlapping markets, while financial buyers seek to acquire LBO targets as more of an investment, with an exit strategy and date in mind on the date of initial buyout.

In recent years, the most active type of acquirer has been private equity firms, which are also known as financial sponsors.

The private equity industry comprises investment firms that acquire privately-held (or public) companies using a substantial amount of debt to fund the purchase. Hence, the acquisitions completed by PE firms are termed “leveraged buyouts”, or “LBOs” for short.

Given the capital structure of the post-LBO company, there is a significant burden placed on the company to perform well in order to meet interest payments and repay debt principal on the date of maturity.

On that note, financial buyers must be careful with the companies they acquire to avoid mismanaging the company and causing it to default on its debt obligations.

Transactions dealing with financial buyers tend to be more time-consuming because of the amount of extensive diligence required, as well as obtaining the necessary debt financing commitments from lenders.

In contrast, the core objective of a strategic buyer is to create long-term value from the acquisition, which can stem from horizontal integration, vertical integration, or building a conglomerate among various other potential strategies.

Strategic buyers usually enter negotiations with a unique value proposition in mind, which rationalizes the acquisition.

The investment horizon for a strategic tends to be longer. In fact, most strategics merge the companies entirely post-deal and never intend to sell the acquired company unless the transaction falls short of expectations and destroys value for all stakeholders, resulting in a divestiture in such a case.

Compared to strategic acquirers, financial buyers are much more returns-oriented, and it is part of their business model to exit the investment typically in a five to eight-year time frame.

From the perspective of the seller, most management teams (and their sell-side advisor) prefer exiting to a strategic rather than to a financial buyer when seeking to undergo a liquidity event.

The aforementioned preference is namely due to the higher premiums that can be fetched from strategics, in addition to the quicker diligence process.

Private Equity Industry Trend: Add-On Acquisitions (Buy and Build)

In recent times, the strategy of add-ons (i.e. “buy-and-build”) by financial buyers has helped close the gap between the purchase price offered between strategic and financial buyers and made them more competitive in auction processes.

By making add-on acquisitions, which is when an existing portfolio company called the “platform” acquires a smaller-sized target, this enables the financial buyer – or the portfolio company, more specifically – to benefit from synergies, similar to strategic acquirers.

Strategic buyers are interested in integrating the target company into their long-term business plans, and add-ons enable the portfolio companies of financial buyers to do so, as well.

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