Timing M&A, Part IV: Qualifying Buyers

Almost every company we talk with has received many calls from potential buyers.  But they might not be what they seem.

Before discussing the nature of those calls, let’s first look at the two basic categories of buyers for mid-market companies:  financial and strategic.

Financial buyers are private equity firms.  They have raised large amounts of money from sources like university endowment funds, public pension plans, and family offices to invest in private companies. Sometimes they prefer taking minority positions, sometimes majority. They care most about investing more than a certain threshold amount.  Often it’s at least 20m or 50m.

Strategic buyers are operating companies that buy target companies using cash or stock.  While they will look at larger deals, they will also look at deals in the 5-20m range.

Financial buyers usually care more about a company’s growth and profitability than its industry.  They do take a close look at a company’s industry, but it’s only in the context of evaluating the company’s growth prospects.  Financial buyers almost always value companies based on a multiple of their operating profits, or EBITDA.

On the other hand, strategic buyers care a lot about industry.  They are very deliberate in targeting acquisitions in certain market segments.  Sometimes these are segments where they already operate.  Sometimes they are adjacent market segments where they want to operate in the future.  They usually will value companies based on EBITDA multiples, but they often can pay a higher multiple than financial buyers because they can expect to see operational synergies.  There are also some occasions where a strategic buyer won’t use an EBITDA multiple for valuation, such as if they are buying technology or product.  While this does happen on a regular basis, it’s much less common than conventional wisdom (i.e., TechCrunch) presumes.   Acquisitions of technology companies for rich valuations are widely reported in business news, but the much more common cases of high-profile technology companies selling for pennies on the dollar receive little media attention.  

Returning now to those calls that every company receives, strategic buyers tend to be very discriminating in whom they contact.  On the other hand, many financial buyers make it a practice to call every growing company they can find.  There are dozens of private equity firms with groups of associates whose job is to cold call companies.  Strategics do not have this organization model.

So, this means that a strategic buyer knocking on your door is going to be more rare—and more meaningful—than a financial buyer.  While financial buyers can often be very attractive buyers, the data point that they are calling on a company doesn’t mean much in of itself.