PE vs. strategic purchase: Understand the difference
In the past few years, private equity firms have become increasingly important players in middle-market mergers and acquisitions. Fueled by a flood of equity capital, a relatively unattractive public market and an accommodative lending environment, private equity firms are paying competitive prices for businesses and, in some cases, beating out strategic buyers.
If you are considering selling your business, you should understand that private equity buyers have different needs and motivations from strategic buyers. Knowing these differences can help you better prepare your business for sale.
- The whole versus the sum of its parts: Private equity firms look for "complete" companies that can grow over time as stand-alone entities. They are therefore interested in every aspect of your company -- from management team to your business plan. Strategic buyers are often focused on only part of the business -- a product line that can be dropped into their sales force or a series of patents that block a competitor from certain markets. As a result, they may be able to see past various weaknesses in a business because they can fill in the gaps with their capabilities. That means some aspects of your business will be less important to them than others. For instance, one of my clients found that strategic buyers had less interest in her company's senior management team and advanced IT infrastructure because they already had similar assets in place.
- Industry knowledge: This varies considerably among private equity firms. Given this, you will need to provide much more detail around key market trends and drivers.
- Future vision and growth: Strategic acquirers often have a highly developed sense of "where they are going," which is one of the reasons they are actively acquiring companies in the first place. Again, this means that they are looking to understand fully how your company fits into their growth strategy. When you present your company to a private equity group, the thrust of the conversation is around your management's vision for future -- how the company fits into broader industry trends, for example, and how its business model will evolve. Private equity groups often want to understand the company's M&A capabilities, the pipeline of potential M&A targets already identified and management's take on the right profiles of M&A targets.
- Exit timing: Private equity investors generally have an investment time horizon of five to seven years, while strategic acquirers are looking to own the business indefinitely. This means that private equity groups are particularly sensitive to cyclicality in a business. Strategic buyers, particularly those from the same industry, are more accustomed to inherent cyclicality.
- Internal rate of return: Strategic acquirers often value a business on both financial and strategic metrics. Private equity investors, by contrast, base their valuations on the likelihood that a company will be larger, more profitable and therefore more valuable at the time of exit.
A private equity investor will have a target internal rate of return of 25 percent to 35 percent over their five- to seven-year horizon. From this, they can determine exactly how much revenue and earnings growth they require to meet their targets. Consequently, we recommend creating a financial model that shows internal rates of return in several growth scenarios.
Selling to a strategic buyer can be very different from taking on private equity investment. Making sure you understand the differences, as well as the unique motivations of the buyers you're negotiating with, is the best way to ensure the success of your transaction.
Elliot T. Williams is president of Mirus Capital Advisors, a Burlington-based investment bank. He is also president of the Boston chapter of the Association for Corporate Growth.
