Strategic Buyer
It is a company that acquires another company operating in the same or a relative industry
What is a Strategic Buyer?
Strategic buyers are companies or entities acquiring another company in the same or similar industry to expand or improve their business.
Because the acquirer believes that the value post-acquisition will be greater than their stand-alone values, we will see these buyers often paying an acquisition premium - the difference between the price paid and the estimated value of the target company.
Additionally, there is another type of buyer in M&A called financial buyer, which may include private equity firms and investment funds whose primary focus is on generating returns on their investments.
Key Takeaways
- A strategic buyer is a company that acquires another company operating in the same or a relative industry. They often look for synergies between their existing operations and the target company.
- Strategic buyers typically have a long-term vision compared to financial buyers as they look forward to enhancing their business post-transaction.
- Acquisition premium is usually the norm among strategic buyers as they are willing to pay a higher price based on their expectations of the value they receive out of that investment.
What do Strategic Buyer look for?
When considering a potential acquisition, they typically look for target companies that align strategically with their business objectives and that they believe can improve their operations and market position or allow them to expand into new markets or regions.
The main reason why strategic buyers tend to pay the premium mentioned above is to capture the potential synergies by merging or acquiring the target firm. There are two types of synergies.
Cost Synergies
These can be cost-saving or operational efficiencies the buyer seeks, thanks to initiatives that can be taken post-acquisition, such as operations integration, talent acquisition, or even mass layoffs due to overlapping departments. These are often associated with the buyer's horizontal expansion strategy.
Note
Horizontal expansion occurs when a company tries to grow within its current industry by acquiring or merging with competitors within the same market.
Revenue Synergies
It refers to the expected improvements in their top-line performance (revenue) either through cross-selling products & services or expanding the customer base.
On the other hand, sales-related synergies usually align with vertical expansion - when a company integrates different stages of the supply chain, from raw material to end products, or by entering related but distinct lines of business.
However, these expansions are not mutually exclusive and can overlap. For instance, a vertical expansion can also bring in cost synergies by mitigating the cost of outsourcing materials.
Strategic Buyer Considerations
Various considerations are considered when a buyer identifies target companies for acquisition. By finding suitable targets, the acquirer has a higher potential of achieving operational efficiencies. Here are some of the key considerations.
Strategic Fit
To find a perfect fit for their acquisition, strategic buyers must ensure that the target company’s operations align with their future goals, and they can do so by evaluating the target company's operations or even their corporate culture.
Industry and Market Analysis
Researching the market trends and main growth drivers of the sector and identifying market dynamics will help the acquirer narrow down their potential targets with high growth potential.
By examining the market's size, the market shares of all participants in the sector, and the industry's level of competition, they can consider the market's competitive environment.
Macroeconomic Outlook
Additionally, during the purchase process, acquirers frequently research the current state of the economy to evaluate the acquisitions' viability and weigh their advantages and disadvantages.
For instance,
- The Fed has been fighting high inflation in recent years by using the Fed Funds Rate.
- Important metrics, like bond interest rates and the yield on the 10-year Treasury bond, have a strong correlation with the Fed Funds Rate.
- High-interest rates, which are used to calculate the discount rate in discounted cash flow valuation and are regarded as risk-free, can negatively affect the target company's valuation.
As a benchmark rate for most interest rates for bonds, loans, and other financial instruments, a high Fed Funds Rate also leads to a surge in interest rates on loans.
These borrowings, in turn, will make it harder and more expensive for acquirers to gain access to the financing needed for the purchase.
Financial Health and Performance
Strategic buyers conduct thorough financial due diligence to source out the perfect fit target with robust financial health, profitability, and liquidity and to help them identify any financial risks associated with the target.
Customer Base and Relationships
Analyzing the target companies’ customer bases, customer relationships, and reputation is relatively essential as it will provide the strategic buyer the ability to identify the target’s ability to retain customers and to consider any enhancements in its distribution channels post-transaction.
Management Team
It is common practice for the buyer to assess the target company's management team and its talent pool. As mentioned above, some departments might overlap when a merger or an acquisition goes through.
Hence, the buyer might consider job cuts to meet their cost-cutting goal. Therefore, by looking at the level of expertise of the targets’ workers, the buyer can develop talent retention plans after the transaction.
Strategic Buyer vs. Financial Buyer
The table below showcases a side-by-side look at strategic buyers versus financial buyers:
| Aspects | Strategic Buyer | Financial Buyer |
|---|---|---|
| Objectives | Seeks strategic operations alignment and business objectives. | Views acquisition as an investment with a focus on financial return. |
| Buyer Types | Often companies within the same or similar industries and looking to expand their operations strategically. | Hedge Funds, Private Equity, Venture Capital, Mutual Funds, Family Offices, and High Net Worth Individuals. |
| Industry Focus | Industry-specific, looking for alignment. | More industry-agnostic, open to various sectors. |
| Ownership Percentage | May acquire partial ownership but typically not 100%. | Often acquires partial or up to 100% ownership, gaining control. |
| Transaction Scale | Focus on specific industries and may not always involve large-scale acquisitions. | Often involves large acquisitions, especially in the context of private equity. |
| Transaction Approach | May involve minority interest in the transactions, especially in partnerships. | May aim for 100% acquisition, particularly in private equity deals. |
| Post-Acquisition Approach | Strategic adjustments for synergy and alignment (streamlining operations, department integrations, etc.). | Radical operational improvements to enhance financial performance might involve mass layoffs to cut costs. |
| Purpose of Acquisition | Enhance strategic position and synergies. | Implement radical operational and strategic changes to improve financial performance. |
| Exit Strategy | Long-term strategic alignment or integration goals. | Exit strategies include selling the enhanced company, often after operational improvements. |
Advantages of Selling to a Strategic Buyer
As opposed to financial buyers, strategic buyers are often driven by the desire to achieve strategic objectives; as a result, working with them can offer various advantages for businesses and even customers. Some of these advantages are:
Exit opportunities for business owners
Once a target business is identified, it is clear that the acquirer has recognized some potential revenue or cost synergies that can be formed if it is a successful purchase.
As a result, in an attempt to outbid other competitors and financial buyers, the acquirer may be willing to pay a premium for the synergies and the strategic advantages, and this is a perfect chance for the selling company’s owner to exit.
Moreover, most strategic buyers have already formed a long-term vision to integrate the business into their current operations. Thus, owners concerned about their firm's legacy and future will most likely be insured.
Industry Expertise
Similarly, both types of purchasers will always conduct their due diligence before entering a bidding process for the target.
However, strategic buyers often possess more in-depth industry expertise due to a deep understanding of the industry, market trends, and customer preferences from years of experience operating in the relative market.
On top of that, working with a strategic buyer might speed up the acquisition process since the acquirer operates in the same space; they will be able to carry the communication and the bidding process much faster than a buyer unfamiliar with the industry.
More offerings for consumers
Considering the financial ability of a strategic buyer, after the transaction, the new company owners might be able to widen their product range by the aforementioned cross-selling.
In addition, higher quality and exclusive prices come along after the new company is formed. As a result, customers might benefit from these transactions.
Conclusion
Strategic buyers play an important role in mergers and acquisitions.
Unlike a financial buyer whose main objective is to acquire companies to improve their operations before exiting after 5 to 10 years to realize their gains on that investment, strategic buyers opt to integrate the acquirer to improve their business in the long run.
Their dedication to long-term value creation is evident in their main focus on synergies, both in terms of cost reductions and revenue synergies. Occasionally, this means paying a greater purchase price in comparison to the target's assessed value.
Their proficiency in handling complex market dynamics and their industry knowledge establish them as powerful players in the M&A arena.
Their capacity to innovate, streamline operations, and capitalize on market trends will remain crucial in maintaining sustainable development and help them gain a competitive advantage in their industry as they continue to shape industries through targeted acquisitions.
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