The question of Strategic vs Financial Buyer typically comes up when a company is being sold, as in M&A or LBOs. A strategic buyer is typically after horizontal or vertical expansions, looking for strategic synergies that will improve their operations. Their primary objective is to identify a business whose products and/or services can be quickly absorbed into their own or existing operations.
A financial buyer, on the other hand, is interested in making an investment in a company and realizing considerable returns from it. Typical financial buyers are Private Equity Firms that use leverage to try and realize large financial returns. So the main task of a financial buyer is to identify companies with excellent growth potential and, thereby, make good their investment within a period of five to seven years.
Below is an overview of the attributes of each type of buyer and the different instances in which one type may be more appropriate than the other.
Strategic Buyer Explained
Essentially, a strategic buyer is interested in how the acquired firm aligns with his long-term business plans. There can be different reasons for acquiring a new company, such as for vertical integration (geared toward clientele or suppliers), horizontal expansion (exploring new markets or product lines), getting rid of competitors, or helping to eliminate or overcome market weaknesses of the acquiring company.
Often, strategic buyers are willing to pay more for companies than financial buyers. One reason is that a strategic buyer is better placed to realize synergistic benefits almost instantly. This is because of the economies of scale that may arise from integrated operations. The more the acquired business fits into the existing company’s structure, the more a strategic buyer will want the business and the higher the premium he will be willing to pay.
Secondly, strategic buyers are usually large and well-established companies with easier access to capital. As a result, they may possess a different currency, in the form of stock. In fact, a strategic buyer can pay for the acquisition by purchasing stock, paying cash, paying stock or through some combination of purchase methods.
Financial Buyer Explained
A financial buyer views an acquisition as an investment. They are looking to invest up to a certain amount of money in acquiring the target company, and then expect that investment to generate a satisfactory return. The financial buyer is open to investing in different kinds of businesses and industries rather than only those that align with his existing operations.
A financial buyer looks to increase his revenues and cash flow through different techniques, including venturing into revenue-generating projects, reducing expenses, and creating economies of scale. Once the financial buyer reaps maximum returns from his initial investment, he is likely to exit the company, either by taking it public or selling it outright.
To ensure he gets a return on his investment, a financial buyer must start by examining the financial records of the company he intends to buy. The one thing that the buyer is interested in is seeing consistency in the target company’s financial statements.
Often, a financial buyer uses borrowed funds to finance acquisition deals. It is not unusual to see a financial buyer using as much as 80% debt for the target company’s acquisition. A lender that partners with a financial buyer reaps returns by charging a lending rate.
Whether a financial or strategic buyer is more ideal for a company’s sale mainly depends on the seller’s objective in selling the business. Here are a few scenarios highlighting the seller’s goals and the likely most appropriate buyer.
1. The seller is only looking for returns
If a seller is looking to get maximum returns from selling his business, regardless of what happens to the workers or property, then he should consider an open auction deal, which can drive the business’ price upward. And since the seller’s primary goal is getting the highest price, a strategic buyer is the best fit, as he is likely to offer more for the firm than a financial buyer.
2. The seller might request covenants
If the individual wants a high price for his business but still has reservations on what happens to the plant and its employees, a strategic buyer is still the best fit. That said, the seller will need to set limitations in place so that the acquisition can work in his favor.
3. The seller is interested in cashing out but wants to remain involved in operations
In such an instance, a financial buyer is probably the best fit. A strategic buyer may already have the expertise to continue the business’ operations. In contrast, a financial buyer may have the money he needs to acquire a given firm, but may not have the necessary knowledge or expertise to successfully operate it. Hence, a need to retain top-level management from the acquisition target.
Every company seller has different goals in mind. As such, the strategic vs financial buyer decision is unique to each firm. Sellers should possess a basic understanding of the buyer’s universe so that they can evaluate their choices from an informed perspective.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:
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