A strategic buyer is a company (not an individual) in the same industry or a related industry to the company for sale. It may be a competitor, a supplier, a customer, or a company in a related field that will achieve a strategic advantage by acquiring the business.
Most importantly, a strategic buyer will benefit more from the acquisition than anyone else. This makes strategic buyers the most important category for sellers to concentrate their efforts on – they are the category of buyer that can pay the most for an acquisition, and they are the most likely to actually buy a company.
Who Buys Small Businesses?
Small businesses (<£2m) are sold to:
- Strategic Buyers
- (Less Commonly) Management via MBO
Private Equity funds (“financial buyers”) rarely acquire genuinely small businesses – these funds target larger companies > £2m and usually >£5m. For example, of the smallest category of acquisitions reported in IBBA Market Pulse reports (link) (a source of comparable data (link) on small business acquisitions), only 1% list private equity as the acquirer. Almost all of these businesses are acquired by individuals and strategic buyers. (Note that management buyouts are not included in broker surveys, since brokers would not be involved in these sales).
As businesses increase in size beyond £2m, private equity starts to get involved in acquisitions. Generally speaking the larger the company the more likely it will be that private equity will be one of the potential acquirers.
Conversely, the smaller a business is, the more likely it will be that an individual will be the acquirer.
Strategic buyers are responsible for a significant proportion of acquisitions at all levels, and are very prominent acquirers of small companies. While most marketing efforts for small businesses tend to be focused on advertising to individuals (via business-for-sale sites, mailshots to email databases and the like), brokers who list successful sales on their websites consistently show that acquirers tend to be strategic buyers. Most of the companies in these lists were acquired by other companies.
Why are strategic buyers so favoured? What makes acquisitions by strategic buyers so successful for the seller? There are a number of reasons.
Advantages of Strategic Buyers
Firstly, the due diligence process can be faster with strategic buyers. Financial buyers (including individuals, who are similar in this regard), are not usually experts in the industry and will have to conduct due diligence not only on the company but on the industry. With strategic buyers this is unnecessary, and can speed up the process.
Targeting strategic buyers is advantageous for sellers for another reason: they are identifiable. While the seller can hope for inbound enquiries from individuals in response to advertising, strategic buyers can be identified and targeted specifically.
More importantly, strategic buyers have the greatest incentive to make these acquisitions, and to pay the highest price.
Why Do Strategic Acquirers Pay More?
Strategic buyers can pay more for acquisitions because they can derive greater benefit from them. One key driver is cost synergies – when a strategic buyer acquires a competitor, many of the functions will be duplicated. The buyer can keep the sales, but remove some of the duplicated costs (eg: rent on duplicated premises). In larger acquisitions whole functions like accounting and HR may be duplicated, and the company can save money by reducing the size of these functions in the combined entity.
Economies of scale are another key driver for strategic buyers: by acquiring a competitor the larger entity will be purchasing in greater volumes, and can negotiate more strongly with suppliers for discounted prices.
Both of these benefits apply to strategic acquirers who are buying competitors, but they do not apply to any other type of acquirer: an individual will not experience any cost synergies or economies of scale from the acquisition; nor would a private equity firm. All buyers will acquire the sales of the company, but strategic buyers have the greatest opportunities to reduce their costs through the acquisition, thereby making more profit.
Other important advantages can be derived by strategic buyers too. Companies often acquire suppliers in order to reduce risk in their supply chain, or to control the supply chain and give them an advantage over competitors. Companies make acquisitions in order to acquire key technology that would be too expensive or time consuming (or just not possible) for them to develop themselves. They sometimes acquire companies in order to “acquhire” key staff, or to gain access to an exclusive client list. Companies are often acquired to give the acquirer ownership of key product lines – with more extensive sales and marketing infrastructure than the target company, the acquirer will achieve more sales from the same products. New markets are another driver: entering a new market may be considered more risky, expensive or time-consuming than simply acquiring a company that already has an established foothold in that market; in other cases it may be considered almost impossible without acquiring a competitor that has achieved dominance in that particular market.
But there is another, very important driver of strategic acquisitions: the valuation multiple. As we discussed in more depth in our blog post on acquisition mathematics, strategic buyers can acquire smaller companies at a lower PE multiple than the multiple that applies to their own company, and thereby immediately add more value to their own enterprise than the cost of the acquisition. For example, we showed how a company could add £1.4m to its own enterprise value through a £600k acquisition. Sometimes acquirers can even achieve a greater valuation multiple for the combined entity once acquisitions are completed, by significantly growing in size. This PE multiple arbitrage is a major driver of value in strategic acquisitions.
Targeting Strategic Buyers
While strategic buyers have the greatest opportunity to benefit from acquisition, most of them are not actively seeking out acquisitions among small companies. In other words, to sell to a strategic acquirer in most cases you will have to go to them, as they won’t always come to you. At the large end of the scale, huge private and public companies will have corporate development teams whose entire job is to work on M&A deals. But smaller companies – the kind that will acquire a very small (<£2m) business – do not have the resources to warrant full-time M&A teams. It is typically the company directors themselves who will be responsible for acquisitions in these cases. They understand the value in making acquisitions, but they don’t have the time to be constantly searching for targets to acquire. This is why advertising alone is not effective in finding strategic buyers – most of them will simply not see your ad.
Because of the nature of strategic acquirers (they are companies in your industry and related industries, of the right size, who can derive strategic advantages from acquiring your business), you will be best-placed to identify them yourself. Brokers will not be able to identify suitable acquirers as effectively as you can. They do not have access to the industry association lists of members that you have access to, nor the detailed knowledge of your market. Unless they are true specialists in your industry they will not be able to identify anyone that you could not already identify yourself. And they will not have the same depth of understanding of your suppliers and companies in related fields that you can identify. In short, even if you decide to use a broker for the sale, the broker will rely heavily on you to provide the list of companies to target (or he will come up with his own list which will be deficient compared to the list you could generate yourself).
These companies need to be filtered to ensure they are the right size to make an acquisition of this value. It can also be useful to check publicly-available financial records for an impression of the company’s financial standing and ability to make an acquisition.
Once the right companies (and the right people within these companies) have been identified, they need to be approached in the most effective way possible. A simple bulk email blast is usually not sufficient to get responses – a more individualised approach is better. The key is clearly demonstrating the opportunity presented by the acquisition, and the risk of missing out on it.
Preparing the business for sale is critical to this process. Understanding what acquirers are looking for, and giving it to them (by presenting the business in a way that meets these objectives), is key to a successful sale. Generating sufficient demand among several buyers to result in competing bids should be the goal from the seller’s point of view.
Structuring the deal in a way that works for the seller, and negotiating the best price and terms, are also critical skills. The seller can lean on advisors for this (the seller’s accountant and lawyer will be involved in the process regardless), but he must also understand these principles himself in order to get the best outcome.
To sell a small business for the highest price and on the best terms, the seller’s strategy must focus on strategic buyers. Combined with a comprehensive strategy to reach individual buyers, and effective management of the sale process itself, this approach will have a far greater likelihood of success.
Selling a business the traditional way (i.e. handing the whole process over to a business broker and hoping for the best), is not effective. Most small businesses marketed this way simply do not sell.
For UK businesses turning over less than £2m, business brokers should not be used. There is a better way: one that leads to greater likelihood of sale, for greater value, at much lower cost.
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