M&A Guide | The 4 Types of Buyers of Businesses

Mastering Marketing 101 begins with a fundamental principle: understand your audience inside and out. Who are they? Where can you find them? What motivates their decisions? What incentives resonate with them? Without a firm grasp of these essentials and more, your sales pitch could face an uphill battle, regardless of whether you’re marketing widgets or entire enterprises.

This rings especially true when it pertains to promoting your company. Equipping yourself with insights into the diverse range of buyers within the market enables you to pinpoint the ideal buyer type for your business. This knowledge is pivotal in gauging your business’s potential worth and devising a potent marketing strategy for selling your enterprise.

The landscape of business buyers can be broadly categorized into four distinct groups:

#1: Individual Buyers – Champions of Small-Scale Enterprises

Individual buyers are guided by dual ambitions: generating income and embracing freedom. Their primary concerns revolve around risk assessment and the feasibility of financing the purchase. For these buyers, the acquisition journey can be emotionally charged. Thus, they often gravitate toward less volatile investments and favor businesses with proven success records. When engaging with individual buyers, it’s advisable to minimize perceived risks and present information in a digestible manner.

#2: Financial Buyers – Navigators of Small and Mid-Sized Ventures

Financial buyers primarily encompass private equity groups (PEGs) and assess a business predominantly based on its numerical performance, disregarding potential synergies. Their core objectives encompass attaining a substantial return on investment and formulating a solid exit strategy. Key focal points are achieving high returns and retaining the existing management team. When targeting financial buyers, emphasis should be on cultivating a robust management team and bolstering EBITDA growth.

#3: Strategic (Synergistic) Buyers – Seekers of Synergy in Small to Medium-Sized Ventures

Strategic buyers emerge as the pinnacle of buyers, often willing to pay a premium when replication of the seller’s offerings proves challenging. These buyers possess extended ownership horizons and don’t adhere to defined exit plans. Their approach centers on seamlessly integrating your business into theirs, with a focus on long-term compatibility. Engaging with strategic buyers entails accentuating distinctive value propositions that defy easy replication, along with enlisting an M&A intermediary to orchestrate a discreet auction process.

#4: Industry Buyers – Integrators and Acquirers of Direct Competitors

For businesses entrenched in asset-intensive sectors with less favorable margins, aligning with an industry buyer might be the most fitting avenue. In certain industries, alternative buyer types may not even be viable options. Industry buyers often assume the role of a last resort, often offering lower valuations. Their deep industry knowledge steers them away from paying for intangibles like goodwill. Transacting with industry buyers introduces an added layer of risk—potential confidentiality breaches. When negotiating with industry buyers, enlisting professional representation, cultivating inimitable value, vigilantly managing confidential disclosures, and avoiding desperation are crucial.

In the ensuing article, we delve comprehensively into these four buyer archetypes, examining their objectives, considerations, and associated risks in detail. For those keen on optimizing their business’s value within a specific target audience, continued reading promises invaluable insights.

Individual Buyers

A minority of middle-market businesses find their match among high-net-worth individuals, a fact that underscores the diversity of buyer profiles.

Consider these compelling statistics illuminating the global landscape of high-net-worth individuals:

• A remarkable 14 million individuals boast high-net-worth status, their financial assets exceeding the $1 million benchmark.
• Furthermore, the ranks include a staggering 225,000 ultra-high-net-worth individuals, individuals whose financial assets surpass the $30 million threshold.

Goal #1: Income

Prospective buyers often set their sights on acquiring a dependable income stream. This intent might stem from recent job setbacks or career dissatisfaction, fueling their desire to chase the aspirations embodied in the American Dream.

Goal #2: Freedom

Research underscores that individuals embark on the journey of starting or purchasing small businesses primarily driven by their pursuit of autonomy and the realization of personal freedom.

Interestingly, the aspiration to amass substantial wealth ranks lower among the motivations propelling these individuals toward business ownership. While income replacement remains the chief goal of acquiring a business, the paramount significance accorded to autonomy and the power to shape one’s destiny consistently outweighs the pursuit of wealth accumulation.

Consideration #1: Risk

For these purchasers, the process of acquiring a business can evoke a range of emotions. This is due to the fact that investing in a business carries inherent risks and often involves committing a significant portion of their accumulated wealth. For some, this marks their inaugural venture into business ownership, amplifying the complexity of the decision-making process.

Consequently, a propensity exists for them to gravitate toward investments that carry lower degrees of risk. Their preference is often directed toward businesses that boast an established history of success. Frequently, they adhere to sectors with which they possess familiarity; nevertheless, certain buyers might entertain the prospect of delving into an unfamiliar industry, provided the business can be swiftly comprehended or the seller is open to an extended transition period.

A subset of individuals might comprise former small business proprietors. In such cases, these buyers are more disposed to taking decisive action compared to counterparts without prior business ownership experience. Their willingness to engage stems from an intimate acquaintance with the inherent risks, particularly if their past ownership pertained to the same industry.

Consideration #2: Financing

Individual buyers orchestrate the acquisition of businesses primarily by melding a blend of personal funds, seller financing, bank loans, SBA support, or tapping into their retirement reserves. The majority of these buyers target businesses with valuations below the $10 million mark.

Strategies for Engaging with Individuals

When engaging with individual buyers, consider these adept approaches:

• Mitigate any perceivable risks attached to your business. For these buyers, risk perception wields more influence over deals than mere opportunities. Enlisting an impartial third party to meticulously scrutinize your business can pinpoint avenues for enhancing its allure to this buyer category. Our Assessment service mirrors an investor’s perspective, culminating in a comprehensive report. This dossier encompasses an evaluation of your business’s market appeal, a comprehensive risk-opportunity analysis, potential deal-breaking factors, risk mitigation strategies, and an actionable roster for diminishing risk and maximizing your business’s value.
• Circumspection with information dissemination is key. The leap into business ownership can engender trepidation among many individuals. Bombarding them with excessive information or orchestrating an excessive number of meetings can potentially overwhelm unprepared individuals. A prudent strategy involves facilitating an environment where most earnest buyers are poised to extend an offer post their second or third engagement. Should this not materialize, a pragmatic course of action is to redirect your focus.

Financial Buyers

Private equity embodies the essence of “equity in privacy,” distinctly set apart from publicly held or traded equity. Among the realm of mid-sized enterprises, private equity groups take the forefront as the predominant and expansive buyers.

Financial buyers predominantly manifest as private equity groups (PEGs), basing their valuation of a business solely on quantifiable metrics, without factoring in the influence of potential synergies.

In the United States, an impressive array of 2,000 to 3,000 private equity firms operates. This landscape further encompasses family investment offices and analogous investor types functioning with a parallel approach to private equity firms.

Private equity groups mobilize resources from institutional investors, channeling these funds into private companies on behalf of these investors. Typically encompassing a decade in duration, the fund serves as the temporal scope for this endeavor. Concurrently, the PEG maintains a holding period spanning three to seven years per invested business. The PEG garners its returns either through distributions funded from the company’s earnings or through the sale of the company at an escalated valuation compared to its acquisition cost.

Goal #1: ROI

Financial buyers emerge as the prevailing force in middle-market company acquisitions, their laser focus honed on return on investment (formally known as the internal rate of return, or IRR), rather than the strategic advantages linked to the acquisition.

Private equity groups (PEGs) wield mastery in propelling companies towards expansion, leveraging strategic affiliations, cultivating robust management teams, and architecting streamlined sales and marketing frameworks. With PEGs at the helm, a seller gains the potential to expedite a company’s growth, fueled by the strategic guidance and support of these seasoned players. Often, the ultimate objective for PEGs rests in transitioning towards an acquisition by a strategic buyer.

The modus operandi of PEGs involves the standalone acquisition of a company, with post-closure endeavors geared toward heightening the company’s valuation. The transformational initiatives are meticulously tailored to elevate profitability and heighten the company’s allure for future investors.

As a result, financial buyers dissect a company’s cash flow through a standalone lens, excluding integration advantages, as they zero in on the capacity for bolstering earnings and escalating investment worth over the forthcoming three to seven years.

Price allocation holds paramount significance for these buyers, given that post-closure operations typically maintain the acquired business as an independent entity, except in cases where it aligns with an existing portfolio company.

Unlike strategic buyers, PEGs generally forego post-closure integration of a newly acquired entity with their existing holdings. This distinct operational approach imposes limitations on the multiples PEGs are willing to pay, making these valuation parameters reasonably foreseeable. Exceptions materialize when a PEG’s portfolio encompasses a company that could potentially yield synergistic advantages with the newly acquired entity.

Goal #2: Integration

A noteworthy exception arises when a financial buyer holds a company within their portfolio that directly competes with the prospective target company. In these scenarios, the buyer’s identity shifts from a financial buyer to an industry buyer.

For those aiming to sell to a private equity group (PEG), crafting a well-defined exit strategy is imperative. Absent a clear exit plan, the likelihood of garnering interest from a PEG diminishes. A pivotal condition for PEG engagement is the potential for substantial value augmentation in the business under consideration.

A significant share of PEGs sets their sights on achieving an internal rate of return (IRR) ranging between 20% to 30% annually. This IRR objective translates to a requisite return on invested capital ranging from two to fourfold, should they opt to exit the investment (i.e., resell your business) within the span of three to five years.

Consideration # 1: ROI

Private equity groups (PEGs) strategically employ substantial leverage during acquisitions, a move that distinctly amplifies their Internal Rate of Return (IRR).

Notably, the IRR is intricately intertwined with the investment’s holding period—the span during which the investment is retained. This dynamic is the driving force behind a PEG’s comparably shorter holding period relative to other buyer categories. In instances where leverage, often in the form of bank debt, is harnessed to secure your business, your business must generate a robust cash flow capable of servicing the debt obligations. Consequently, a PEG’s valuation for your business is constrained by the pragmatic dictates of the financial figures.

Consideration #2: Retaining the Management Team

Retaining the current management team and owner stands as a predominant inclination for private equity firms. This predilection is grounded in the pragmatic reality that private equity entities frequently lack industry expertise, necessitating a proficient hand to steer the ship following the transaction’s closure. In scenarios where the incumbent owner and management team opt out of continued operation, the onus falls on the private equity firm to assemble a new operational team.

Should you sell to a financial buyer?

Opting to sell to a PEG offers owners the opportunity to divest a portion of their company at present, a strategic move that not only spreads risk but can also pave the way for a subsequent, more substantial exit in a span of three to seven years when the PEG orchestrates the business’s resale. This setup is structured to motivate the owner’s continued involvement, achieved by retaining equity. Typically, the PEG advocates for the owner to uphold a minimum 20% stake in the business.

For instance, consider a scenario where the owner sells 80% of their shares, a proportion often sufficient to secure a comfortable retirement. This arrangement allows them to retain a 20% stake post-closure. Interestingly, this remaining 20% equity could potentially yield a more sizable exit for the entrepreneur than the initial sale of 80%.

Tips for Dealing with Financial Buyers

When engaging with financial buyers, consider the following directives:

• Cultivate a robust management team. Financial buyers generally stipulate that the current management team continues to oversee business operations post-closure.
• Elevate EBITDA, the key benchmark financial buyers rely on for business valuation.

Strategic Buyers

Strategic acquisitions predominantly unfold within emerging industries, particularly those characterized by venture-capital-backed enterprises or the dynamic of “winner take all” sectors. Such sectors encompass technology platforms and industries heavily reliant on research and development (R&D) for sustained success.

Prominent technology giants like Google, Salesforce, Microsoft, Apple, and PayPal consistently engage in acquisition endeavors. As fledgling industries mature, companies turn to acquisitions as a strategic maneuver to eliminate competition. Notable instances include Facebook’s absorption of Instagram and WhatsApp, PayPal’s integration of Braintree, Google’s acquisition of Motorola, and HP’s merger with Compaq. In these realms, the pace of expansion is so frenetic that companies vie fervently to secure the position of dominant industry frontrunner in the race for dominance.

Strategic buyers represent the pinnacle of the buyer spectrum and might offer higher valuation multiples compared to their counterparts if they encounter difficulties replicating the offerings of the seller’s company. The pivotal criterion here is the challenge of swift replication.

Goals

Strategic or synergistic buyers stand as proactive competitors, both direct and indirect, who opt for acquisitions as an alternative to conventional organic expansion strategies.

This spectrum encompasses rivals, customers, or suppliers, each driven by motivations to access novel markets, proprietary assets, technological prowess, or an expanded customer base.

Distinguished by extended ownership tenures, these buyers deviate from the exit-focused strategies of financial counterparts. Their approach centers on complete assimilation of your company within their operational framework, underpinned by a long-term outlook devoid of preset exit strategies. There are instances, though, where their objectives may concentrate on acquiring specific assets like technology, intellectual property, or clientele, leading to post-closure operational closures and staff layoffs.

Enter the realm of “acqui-hire,” where a competitor’s acquisition is singularly geared toward securing your workforce, culminating in operational discontinuation upon closure. This scenario is commonplace, particularly within talent-scarce domains such as the technology sector.

In scenarios where creating fresh products, services, or customer bases proves less cost-effective, strategic buyers often opt to amplify their prowess through acquisitions. This pattern finds particular resonance within mature industries—examples abound in cellular (T-Mobile’s acquisition of Sprint and MetroPCS), media (AT&T’s merger with Time Warner, or Walt Disney’s assimilation of Twenty-First Century Fox), and consumer products (Heinz’s takeover of Kraft). Here, where the impetus for organic growth dwindles, the imperative for augmenting revenue takes on the form of “buying growth.”

Considerations

The strategic acquirers pivot their attention towards the enduring alignment with their enterprise, synergy prospects, and the seamless integration potential between your company and theirs.

A universal trait among strategic buyers is their capacity to replicate the value you offer, granted they can do so at a lower cost compared to acquiring your business outright. Furthermore, these enterprises meticulously assess the time investment required for reconstructing your value proposition. Should urgency be a factor, the option of acquiring your business gains traction, given the opportunity cost incurred by not seizing an immediate foothold through acquisition.

Tips for Dealing with Strategic Buyers

In the realm of strategic buyer engagement, a few strategic recommendations stand as cornerstones:

• Cultivate a business with a unique value proposition that defies easy replication. A strategically inclined buyer’s interest thrives on distinctive attributes that set your company apart; they seek what’s exceptional.
• Exercise pragmatism in assessing your business’s compatibility with strategic buyers. Engage the expertise of a middle-market M&A advisor, such as our own, for an impartial evaluation. This process unveils the potential alignment with a synergistic buyer. Our assessment indicates that a mere fraction—less than 5%—of middle-market entities align with the criteria of a strategic buyer.
• Employ the services of an M&A intermediary to orchestrate a discrete auction. The competitive dynamics of a private auction elevate the stakes, compelling strategic buyers to recognize and vie for the strategic value they stand to gain. The knowledge of rival bidders fosters a willingness to invest in strategic worth—an element often left unaddressed without competitive pressures.

Industry Buyers (Direct Competitors)

Should your business exhibit an asset-intensive nature accompanied by less-than-optimal margins, the avenue of selling to an industry buyer could emerge as the definitive recourse. In certain sectors, the conventional paths of engaging with financial or strategic buyers might not apply. Alternatively, if your business boasts an exceptional degree of specialization, the logical acquirer might indeed be a direct competitor.

Goals

Within the realm of acquisition, industry buyers frequently occupy the role of ultimate choice, albeit associated with a propensity for offering relatively lower prices. Profoundly acquainted with the industry’s dynamics, these buyers exhibit a measured approach and often refrain from assigning value to intangible assets like goodwill. The crux of your company’s valuation lies in the distinctive attributes that defy easy replication by the buyer.

Illustratively, consider a scenario where you seek a $10 million valuation for your enterprise. If the buyer can attain equivalent revenue by channeling $3 million into marketing efforts, their decision to acquire hinges on whether the total cost surpasses this $3 million threshold. Informed by such strategic calculations, the landscape of industry buyer engagements is navigated with assurance and clarity.

Risks in Selling to a Strategic Buyer

Selling to industry buyers introduces an extra dimension of risk: the potential for confidentiality breaches. Navigating dealings with direct competitors entails inherent risk, and it’s prudent to anticipate some level of information dissemination. In the face of this reality, competitors might exploit the situation to their advantage by attempting to lure your customers or staff. Vigilance is key, as such developments can impact your company’s valuation and even jeopardize ongoing negotiations.

Tips for Dealing with Industry Buyers

In the context of engaging with industry buyers, consider the following pragmatic steps:

• Engage a skilled professional to handle negotiations on your behalf. These buyers often commence with conservative offers, adjusting them only if competition appears imminent.
• Foster intrinsic value within your enterprise that eludes easy replication by competitors. Factors like intellectual property (patents, trademarks, trade secrets) and enduring customer contracts fortify your distinctiveness.
• Rigorously monitor the confidentiality of sensitive materials. Serialization of confidential documents, including the Confidential Information Memorandum (CIM), enables a systematic trace in case of confidentiality breaches.
• Maintain an unwavering stance of composure. Demonstrating resolve is pivotal, preventing any signs of desperation from becoming bargaining chips wielded against you throughout negotiations.

Summary

In the process of selling your business, factor in the potential buyer profile. Gauge whether individual, strategic, financial, or industry buyers are more probable, aligning your marketing efforts and strategies accordingly based on your business’s size and distinct strengths.

This understanding lays the foundation for formulating preparatory actions, tailoring your marketing tactics, and shaping a comprehensive sales strategy. The ultimate aim is to optimize your company’s value through a pragmatic and targeted approach.