Corporate Finance
Feb 21, 2023
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This article aims to explain the difference between two categories of buyers—financial and strategic buyers. Financial and strategic buyers have different objectives for making acquisitions. Here is a quick list of points to help you understand the difference.
A financial buyer is a type of buyer that’s interested in making an acquisition because of the return that can be made above and beyond the purchase price. Their primary focus is on the cash flow of the target business and on the potential exit strategy they can use to realize their return on investment.
The term financial buyer most often refers to a private equity company. Financial buyers use leverage to make acquisitions, meaning they borrow money from other investors and financial institutions to finance their acquisitions. You can learn more about this here: What is Financial Leverage?
Financial buyers typically work on a five- to ten-year time frame—meaning they plan to exit the business in five to ten years. Various exit strategies could include taking the company public with an IPO, or an outright sale of the business or its assets (see: Asset Purchase vs Stock Purchase).
Financial buyers look to improve the companies they purchase from a financial standpoint before they look to make changes to the management of the business. They typically look to generate more cash flow by boosting revenue with a capital investment, by cutting costs, or by achieving economies of scale by purchasing complimentary businesses.
Strategic buyers are primarily concerned with achieving synergies and how the target business could help them achieve their strategic goals. The main idea with strategic mergers and acquisitions is that the company would improve its core business by making this deal. You can learn more about Financial Synergies here.
Strategic buyers are typically interested in horizontal and vertical expansion, and in creating synergies and revenue enhancements. An example of this could be when a retail company buys a manufacturing company. This would save them money on manufacturing costs and improve profitability. The focus here is on strategic improvement of the business. As a result of this transaction, the business would be more profitable. You can learn more about Vertical Integration and Horizontal Integration.
Strategic buyers tend to be other operating companies in the same industry. They are more long-term focused in acquisitions and aren’t as concerned with the immediate cash flow of the business they are thinking of buying as they are interested in how this acquisition can help them grow.
Strategic buyers aim to create a better business through acquisitions. Their goal is that the end result of the merger or acquisition will be a better company than without it. This is their rationale for doing the deal.
Financial buyers are typically non-operators, meaning they would prefer to make an acquisition and not need to get involved with the day-to-day of running the company. Because of this, financial buyers are typically long-term focused (five- to ten-year exit strategy) and aim to make a return on buying a well-run and well-managed business over time.
Financial buyers may be more concerned with the target company’s ability to generate quick cash flow than strategic buyers, who can often benefit greatly from strategic improvements. Part of this has to do with the fact that financial buyers typically use more leverage in a transaction than strategic buyers do. This cash flow is often required to offset a debt repayment structure.
Strategic buyers tend to be large companies that are well capitalized and able to look past immediate cash flow and instead focus on the possibilities for the growth of their core operations.
This isn’t to say that strategic buyers don’t care about cash flow, or that private equity companies won’t work on business operations. That’s not the purpose of distinguishing between strategic and financial buyers. The purpose of this is to illustrate the two buyer categories and how they are different in their objectives for doing M&A deals.
In the end of the day, both types of buyers are looking to create value and make a return on investment from their M&A deals.
Although this is not always the case, generally speaking strategic buyers are more open to paying a premium price for an acquisition because they expect to get more value out of the transaction over the long-term than a financial buyer would. This is not always the case though, and there are circumstances why a financial buyer would be able to offer more money than a strategic buyer would.
Financial buyers are also, as a general rule of thumb, more interested in seeing consistency in financial statements going back over the years. Less volatility is considered a big plus to a private equity company. Remember, they are going to use leverage (borrow money) to finance this acquisition. Private equity companies can borrow up to 80 percent of the purchase price, in order to fund the transaction. So, they need to be able to service that debt. Financial buyers therefore are typically more concerned with seeing consistency in earnings and strong cashflow in a potential deal.
In summary, a financial buyer is more concerned with purchasing a business with higher growth potential, allowing them to make considerable returns on their investment in purchasing the business. They are less interested in getting heavily involved in management and operations than strategic buyers are. Strategic buyers are looking to use this M&A transaction to improve their core business operations over the long-term.
