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THERE ARE 8 TYPES OF M&A BUYER. ONE FITS YOU BEST

By Ryan Kuhn. A Harvard MBA, Ryan founded M&A advisor Kuhn Capital 35 years ago. Since then, the firm has sourced, prepared clients for, and closed hundreds of high-IP mid-market M&A transactions together worth more than $3 billion. This article was first published 10/05/23 under the title Which Acquirer Fits Your Company Best? and revised 4/29/24.

Potential acquirers come in eight flavors. Each one offers a different combination of price, closing speed, financing certainty, how much cash you get upfront, the fate of employees (and you) post-close, etc. Find the right combination for you by getting to know:

  1. The Strategic
  2. The Private Equity Firm
  3. The Family Office
  4. The Owner/Operator
  5. The Insider
  6. The CEO-in-Residence
  7. The Search Fund
  8. The Fundless Sponsor

1) The Strategic

Description

Strategic buyers are operating companies that use M&A to move pieces around the chessboard. They’re driven by the strategic thought that they’ll increase market share and grow profit faster than organic growth permits by absorbing another business. That usually meansStrategic Moves they want the acquisition target’s access to new products and/or customer base. But sometimes they’ll buy a direct competitor to reduce pricing pressure.

Buyer Rationale

Strategics believe that operating synergies with the target company, and/or the lower valuation multiples of the target compared to their own, will make the acquisition “accretive.”

Source of Financing

Strategics mostly pay for acquisition targets using internal resources whether that be cash or some combination of cash and their own shares.

Deal Size

From $10 million to billions.

Deal Structure

As mentioned, larger public Strategic buyers pay with a mix of cash, stock, possibly a small slice of earn-out. But beware the value of micro-cap, penny and private company stock due to its volatility and limited liquidity. (Investment bankers can help value these shares.)

Strategic acquirers that are substantially larger than their target companies, and aren’t concerned about retaining its management, may make all-cash offers. But Strategics that want seller management to stick around after close will place emphasis on incentives based on performance.

Financing Risk

Generally Low. The less reliance on external funding by the Strategic, the lower the deal risk (and the faster the close).

Deal Speed

  • Can be among the slowest due to internal politics.
  • And also because sellside M&A advisors may struggle figuring out who the Strategic’s decision-makers are.

Valuation

Strategics often offer the richest multiples due to their expectations of strong synergies with the seller. Sometimes empire-building Strategic CEOs push target multiples even higher. (For a description of how Strategics and others estimate target value, see our HOW TO VALUE A GOING BUSINESS.)

Life After Close

Strategics that already have a successor to the target’s CEO on payroll often offer to selling owner/operators tenures of one year to one and a half. But sometimes they want the target company’s management to stick around awhile to help navigate through what are — at least to them — new markets or technologies.

Downsides?

  • Culture conflicts with Strategics can kill deals or make for unhappy marriages. (To avoid that fate, see my AVOID THE 7 MOST COMMON MISTAKES M&A BUYERS MAKE and 
  • TOP 5 WAYS BUSINESS OWNERS KILL M&A DEALS and
  • Seller CEOs may chafe under new oversight and operations controls. This can become quite irksome for sellers who are trying to reach earn-out goals.
  • Finally, it’s not uncommon for Strategics – in pursuit of the synergies they paid for – to fire seller’s admin staff.

Upsides?

Many owners contemplating eventual retirement find the combination of brief post-sale CEO tenure and high valuation irresistible.

Bottom Line

Strategic buyers are a strong fit for older owners looking to exit quickly, often after selling at the market’s best price. But they must be prepared for a slow M&A process and puzzle-palace corporate decision-making.


2) The Private Equity Firm (a “Financial” buyer)

Description

Financial buyers are either Private Equity groups or Family Offices. Unlike Strategics, Financial acquirers don’t usually have portfolio companies to synergize with a target.

PE Financial Buyer

What PE Financial buyers do have is money and (they hope) good ideas about to sell the target later for a profit. Family Office acquirers work differently. See below for how.

Yet some PE firms walk and talk like Strategics. That’s because they own “platform” companies that can synergize with targets in “roll-up or “tack-on” M&A transactions. (For definitions of terms like these, see my FOUNDER’S GUIDE TO M&A AND FUND-RAISING TERMS.)

Buyer Rationale

To increase target ROE, PE firms buy companies that…

  • Will later become Strategic targets in a consolidating industry;
  • Promise:
    • Operational enhancements;
    • IP exploitation;
    • Economies of scale;
  • The PE firm can introduce to clients and suppliers.
  • Allow a purchase structure featuring minimal cash. See how this happens in the Structure section below.

Source of Financing

PE firms attract capital commitments from large investors like insurance companies, pension funds, HNW individuals, sovereign funds, even large Strategics. These PE investors are called limited partners or LPs.

They commit cash to the PE firm for the life of a specific PE fund, about five years. Within that fund’s life, the PE firm must find, buy and resell targets.

Deal Size

From $10 million to billions.

Deal Structure

  • As much leverage as the PE firm can expect the target to manage.
  • Minimize cash at close by placing heavy emphasis on management earn-outs and equity in the surviving entity.

Financing Risk

Low because LPs are big and legally bound to meet their funding commitment, and because PE firms know how to engineer debt-heavy balance sheets.

Deal Speed

  • The fastest deal doers around. Smart, experienced, hungry people.
  • Flat organizational structure facilities rapid decision-making.

Valuation

Competitive when considering back-end seller compensation should management meet exit value expectations. That said, PEs can’t compete with Strategics for cash payment up-front.

Life After Close

For the target’s CEO, performance incentives can be big but they come with pressure to perform. Owners looking for a quick exit with no able successor don’t fit the PE model.

Downsides?

  • The team running the target post-close must manage the debt the PE firm used to buy it.
  • The target gets sold again in about five years.

Upsides?

  • Fair valuation, albeit back-loaded;
  • The seller’s CEO stays in operational control post-close;
  • That CEO has a shot at a second bite of the apple.

Bottom Line

PE transactions are for younger, energetic sellers — successful entrepreneurs looking to harness the connections and potential growth investments of their demanding bosses.


3) The Family Office (another “Financial” buyer)

Description

Like the PE firm, the Family Office (FO) uses a captive pool of capital to buy operating companies. But big difference — the cash it invests is its own.

Funded by wealthy individuals or even multiple families, FOs hold their acquisitions for 10 years and commonly more, not five like PE firms.Family Office

FOs traditionally emphasized passive real estate investments but are now venturing into buying operating companies. They want to avoid PE firm fees and decide for themselves whether to sell a portfolio company. For more about today’s FOs, according to RSM, click here.

Buyer Rationale

Slow and steady as she goes. FOs look for targets with stable stand-alone performance.

Financing Source

As above, self-funded.

Deal Size

FOs rarely do deals worth less than $5 million or more than $50 million. An FO’s “bite-size” depends on the depth of its investment pool and its risk tolerance (which is low).

Deal Structure

  • Pays cash.
  • Rarely uses bank debt because they usually don’t need it.
  • Target CEOs get performance bonuses, maybe phantom stock.

Financing Risk

Very Low.

Deal Speed

Moves quickly if the chemistry is good but generally a cautious, highly selective buyer.

Valuation

Value multiples can be strong and fair, but like Warren Buffett, they aren’t known for overpaying.

Life After Close

Keep on truckin’. That is, keep generating cash. Target CEOs with acceptable post-close performance often stay on till retirement.

FOs are far less hands-on than Strategic or PE buyers and only intercede in portfolio company operations when forced. In a word, life after close is like working in a family company.

Downsides?

  • PE firms have stronger industry and finance networks than FOs. Therefore, FO CEOs are less likely to be recruited.
  • The FO CEO job description may not fit the young, restless entrepreneur well.

Upsides?

  • Can be a great way to “gradually fade away” while building a nest egg.
  • Since FOs don’t necessarily have the contacts or urgency to replace under-performers, job security is high.

Bottom Line

The FO model fits the older executive who values a drama-free M&A deal transition. For a positive spin on the advantages of selling to an FO, see this piece written by one.


4) The Owner/Operator

Description

Owner/Operators are individuals that usually use their own money plus debt backed by the target to finance its purchase. Post-close they become the target’s CEO.The Owner/Operator

Deal Rationale

Such individuals may be retired corporate execs wanting to try their hand running a business or entrepreneurs fresh off an exit. Veteran corporate execs ideally have relevant industry experience. If an entrepreneur, the seller would want to see a successful track record.

Financing Source

With the O/O, the seller needs a clear idea of where the funds come from and with how much certainty. If the deal requires seller paper, exercise extra caution.

Deal Size

$1 million to $15 million.

Deal Structure

Individual buyers almost always need debt financing, preferably from a bank or the FDA. The good news is that these lenders will conduct their own independent due diligence.

Financing Risk

Usually Medium but can be High depending on the amount of seller paper.

Deal Speed

The O/O may require less thorough due diligence on its target than any other type of buyer due to inexperience and — in the case of former corporate execs – perhaps some undeserved confidence. Given that, and in-place financing, deal closing can move Fast.

Valuation

All over the map, again depending on experience and resources or lack thereof.

Life After Close

Either through eagerness to take the reins or hubris, the new O/O owner often wants to move fast. Experienced entrepreneurs are likelier to place more value on the selling CEO’s experience.

Downsides?

First, risky deal financing. Second, successful corporate execs don’t always make successful small business operators.

Upsides?

Individuals may be the best – or even only – buyers of businesses too small to attract Strategics and Financial buyers.

Bottom Line

The burden of due diligence falls on the business owner considering selling to an O/O.


5) The Insider (MBO/ESOP)

Description

Employees acquire their employer by:

  • Using cash derived from a bank loan that’s based on target value (aka, a management buy-out or MBO) or;
  • Using an earn-out combined with seller paper (aka, the ESOP or employee stock ownership plan) or;
  • Doing both in a “leveraged ESOP.”MBO - ESOP

Deal Rationale

Insider acquisitions allow exiting owners a way to reward loyal employees. LBO can also offer owners the quickest exit post-close because the managers staying on are already well up to speed.

Financing Source

Employee cash, earn-out and seller note. Sometimes external debt.

Deal Size

ESOPs are complicated so you must hire expensive advisors. The cost means targets need about 20 employees. For a similar reason, MBO deals are generally worth at least $5 million.

Deal Structure

You’ll need about $100K to set the ESOP up and if you also need external debt financing, add another $20K – $30K. Trustee fees cost about $30K. Total: about $150K

Then figure another $5K or more per year in ESOP maintenance till the deal’s finally paid off. See this National Center for Employee Ownership article for itemized ESOP expenses.

Believe it or not, tax breaks can make all this IRS hoop-jumping worthwhile.

Financing Risk

  • Assuming the ESOP plan is thoroughly vetted, Low.
  • Medium risk for MBOs, especially in the first few years post-close. It’s like a mortgage.

Deal Speed

  • For MBOs, figure it takes about six months to close;
  • For ESOPs, selling stock to employees can extend over year. See BDO’s ESOP article for details.

Valuation

  • In order to get the tax treatment that makes ESOPs attractive, the deal must be priced at “fair market value“ (FMV) by a consultant.
  • In MBOs, the target’s debt capacity must satisfy most of what the seller demands. If not, the acquiring team’s cash may not be enough to close the deal.

Life After Close

Both MBOs and ESOPS preserve management teams, though for MBO and leveraged ESOP deals to work they may have to fire employees.

Downsides?

  • If the MBO’s debt proves too much to manage, a messy default could follow.
  • For ESOPs, the risk of default is much lower. However, completing the sale of all ESOP equity to employees commonly takes years.
  • Both Insider deals may not generate the highest valuation since no investment banker markets the seller to Strategics whose synergy aspirations could exceed “fair market value.”

Upsides?

Both types of Insider deals offer a high level of continuity and a way for the owner to say “thanks” to employees. With MBOs, owners exit fast. With ESOPs, not so much.

Bottom Line

For business owners who wish to deal with the “devil they know,” Insider transactions are comparatively stress-free for two reasons:

  • Buyer and seller don’t have to haggle over “fair market value” (FMV) and the company’s debt capacity since lenders and ESOP consultants quantify those things. The deal either works or it doesn’t.
  • Since the acquirors (target employees) know the company intimately, they have much less concern about due diligence and seller reps and warranties.

For more ESOP detail see this National Center for Employee Ownership’s informative article.


6) The CEO-in-Residence

Description

The CEO-in-Residence (aka Entrepreneur-in-Residence) is an accomplished industry executive that a PE firm pays to find, help acquire and run a company.CEO-in-Residence

Deal Rationale

The PE firm is backing a winner in an attractive industry.

Financing Source

See PE firm.

Deal Size

See PE firm.

Deal Structure

See PE firm.

Financing Risk

While PE firm financing risk is low, the CEO-in-Residence must still convince the PE firm’s partners to invest. The result is Medium financing risk.

Deal Speed

For the same reason, deal speed may be Medium rather than the usual PE firm Fast.

Valuation

Since the CEO-in-Residence replaces the selling CEO, he/she would not receive Newco carried equity or an earn-out.

Life After Close

PE firms expect their CEO-in-Residence to replace the selling CEO in perhaps six months or less.

Downsides?

  • PE firm decides to pass on the CEO-in-Residence’s deal.
  • No earn-out or equity roll-over for the target’s former owner/CEO.

Upsides?

  • Among the fastest exits.
  • The CEO-in-Residence becomes the deal’s champion so the selling owner doesn’t have to.

Bottom Line

    • Some risk the CEO-in-Residence can’t convince his/her PE bosses to buy.
    • Quick post-close disengagement.
    • No upside if the company reaches goals after sale.

Addendum

7) The Search Fund, Cousin to the CEO-in-Residence

Both CEO-in-Residence and “Search Fund” programs sponsor entrepreneurs in their search for targets. But they differ in that:Search Fund

  • Search Funds are formed by loose affiliations of HNW individuals, not established offices;
  • Search Fund investors sponsor younger, less experienced entrepreneurs than CEOs-in-Residence.
    • For example, the first Search Fund was created by a Stanford MBA professor to finance target purchases made by several students. See the story here.
    • So sellers to Search Fund entrepreneurs must value seller paper or residual equity cautiously.
  • Search Funds don’t have much money.

8) The Fundless Sponsor

Description

Fundless Sponsors, also known as  Independent Sponsors, first find targets, then find investors to acquire them. There are two subtypes of Fundless Sponsors – those who have done so successfully, and those who haven’t yet.

For a description of the former — which we’ll call Fundless Sponsor “Professionals” — see here. They have pre-established investor connections even if they don’t have pre-established deal commitments.Fundless Sponsor

For a description of the latter — which we’ll call Fundless Sponsor “Amateurs” — see here. They don’t have such connections.

There is another distinction between Fundless Professionals and Amateurs as well – how they’re paid:

  • Professionals mostly earn their fees from investors for finding the deal while…
  • Amateurs may also, but they often want a salary and some equity as new CEO of the target too.

Deal Rationale

  • Professionals know the target and its industry well and can advise a buyer on target direction post-close. So investors reward them with carried interest, target equity, and board fees. Professionals don’t seek to run targets but rather move on after close.
  • Amateurs — who don’t have any or much money of their own — must get lucky not two, but three times:
    • Find an attractive target;
    • “Retail” it to investors;
    • Qualify as CEO of the target post-close.

Financing Source

TBD

Deal Size

$1 million to $15 million.

Deal Structure

TBD

Financing Risk

Medium for professionals, High for amateurs.

Deal Speed

Medium for professionals, Slow for amateurs

Valuation

Medium for professionals, Low for amateurs (though highly variable depending on valuation expertise).

Life After Close

In the case of the Fundless Pro, most likely the selling CEO stays on under circumstances like those of PE portfolio company CEOs (see). Obviously, for Fundless Amateurs, the selling CEO exits promptly stage left.

Upsides?

Fundless Pros can deliver services similar to those offered by sell-side investment bankers. Both market targets to investors. The Pros’ advantage is that they don’t charge an upfront fee to do so.

As for Fundless Amateurs, the upside is having an eager would-be CEO scouring the market for investors on the seller’s behalf also at no cost.

Downsides?

On the other hand, Fundless Pros:

  • Typically cost the seller more in total fees than an investment bankers would, and sometimes they charge both the seller and investor fees.
  • Usually won’t market the seller as effectively as an investment banker since they may contact only a handful of their “go-to” industry investors or ones who pay them the highest finder’s fee.

And Fundless Amateurs:

  • May be first time at bat and fail to close;
  • Can tarnish the seller’s reputation and disclose proprietary information with indiscriminate and, well, amateur marketing.

In general, proceed with caution when dealing with Fundless Sponsors, especially so when he/she is an Amateur. To help predict whether an individual without extensive entrepreneur experience could be successful as a Fundless Amateur, see my CHARACTERISTICS OF A SUCCESSFUL ENTREPRENEUR.


The Bottom Line of Bottom Lines

Wrapping Things Up

  • Strategic and Private Equity buyers offer the highest acquisition certainty but Strategic acquisitions pay higher initial valuations while PE firms offer greater back-end incentives for post-close CEOs.List of Buyer Types
  • Owner/Operator buyers bring transaction simplicity but also greater risk unless experienced and well-capitalized.
  • Insider and Fundless buyers can pose higher deal risks but enable options like gradual exits or avoiding third-party buyers altogether.

So the right acquirer is the one with the best fit between your particular objectives and constraints and its own.

Now knowing more about the characteristics of the eight buyer types should help you focus on those with whom you are more likely to reach terms.

For your convenience, I’ve compacted all this info about different types of potential buyers into two handy pocket charts.

See this one for descriptions of those with immediate access to material funds. For those without such access, see here.

While every seller prefers buyers with sufficient funds on hand to close stat, know that less cash-rich buyers are sometimes the smaller company’s ideal acquisition partner, or maybe the only.

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Ryan Kuhn

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04/30/24

“Ryan Kuhn is the founder of Kuhn Capital (bio). This article is not the product of AI. AI is a product of this article.