Acquirers come in eight flavors. Do you know which one is likely to fit your situation best? Find the right buyer by getting to know:
- The Strategic
- The Private Equity Firm
- The Family Office
- The Owner/Operator
- The Insider
- The CEO-in-Residence
- The Search Fund
- The Fundless Sponsor
Before we describe each in turn, recognize that:
- Not all acquirers fall neatly into single categories. Some are hybrids or mixtures of several types.
- We wrote this article from the perspective of a company owner or CEO who may one day consider an exit.
- And for your viewing enjoyment, we’ve created two handy guides to the types of acquirers listed above. For acquirers with immediate access to material funds, see here. For buyers without such access, see here.
Strategics are operating companies that use M&A to move pieces around the chessboard. They’re driven by the strategic thought that they’ll grow faster and more profitably by buying or merging with a target.
Or rarely, they believe they can profit from acquiring and then dissolving a target in order to reduce competition.
Strategics assume that the enhancements gained by operating synergies or reduced competition will more than pay for their acquisition costs. Particularly if public, Strategics can be further motivated by a belief that the transaction is “accretive.”
That is, if their P/E or EBITDA or sales multiple is higher than the multiple they’re paying for the target, then buying the target will add or accrete to their value more than it cost them to buy it.
This perpetual motion accretion machine drove growth by acquisition back in the days of conglomerates like GE.
(Lots of debate continues over how often acquirers actually realize the value they project from their accretive deals and anticipated synergies.)
Source of Financing
Strategics mostly pay for targets using their own internal resources whether it be cash, or if public, some combination of cash and their own shares.
We’ll focus here on Strategics self-funded transactions rather than ones where they bring on external debt to finance the deal, or ones where they merge with the target.
From $10 million to billions.
Healthy public Strategic buyers might pay with a mix of cash, stock, and a small slice of earn-out. But beware accepting the shares of micro-cap, penny and private company stock due to their volatility and limited liquidity. (Investment bankers can help the seller value those shares.)
And what determines the amount of cash as opposed to how much stock a Strategic might offer? If they’re substantially larger than the target, and aren’t concerned about retaining its management, sellers could see an all-cash offer for 100% of its relevant assets or equity.
But if the Strategic wants the seller’s management to stick around after close, expect more emphasis on an earnout, options and/or stock that vests over some years.
Generally Low. The less reliance on external funding by the Strategic, the lower the deal risk (and the faster the close).
- Among the slowest due to internal politics, and the time the buyer takes to recruit an internal “champion” for the deal, if any. (The more successful Strategic acquirers do engage so-called champions.)
- M&A advisors who represent sellers can also find slow-going just trying to figure out who in the Strategic can make go, no-go decisions.
Strategics often offer the richest multiples due to their expectations of strong synergies with the seller, synergies that they project to jack up cash flow more than either could alone.
And sometimes empire-building CEOs push Strategic multiples even higher, especially when other suitors bid for the target’s hand and goad the CEO’s competitive instincts.
(For a description of how Strategics and others calculate a company’s value, see our HOW TO VALUE A GOING BUSINESS.)
Life After Close
Strategics most often propose a short tenure for the selling owner/operator, from one to one-half years, just long enough to familiarize a successor which is likely already on their payroll.
But not always is seller CEO tenure short. Sometimes, when the Strategic acquires a target to expand into related but new and unfamiliar markets or technologies, it will rely on target management to head up its forays in that novel terrain.
- Culture conflicts can kill deals and later make for unhappy marriages. (For how to avoid that fate and other bad deal chi, see our HOW SELLERS KILL M&A DEALS and HOW BUYERS KILL M&A DEALS.)
- Seller CEOs used to autonomy may chafe under new management oversight and less-than-full operational control.
- The problem of incomplete control can become particularly bothersome when the seller’s earn-out is at stake.
- Finally, Strategics — while pursuing the synergies they paid for — may hand out pink slips to seller’s administrative staff. After all, they typically have idle infrastructure capacity. Some sellers prefer to spare their former employees this fate.
Many owners contemplating eventual retirement find the combination of brief post-sale CEO tenure and relatively high valuation to be irresistible.
A strong fit for older owners looking to exit soon after selling for what is often the market’s best price.
But this assumes they have the patience and time to tolerate a slow deal courtship, due diligence and negotiation pace, as well as puzzle-palace corporate decision-making.
The Private Equity Firm (a “Financial” buyer)
Most PE buyers don’t own companies available to synergize with a target. Instead, they bring money and various ways they think they can sell the target later for a lot more than they spent buying it.
That said, some PE firms look like Strategics. They own “platform” companies that can synergize with targets in “roll-up or “tack-on” M&A transactions. For a definition of these terms and other lingo used in the M&A business, see our FOUNDER’S GUIDE TO M&A AND FUND-RAISING TERMS.)
PE firms use three ways to increase target return on equity (ROE):
- Find companies that will later become targets in a consolidating industry;
- In any case, find companies that show strong ROE potential through:
- Operational enhancements;
- Exploitation of intellectual property;
- Additional funding and economies of scale, or;
- The PE firm’s contacts with potential clients and suppliers for the target.
- Minimize the amount of cash they contribute to the purchase price. We explain how they do this in the Structure section below.
Source of Financing
PE firms attract capital commitments from large investors looking for higher-than-average returns — insurance companies, pension funds, HNW individuals, sovereign funds, even large Strategics. In the PE world, all these investors are called limited partners or LPs.
They make money available to the PE firm on call for the life of a specific PE fund, about five years. During the fund’s life the PE firm must find, buy and resell its acquisitions in order to return the LPs’ money on the fund’s arbitrary schedule.
From $10 million to billions.
- As much leverage as the PE firm can safely project the target to manage.
- The PE firm encourages management performance with a heavy emphasis on earn-outs and Newco carried equity. (Newco is the target’s successor entity.)
Low. Since PE firm LPs are big and legally bound to meet their funding commitment, deal financing risk is Low.
- PE firms are the fastest deal doers around. Smart, experienced people highly motivated to get rich and richer quick.
- Flat organizational structure facilities rapid decision-making.
Can be competitive. especially considering back-end seller compensation when management meets the PE’s exit value expectations. That said, clearly less generous than Strategics for cash payments made up-front at close.
Life After Close
For the target’s owner or competent successor — who’s expected to stay on as manager for up to the duration of the fund’s life — there can be big incentives to win but they come with pressure to perform. Owners looking for a quick exit with no able successor, or contemplating retirement, don’t fit the PE model.
- The team running the former owner’s business must manage the debt the PE firm used to buy it.
- The seller’s company goes back on the market in five years or less. If bought again by a PE, it’s rinse and repeat. (We know a CEO who went through this cycle three times before saying “no mas.”)
- Fair valuation, albeit back-loaded;
- The seller’s CEO stays in operational control post close;
- And that CEO has a shot at a second bite of the apple five years or less down the road.
PE transactions are for younger, energetic sellers — successful entrepreneurs all — looking to harness the connections and potential growth investments of their demanding bosses.
The Family Office (another “Financial” buyer)
Like the PE firm, the Family Office (FO) uses a captive pool of capital to buy operating companies. But there’s a big difference: the cash it invests is its own, not that of LPs.
Funded by one or more wealthy families or even individuals, the FO may hold a company it purchases indefinitely or at least for a long time, 10 years and more.
That’s a very different approach than that used by PE firms who must liquidate their portfolio company investment within a time certain and move on.
FOs traditionally emphasized passive real estate investments but are now increasingly active acquirors of operating companies. They do so to:
- Avoid the fees that PE firms charge to do the same thing and;
- Decide themselves when to sell a portfolio company rather than be compelled to do so on the PE firm’s clock.
RSM writes more about the current state of FOs here.
Slow and steady as she goes, indeed through thick and thin. When considering targets, the FO looks most favorably upon those that demonstrate stable performance.
Contrast this approach with that of Strategics and PE firms who seek targets with strong potential to scale rapidly. Instead, the FO usually regards each target as a stand-alone cash-flowing business.
As above, self-funded.
The FO rarely does deals worth less than $5 million or more than $50 million. Its “bite-size” depends on the depth of its investment pool and its risk tolerance (which is low).
- Pays cash for all target equity or relevant assets.
- Rarely finances deals using bank debt because the FO usually doesn’t need any.
- Offers the target CEO performance bonuses and perhaps phantom stock.
Very Low for reasons cited above.
May move relatively quickly if the chemistry is good but overall, a cautious, highly selective buyer.
Value multiples can be strong and fair but Warren Buffett isn’t known for overpaying.
Life After Close
Keep on truckin’. That is, keep on generating cash. Selling company CEOs often stay on till retirement assuming acceptable post-close performance.
Family offices are far less hands-on than Strategic or PE buyers and only intercede in their portfolio companies if absolutely compelled. In a word, life after close is like working in a family company.
- FO contacts in industry and finance circles are far less developed than those of PE firms. So the managers running FO companies are less likely to attract job offers or acquire much industry visibility compared to those running PE portfolio companies.
- And FO growth goals are also usually much less aggressive. Therefore, the job description for managers of FO companies may not be an optimal fit for young, restless entrepreneurs.
- Can be a great way to “gradually fade away,” as General MacArthur put it, while continuing to build a nest egg as you do.
- Since FOs don’t necessarily have the contacts or urgency to replace average performers, job security can be far higher than at PE firms.
The FO model fits the older executive who values a trauma-free M&A transition for his/her employees. For a sympathetic take on the advantages of selling to a Family Office, see this piece written by one.
Owner/Operators are individual acquirers using their own resources usually in combination with the target’s debt and/or an FDA loan to purchase the target’s shares or assets.
They then take over CEO responsibilities. In contrast to Fundless amateurs (see below), Owner/Operators don’t require funding from third-party equity investors to purchase the target.
Such individuals may be corporate executives seeking a new challenge or entrepreneurs fresh off their last start-up. In the case of veteran corporate execs, they ideally have relevant industry experience. As for entrepreneurs, the seller would want to see a successful track record.
Alternatively, the would-be buyer may be neither of the above, just someone looking for a job with benefits. Caveat the emptor.
In all cases, the seller needs a clear idea of where the funds originate from and with how much certainty. If the deal requires seller paper, exercise extra caution, especially in the case of newbies.
$1 million to $15 million.
Individual buyers almost always need debt financing from some source — preferably a bank or the FDA — that conducts its own independent due diligence.
To the degree seller paper is required, can be High but usually Medium.
Individuals may require less thorough due diligence on their targets than any other buyer type due to their transaction inexperience and — in the case of the former corporate executive – perhaps a whiff of undeserved confidence. Given that, and in-place financing, deal closing speed can be Fast.
May be all over the map again because of inexperience and/or lack of resources. Weak resources drive up acquirer’s price sensitivity.
Life After Close
Either through eagerness to take the reins or hubris, the acquiring CEO often wants to move in quickly and may feel the former CEO stands in the way of needed change. The accomplished entrepreneur is likelier to be more collaborative and place more value on the selling CEO’s experience.
Primarily, inadequate or risky deal financing. Secondarily but related, successful corporate executives don’t necessarily make successful small business operators. That can mean a decline in the target’s value post-close and a default on the seller’s paper.
Individuals may be the best – or even only – acquiror for businesses too small to attract Strategics and Financial buyers.
As with Fundless Sponsors (again see below), the burden of due diligence falls on owners who sell to individual owner/operators.
The Insider (MBO/ESOP)
Employees acquire their employer’s stock or assets by:
- Either raising cash by laying on the company a big chunk of bank debt (MBO) or;
- Setting up a mechanism whereby employees buy the company using a combination of earn-out and indebtedness to the owner (the ESOP or employee stock ownership plan) or;
- Combining both in a so-called “leveraged ESOP.”
Insider acquisitions are a satisfying way for exiting owners to reward loyal employees. In LBOs, the owner could also see a quicker departure than that offered by any other buyer type. That’s because the managers staying on are already well up to speed.
A combination of employee cash, seller note and sometimes external debt.
Because setting up and maintaining an ESOP requires expensive advisors, that fixed overhead means the target needs at least 15 employees. More comfortably it’s 20 plus. For a similar reason, MBO’s are generally priced at $5 million and more.
Complicated enough you’ll need about $100,000 to set the ESOP up and if you require external debt financing, add another $20,000 to $30,000. Trustee fees cost about $30,000 more for a total of about $150,000.
But you’re not done yet – you’ll see another $5,000 or more per year in ESOP maintenance till the deal’s done. See this National Center for Employee Ownership article for an itemized totaling up of ESOP expenses.
Believe it or not, tax breaks can make all this expensive jumping over IRS hoops worthwhile.
- Assuming the ESOP plan is thoroughly vetted, Low.
- Medium risk for LBOs, especially in the first few years post-close when nearly all free cash flow goes to lenders, like paying down a mortgage.
- For LBOs, figure about six months;
- For ESOPs, the sale of stock to employees can extend over years, though sellers see tax advantages in moving things along. See BDO’s ESOP article for more detail.
- In order to qualify for favorable tax treatment, which makes ESOPs attractive enough to work, the deal must be priced at “fair market value “ (FMV) — something that’s estimated by third-party consultants.
- In MBOs as well, the target’s debt capacity must equal most of what the selling owner demands. If not, the acquiring team’s ability to contribute cash — even when combined with seller paper and the target’s debt capacity — may not be enough to satisfy seller’s needs.
Life After Close
Both MBOs and ESOPS preserve pre-close management teams, though to allow MBOs and leveraged ESOPs to succeed may require cost-cutting, e.g., terminating some employees.
- From the owner’s perspective, if the MBO’s debt proves too much for the surviving management team to manage, a messy default could follow. That could have the owner called back into managing the company as its largest creditor.
- For ESOPs, the risk of default is much lower. However, as noted above, completing the sale of all ESOP equity commonly takes years.
- Both Insider deals may not generate the highest valuation since there’s no investment banker marketing the company to Strategics whose synergy aspirations could exceed so-called “fair market value.”
Both types of Insider deals offer a high level of continuity and a way for the owner to say “thanks” at least to those employees who stay on post-close. Depending on whether the Insider deal is an MBO or ESOP, the owner can exit quite fast or very slowly according to taste
For owners who wish to deal with the “devil they know,” Insider transactions are comparatively stress-free for two reasons:
- What defines “fair market value” (FMV) and the company’s debt capacity isn’t up for negotiation between buyer and seller. Those numbers are largely in the hands of outsiders (lenders and ESOP consultants as the case may be). The deal’s gears either mesh or they don’t.
- Since the employee acquirors know the company intimately, the selling owner is spared most of the rigors of delivering tedious due diligence data and only retains minimal liability for the customary seller representations and warranties.
For more ESOP detail see this National Center for Employee Ownership’s informative article.
The CEO-in-Residence (aka Entrepreneur-in-Residence) is an accomplished industry executive that a PE firm pays to find and help acquire a company, then run it.
Back a winner in an industry that the PE firm earlier identified as promising.
See PE firm.
See PE firm.
See PE firm.
While PE firm financing risk is low, recall that the CEO-in-Residence must convince the partners at the PE firm to invest. Net result? Perhaps Medium financing risk.
For the same reason, deal speed may be Medium rather than Fast.
See PE firm. But keep in mind that the usual PE deal assumes the selling CEO stays on board.
Life After Close
CEO-in-Residence deals expect the selling CEO to exit quickly, perhaps in six months or less. After all, the idea is that the PE firm’s CEO-in-Residence will assume operating control shortly after target purchase.
- PE firm decides to pass on the deal. If the deal does close, there’s no earn-out or equity roll-over for the target’s CEO. That means a lower purchase price than if the seller’s CEO stayed on.
- On the other hand, that CEO isn’t much interested in those inducements anyhow.
- Offers among the fastest exits available, faster than selling to a Strategic.
- Also, the CEO-in-Residence becomes the deal’s champion, taking that sales job pressure off the selling owner.
- Quick post-close disengagement.
- But at a price — no upside if the company reaches goals after sale.
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:
- Loose ad hoc affiliations of HNW individuals form Search Funds rather than PE firms with established offices;
- Search Fund investors sponsor younger, less experienced entrepreneurs than CEOs-in-Residence.
- To give you a flavor of what Search Fund entrepreneurs are like, know that a business school professor created the first such Fund to finance the aspirations of several of his students. See the story here.
- Obviously, sellers to the would-be entrepreneurs of Search Funds must tread carefully if a large chunk of deal value is tied up in their future performance.
- Search Funds have much less money to spend.
The Fundless Sponsor
Fundless (aka Independent) Sponsors first find targets, then find investors to acquire them. There are two types of such 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 commitments. 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 can do so as well, but they often prefer a salary and some equity as CEO of the target post-close.
- Professionals know the target and its industry well, have strong investor connections, and can act as an advisor to the target post-close. For this, investors reward them with carried interest, target equity, and board fees. Professionals don’t seek to run target companies but rather move on to the next target 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.
$1 million to $15 million.
Medium for professionals, High for amateurs.
Medium for professionals, Slow for amateurs
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.
Fundless Pros can deliver services similar to those offered by sell-side investment bankers in that they market targets to investors. The 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.
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 investors fees, reducing the seller’s net further.
- May not market the seller as thoroughly and effectively as an investment banker since they may only contact a handful of their “go-to” investors or ones who pay them the highest fees.
And Fundless Amateurs:
- Frequently fail to close;
- Can tarnish the seller’s reputation and disclose proprietary information with indiscriminate and, well, amateur marketing.
In general, with Fundless Sponsors proceed with caution, especially so when dealing with the Amateur version. To help predict whether an individual without extensive entrepreneur experience could be successful as a Fundless Amateur, see our CHARACTERISTICS OF A SUCCESSFUL ENTREPRENEUR.
The Bottom Line of Bottom Lines
Rich pricing and a quick exit can reward those with patience and a tolerance of sometimes quirky corporate cultures. Just don’t place much weight on earn-outs or multi-year stock vesting schedules.
The Private Equity Firm
You’ll see an acceptable pay-out at close and a handsome reward if you work hard and effectively as CEO over the next three to five years.
The Family Office
Nice pay-out at close and a secure, relatively stress-free job going forward. Not necessarily a fit for the young, ambitious CEO.
Say thanks to loyal employees while earning fair market value for the business. Avoid the pressure and hassles of selling to a third-party. But beware the company debt that MBOs require and how much time ESOPs take to close.
These would-be-CEOs have PE backing but they’re not deal decision-makers. Yet if the PE firm does commit, things will move quickly, including a rapid exit for the selling CEO. That said, know that sellers to CEOs-in-Residence will not participate in the potentially rich post-close incentives that PE firms typically offer portfolio company teams.
Given the right track record and financial resources, an owner/operator can be the small business owner’s best exit. Otherwise, not so much.
The Fundless Sponsor
“Professional” Fundless Sponsors do some of what you could hire a competent investment banker (IB) to do and they won’t charge a retainer. (See a description of what IBs do here.)
But they cost at close more than an IB and you may see a lower valuation due to their limited marketing.
“Amateur” Fundless Sponsors may be viable given no stronger candidates, but sellers need be aware of the risks of accepting seller paper and lack of Amateur operating experience.