Your Best Acquirer

By Ryan Kuhn, founder of Kuhn Capital, an M&A advisor to mid-market technology companies.

This article describes the eight types of acquirers. They differ in which companies they target, how they structure deals, how quickly they close, how certain their financing is and what life is like for sellers after close. We’ve ranked them roughly by deal size, from largest to smallest. One of them fits your business. Don’t waste time or risk disappointment by soliciting the wrong type of acquirer.

Types of Acquirers

Click a buyer type in the table below to jump to its section, or read them all for a full picture of who buys mid-market companies:

Note that distinctions between types can blur.

Acquirer Characteristics

For each acquirer type, we cover the following:

For a side-by-side comparison of all eight types, see the summary tables near the end of this article.

1) The Strategic

Description

Strategic buyers are operating companies that use M&A to move pieces around their business chessboard. Their logic: buying growth and margins can be faster and cheaper than building them internally, or “organically.” They typically want access to new products, technologies, or customers. Occasionally, they’ll buy a direct competitor to ease pricing pressure or eliminate a threat altogether.

Buyer Rationale

Strategics rely on synergies (economies of scale, shared costs, and new revenue streams) to hit growth goals. If they’re public, many also believe buying a target at a lower valuation multiple than their own will make the acquisition “accretive,” meaning adding the target’s earnings will raise earnings per share. Example: they buy a private target for 5x EBITDA while the stock market values their business at 10x EBITDA.

Source of Financing

For comparatively smaller deals, Strategics usually fund acquisitions with cash, stock, or a mix of both. For much larger deals, they access debt.

Deal Size

From $10 million to multi-billion.

Deal Structure

In addition to cash, stock, and/or debt, Strategics sometimes add an earnout to reduce cash at close and to encourage the seller’s management to stay with the company longer after close. But earnouts aren’t without seller risk, as explained in Earn-outs: The Owner’s Guide. Lastly, note that accepting stock from micro-cap or private buyers entails volatility and liquidity risks. M&A advisors can help with the tricky task of valuing such shares.

The good news: large Strategics that don’t need to retain target management often offer more cash at close than any other buyer type.

Financing Risk

Generally low. The less a Strategic depends on outside funding, the lower the risk, and the faster the close.

Deal Speed

Even with funding in place, Strategics can close the slowest due to internal politics and complex approval processes. Another factor that slows deal closing with Strategics is simply the difficulty some sell-side M&A advisors may have in determining who the Strategic’s decision-makers are.

Valuation

Strategics have traditionally offered the richest acquisition multiples because they expect synergies with the seller, but recently, PEGs have become more competitive as they dig deeper into ways to improve target efficiency and build platforms for economies of scale. That said, sometimes ambitious Strategic CEOs push those multiples even higher. For a description of the techniques that Strategic acquirers use to value targets, see my article How to Value a Business.

Life After Close

If a Strategic already has a successor lined up, the selling CEO may be offered a brief tenure: six months or less. But sometimes they want the target company’s management to stay long enough to teach them how to navigate new markets or technologies.

Downsides?

• Culture conflicts with Strategics can kill deals or make for unhappy marriages. (To skirt that fate, see The 7 Deadliest Ways M&A Buyers Kill Deals and Avoid the 5 Ways Business Sellers Kill M&A Deals.)
• Seller CEOs may chafe under new oversight and operations controls. This can be particularly frustrating for sellers trying to meet earnout targets.
• Finally, Strategics, in pursuit of the synergies they paid for, often fire the seller’s administrative staff, especially the CFO.

Upsides?

Many owners nearing retirement find strategic buyers the ideal M&A partner: they often offer a brief post-sale CEO tenure and a cash-rich deal structure.

Bottom Line

Older owners looking to exit quickly with a lump-sum payment will often find Strategics to be their best acquirer. But M&A advisors will testify that Strategics can move slowly, may engage in puzzle-palace decision-making, and make unnecessary due diligence demands, all characteristics of those with little M&A experience or those based overseas.

2) The Private Equity Firm or PEG (a Financial Buyer)

Description

Financial buyers fall into two categories: PEGs and Family Offices (FOs). Unlike Strategics, Financial acquirers don’t usually have operating businesses to synergize with their targets. Their focus is on structuring financial transactions.

PEGs also intend to sell the target within about five years for a strong ROI. FO acquirers work differently, as described below.

Yet some PEGs walk and talk like Strategics because they own a “platform,” a company that can synergize with a target in “roll-up” or “tack-on” transactions. (For definitions of terms like “roll-up,” see The Founder’s Guide to M&A and Fund-Raising Terms.)

Buyer Rationale

To increase target ROE, PEGs seek companies that will later become a Strategic target in a consolidating industry and that promise:

• Operational enhancements
• IP exploitation
• Economies of scale
• Synergistic relationships with the PEG’s other portfolio companies’ clients and suppliers
• A purchase structure that features minimal PE cash (most cash at close comes from lenders). See how that works in the Deal Structure section below.

Source of Financing

PEGs attract capital commitments from large investors, including limited partners (LPs) such as insurance companies, pension funds, high-net-worth (HNW) individuals, sovereign funds, and large Strategics. LPs commit to one of a PEG’s discrete funds, typically with a five-year investment period and a total ten-year life. During the investment period, the PEG acquires targets, then sells them over the remaining years.

Deal Size

Also $10 million to multi-billion, but skews toward $20 million to $300 million EV.

Deal Structure

• As much leverage as the PEG estimates the target can safely manage.
• Minimal cash at close, achieved by having management roll equity into the new entity (often 10% to 30% of Newco) and by using performance-based components.

Financing Risk

It’s low at close because LPs are big and legally bound to meet their funding commitments, and because PEGs typically know how to engineer debt-heavy balance sheets. Sometimes, though, they load on too much debt, devaluing the management team’s equity.

Deal Speed

• PEG teams typically move quickly because of their experience and streamlined internal approval processes.
• A PEG’s flat organization facilitates rapid decision-making.

Valuation

Competitive when you factor in the seller management team’s compensation, provided they meet the PEG’s exit-value expectations. That said, PEGs can’t compete with Strategics for cash at deal closing.

Life After Close

For the target’s management team, performance incentives can be generous. But they come with pressure and risk. Owners looking for a quick exit don’t fit the PEG model.

Downsides?

• The team running the target must manage the debt the PEG took on to acquire it.
• The target gets sold again in about five years, then possibly again, and again.
• PEGs will fire underperforming management team members, albeit reluctantly.

Upsides?

• Fair valuation, albeit back-loaded.
• The seller’s CEO stays in operational control post-close.
• The target’s management team may get a second bite of the apple.

Bottom Line

PEGs close fast and offer deal structures with upside. That can make PEGs an attractive fit for energetic, typically younger, successful entrepreneurs seeking to leverage the connections and guidance of their demanding bosses.

3) The Family Office (Another Financial Buyer)

Description

Like the PEG, the Family Office buys targets with a captive pool of capital. But one key difference: the cash FOs invest is their own, not that of a PEG’s limited partners.

Funded by HNWs or multiple families, FOs often hold acquisitions long-term (ten or more years), unlike PEGs, which hold for about half that. FOs are also more likely to buy minority equity, while PEGs almost always want control.

FOs have traditionally focused on real estate but increasingly acquire operating companies. They seek to avoid PEGs’ limited-partner fees and to decide for themselves whether to sell a portfolio company. For more about today’s FOs, see RSM’s outlook for family office investors.

Buyer Rationale

Slow and steady as she goes. FOs look for targets with stable stand-alone performance. That is, they rarely buy platforms and then add other acquisitions that synergize to lower unit costs.

Source of Financing

As above, self-funded.

Deal Size

Roughly $5 million to $50 million EV, with some going higher. More than other acquirers, an FO’s equity “bite size” varies widely depending on how much cash it has on hand and how much risk it can tolerate.

Deal Structure

• Pays cash.
• Rarely uses bank debt because FOs usually don’t need it.
• Grants CEOs performance bonuses, sometimes phantom stock.

Financing Risk

Very low.

Deal Speed

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

Valuation

The acquisition multiples FOs pay can be fair, but like Berkshire Hathaway, 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 remain in their roles until retirement. FOs are far less hands-on than Strategics or PEGs and only step into portfolio company operations when forced. In short, target CEOs’ lives after the close are like working in a family company, because that’s what their companies become.

Downsides?

• FO-owned companies are less visible than PEG portfolio companies, which participate in wide industry and finance networks. As a result, executive recruiters rarely approach FO CEOs, potentially narrowing a seller-CEO’s future career options.
• The FO CEO job description may not fit young, restless entrepreneurs.

Upsides?

• Selling to an FO is a great way to “gradually fade away” while building a nest egg.
• Since FOs don’t necessarily have the contacts or urgency to replace underperformers, and many loathe change, job security is higher than usual.

Bottom Line

The FO model is a strong M&A fit for business owners who value long-term stability and a drama-free transition. For a positive spin on the advantages of selling to an FO, see this piece written by one.

4) The CEO-in-Residence

Description

CEOs-in-Residence (also known as Entrepreneurs-in-Residence) are accomplished industry executives whom PEGs retain to identify, help acquire, and run a portfolio company.

Buyer Rationale

The PEG is backing a proven executive in an attractive industry.

Source of Financing

See PEG.

Deal Size

See PEG. Often $20 million to $200 million.

Deal Structure

See PEG.

Financing Risk

PEG financing risk is generally low, but the CEO-in-Residence still needs partner approval, so net risk is medium.

Deal Speed

For the same reason, deal speed may be medium rather than the PEG’s usual fast.

Valuation

See PEG. Note that the CEO-in-Residence replaces the selling CEO, so the seller typically gets no earnout or rollover equity package.

Life After Close

Most PEGs expect their CEO-in-Residence to assume full management responsibility about three months after close.

Downsides?

• If the PEG passes on the deal, the CEO-in-Residence moves on, leaving the seller without competing bidders: “All dressed up and no place to go.”
• No rollover equity for the seller, so no share in future upside.

Upsides?

• Probably the fastest exit after close for target owners.
• No finder’s fee.
• Low risk of disclosure that the seller is “in play.”
• The CEO-in-Residence champions the deal, freeing the seller to focus on other matters, such as planning a transition.

Bottom Line

• Some risk that the CEO-in-Residence can’t convince the PEG to buy, and that an M&A advisor-managed sell-side campaign would have fetched a higher price.
• Rapid exit.
• No second bite of the apple if the target reaches post-close goals.

5) The Search Fund (Cousin to the CEO-in-Residence)

Description

Traditional Search Funds commonly acquire targets priced between $5 million and $40 million. Like PEGs with CEOs-in-Residence, they compensate entrepreneurs to search for and complete due diligence on targets.

But Search Funds:

• Are backed by a loose affiliation of HNW investors, unlike institutional PEG funds.
• Sponsor less experienced entrepreneurs, typically recent business school graduates. The model originated at U.S. business schools in the 1980s.
• Often have would-be CEOs who lack operating experience, so sellers should exercise caution when providing deal financing or retaining minority equity.

6) The Fundless Sponsor

Description

The Fundless Sponsor (aka Independent Sponsor) finds targets, then seeks investors to buy them. After that, the sponsor manages the target under a compensation arrangement similar to those PEGs use for portfolio company managers. There are two varieties of Fundless Sponsor. The first we’ll call Pros: operators who have successfully run similar businesses in the past and have established investor connections, even if those investors aren’t legally committed like PEG limited partners. For more on Pros, see how independent sponsors differ from traditional private equity buyers.

The second type we’ll call Amateurs: they have little or no relevant industry experience and a weak or nonexistent investor network. For more on Amateurs, see this definition of a fundless sponsor.

Buyer Rationale

Pros know the target’s industry well and may have the personal financial capacity to fund a meaningful portion of the purchase price. Amateurs are young and have limited personal funds to invest. But they are also energetic advocates for the target among investors.

Source of Financing

Investor equity plus senior and mezzanine debt, raised deal by deal.

Deal Size

Highly variable, typically $5 million to $30 million, rarely as much as $40 million.

Deal Structure

Investor equity plus senior and mezzanine debt, arranged deal by deal. Sponsors often ask the seller to carry a note or roll over some equity to close the funding gap.

Financing Risk

Medium for Pros, high for Amateurs.

Deal Speed

Medium for Pros, slow for Amateurs.

Valuation

Medium for Pros. Low, but highly variable, for Amateurs.

Life After Close

Both Pros and Amateurs are likely to move into target management quickly: the Pros’ speed is driven by experience, the Amateurs’ by eagerness.

Downsides?

• They can cost the seller more in total fees than an M&A advisor, since they may charge both sellers and buyers for success.
• They won’t widely market the company to acquirers. They tend to seek only investors willing to let them run the companies they find.
• If the Sponsor approaches investors indiscriminately, the seller’s availability is more likely to become widely known.
• Fundless Sponsors provide the seller with only a limited subset of the services sell-side M&A advisors offer, even though both act as intermediaries.

Upsides?

• Sponsors typically don’t request retainers. Although some may seek a seller-paid finder’s fee, investors usually compensate them in cash or target equity.
• They take the reins quickly after closing.

Bottom Line

In general, proceed with caution when dealing with Fundless Sponsor Amateurs, and recognize that while they may look like M&A advisors, they’re not.

7) The Owner/Operator

Description

Owner/Operators (O/Os) usually use their own money, plus debt collateralized by the target, to finance their acquisition. Post-close, they become the target’s CEO.

Buyer Rationale

Such individuals may be retired corporate executives looking to run a business or entrepreneurs fresh off an exit. Ideally, veteran corporate executives have relevant industry experience. If the acquirer is an entrepreneur, the seller would want to see a successful track record.

Source of Financing

With the O/O, sellers need a clear understanding of the funding source and how certain it is. 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 SBA. The good news is that these lenders conduct their own independent due diligence, so if the buyer can’t close the needed loan, the seller probably needs to move on.

Financing Risk

Usually medium, but can be high depending on the amount of seller paper.

Deal Speed

O/Os often require less thorough due diligence on their targets than any other buyer type, due to modest transaction experience or, as may be the case with a former corporate executive, undeserved confidence. Given that, and the availability of leverage, O/Os can move fast.

Valuation

All over the map, depending on experience and resources.

Life After Close

Either through eagerness to take the reins or hubris, O/Os sometimes want to move fast after close. That’s acceptable if the seller’s compensation doesn’t depend heavily on seller paper or an earnout.

Downsides?

First, the deal may have a risky financing structure. Second, successful corporate executives don’t always make successful small-business operators.

Upsides?

O/Os can be the best, even only, buyers of businesses too small or too “hairy” to attract traditional Strategics or Financial buyers.

Bottom Line

With O/Os, the seller bears the due diligence burden.

8) The Insider (MBO/ESOP)

Description

Employees acquire their employer by:

• Borrowing against the company’s value to buy it (a management buyout, or MBO); or
• Selling shares to an employee stock ownership plan (ESOP), a trust usually financed by a seller note, a bank loan or both (a “leveraged ESOP” when it borrows).

Buyer Rationale

Insider acquisitions let exiting owners reward loyal employees. MBOs can also offer owners the quickest post-close exit because the managers staying on are already up to speed.

Source of Financing

Bank debt and seller notes, plus, for MBOs, the managers’ own cash.

Deal Size

Because of high advisory fees, MBOs and ESOPs are most cost-effective when the target is valued at $8 million or more. Given the complexity of setting up an ESOP, companies with fewer than 20 employees or less than $3 million in EBITDA struggle.

Deal Structure

Setting up an ESOP generally costs at least $125,000, and $200,000 to $500,000 for most deals, excluding the purchase price. After that, expect ongoing costs in the tens of thousands of dollars a year: a required annual valuation, plan administration and, if you use an outside trustee, trustee fees that the National Center for Employee Ownership puts in the mid-five figures. See this NCEO article on whether a company is too small for an ESOP. Believe it or not, tax incentives can make the ESOP’s infamous red tape worth it.

Financing Risk

• Low for ESOPs, assuming the plan is thoroughly vetted (which they usually are).
• Medium for MBOs, especially in the first few years post-close, when debt eats up most of the cash flow.

Deal Speed

• MBOs take about six months to close.
• For ESOPs, selling stock to employees can extend over years.

Valuation

• To obtain the tax treatment that makes ESOPs attractive, the deal must be priced at “fair market value” (FMV) by an independent appraiser.
• In MBOs, the target’s debt capacity must meet most of the seller’s 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. But for MBO and leveraged ESOP deals to work, management may have to cut staff.

Downsides?

If the MBO’s debt becomes too much to manage, a messy default could put the company’s assets back in the seller’s lap. For ESOPs, the default risk is much lower. However, for employees to buy all ESOP equity from the owner typically takes years. Both Insider paths may not maximize value, since the owner typically doesn’t run a broad marketing process. That is, Strategic or Financial buyers might offer more than an appraiser’s calculation of “fair market value.”

Upsides?

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

Bottom Line

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

• Buyers and sellers don’t have to haggle over fair market value (FMV) or the target’s debt capacity, since lenders and ESOP appraisers quantify those. The deal either works or it doesn’t.
• Because the acquirers (the target’s employees) know the company intimately, they have far less concern about due diligence and seller reps and warranties.

For more details on ESOPs, see this informative article from the National Center for Employee Ownership.

Side-by-Side Comparison

In Sum, Key Differences Among Buyer Types

• Strategics offer very low deal financing risk and the highest cash proportion of deal value.
• PEGs also offer relatively low financing risk and competitive valuations, but they tie a substantial portion of the purchase price to the seller team’s future performance through rollover equity.
• Owner/Operators bring transaction simplicity but greater deal-financing and post-close operating risk unless they’re experienced and well-funded.
• Insiders and Fundless Sponsors can also pose higher financing risk, but may still close a sale when other buyer types are scarce.

We developed these eight acquirer descriptions to help mid-market business owners focus on the buyers most likely to match their business and unique personal circumstances.