Selling Your Business to a Strategic Buyer or Private Equity Group – Which is Better?

The classic take on whether you should sell your business to a Private Equity Group (or PEG) says that you will be able to negotiate a better deal with a “strategic” buyer than with a “financial” buyer. The reason is quite simple:  A strategic buyer will pay more.   The thinking is there will be synergies between the buyer and the seller which will translate into a higher return on investment (ROI) for the strategic buyer.  The higher ROI will justify a higher price.  The common opinion about PEGs is they are merely “financial” buyers; this means they cannot take advantage of buyer-seller synergies. Therefore, the theory goes, PEGs will always pay less.

This kind of thinking may have been valid five or ten years ago, but it is somewhat outdated in today’s merger and acquisition (M&A) environment.

First of all, there are synergies that PEGs can take advantage of to create shareholder value – and thus support a higher purchase price than with a strategic buyer.  These may not be the typical synergies that one thinks of when one company buys another, but they exist nonetheless.  For example, PEGs can contribute things like cash and management expertise to help their portfolio companies take advantage of growth opportunities. This creates shareholder value and increases ROI. 

Just the fact of having cash available in this current economic environment can also tip the scales toward the Private Equity buyer.  Many strategic buyers are in a survival mode, so the recent trend for them is to divest noncore divisions and product lines rather than to spend lavishly on acquisitions.  Although some high profile companies like Cisco and Google are sitting on mountains of cash available for acquisitions, most companies are cash poor right now.  

Unlike strategic acquirers, Private Equity Groups are sitting on a sizable war chest of cash.  According to an Ernst & Young report, PEGs currently have between one half of a billion and one trillion dollars in available cash to invest in buyouts and other transactions.  For more information on this, please see my post titled, “Private Equity in 2010 – An Optimistic Outlook.” I have seen a number of transactions where the price offered by a PEG was less than the offer made by a strategic buyer, but the higher cash component of the PEG’s offer made it the more appealing option for the seller. 

The most compelling change over the last few years is that many Private Equity Groups are no longer pure financial buyers.  These days they act more like strategic buyers, because they are strategic buyers.  In most of the private equity transactions that I have been involved in recently, we were able to identify a private equity group with a portfolio company in the same or a similar industry as the seller.  We had a buyer – the portfolio company – that could take advantage of all the synergies that a strategic buyer could. As well, we had a buyer – the Private Equity Group – that was able to provide the necessary funding to close the transaction in a short period of time and with a minimum amount of hassle. 

So selling your business to a Private Equity Group with a portfolio company in the industry rather than to a strategic buyer will usually be the better choice for most sellers.  In my opinion, this type of acquirer can offer a seller the best of both worlds.