Note: The “Tale of Two Deals” series explores different aspects of two deals that we closed recently in the same week.
The world is rarely black and white, but with the two deals, one went to a strategic buyer that practically defines the term strategic, while the other went to a financial buyer, a classic private equity group with a dedicated fund and intelligent, professional management.
The Strategic Buyer
WETLabs, Inc. makes underwater instrumentation to detect vital biological and chemical parameters in oceans and lakes. This is a very active area, and it is expected to have a healthy growth rate because of the global concern about the environmental state of our oceans, lakes and streams. It turns out there are some very large companies that are building a foundation for water quality testing and measurement. The companies that were most interested in WETLabs were very large companies that already had other types of water quality testing and measurement systems, or complementary technologies such as the underwater vehicles that carry the sensors.
The successful bidder was one of those companies – a multi-billion company that fit every definition of a strategic buyer. This strategic buyer felt they could both increase revenue by using their complementary products and services, and also decrease cost by using their purchasing muscle and manufacturing knowledge.
So first question that many will ask is: “Did they pay more than a financial buyer?” It is a little hard to say because the potential and growth rate would command a good price even from financial buyers, but yes, this buyer likely paid more than a financial buyer would have.
HOWEVER, a common myth is that the strategic buyer isn’t buying financial performance and doesn’t pay much attention to the financials. This was the perfect strategic buyer, they just don’t come any better, and yet this buyer was focused on the financials throughout. Make no mistake, it is all about the earnings, even with a strategic buyer. They may be looking at future earnings that are hard to conceptualize at the time, but it is all about the earnings.
While we are negotiating price with the strategic buyer, the smart ones are not saying, “Gee, we REALLY want this business so let’s pay more”. They are running their financial models and calculating return on investment, and figuring out how much they can pay. For some strategic buyers this means they can pay more than a financial buyer, but in some cases it means they will pay less. They know too much!
The strategic buyer is looking at the financials, but is also looking at the synergies. This can result in a very busy due diligence period (when the buyer can come in a take an open-book look at the business). Whereas a financial buyer usually leaves things pretty much as they are, a strategic buyer typically has to answer a lot of questions. Here are a few:
– How will the sales teams work together?
– How will the employees be paid in the short term and the long term, relative to the new company’s policies?
– How will sick time, vacation time and health insurance change, if at all?
– If there is a plan to increase gross margins, how will this actually happen?
– Are there any overlapping products, customers or competitors?
We try to offload as much work as we can to resolve these issues for the business owner, but it still takes an enormous amount of time. As compared with the financial buyer deal we did, there were more trips and meetings, and more of the seller’s employees involved with the strategic deal.
In contrast to a financial buyer, which can be thought of as a partner that can lend financial and management assistance, WETLabs found a home, an organization that has vast resources and complementary products and services.