HR & Management

Selling your business: A guide to institutional (or financial) buyers

8 min read

07 October 2015

What are the advantages of selling to an institutional buyer? What does it mean for the founder?

As the plan for the sale of your business develops, it’s important to grasp some of the key concepts associated with different type of buyers. The ability to assess different buyers provides a focal point around which to develop an effective strategy for selling your business.

Trade (or strategic) buyers aim to grow their business by realising synergies with newly acquired assets (i.e. your company). The advantages they can offer sellers are numerous – they tend to value potential purchases on the basis of what they could contribute to their existing operations, and are happy to pay a premium for that.

Institutional buyers are investors who pool their finances together in order to grow through acquisitions. Their goals typically involve growing their portfolio of companies through leveraging assets, investing capital, increasing efficiency or implementing extra financial discipline, in order to make a return on it from a buyer later down the line.

Your company’s value, finances and projections

Whereas trade buyers look for synergies and the return they can achieve by incorporating a company’s assets into their existing operations, institutional (or financial) buyers are generally interested in the direct return they will see by acquiring an existing business.

They are not as interested in its future potential for expanding future cashflow opportunities, as they are in its value, finances and projections at the point of sale. While this might seem a ‘colder’ approach, this model of buyer could have a lot to offer.

A trade buyer will tend to value your company higher than an institutional buyer; they will also often be more personally invested in your company’s future due to their direct involvement in the industry. However, they aren’t the answer to every situation. Selling to an institutional buyer can be hugely advantageous, given the right circumstances.

In their article Strategic Buyers vs Private Equity Buyers in an Investment Process, Vild and Zeisberger begin with a basic problem. Traditionally, trade buyers were seen to be significantly advantageous over institutional buyers “due to their ability to share with the sellers a portion of the value generated by the post-acquisition synergies.”

However, in recent years, this has reversed: institutional buyers, and particularly private equity investors, have become “potent competitors”. Given that the ‘synergy’ argument (ie that trade buyers will pay more than private equity groups) appears valid, they seek to explore and explain this phenomenon in detail.

The article offers a number of important insights into why this phenomenon has occurred.

Although fundraising is the core challenge of any private equity firm, Vild and Zeisberger argue that this imposes financial discipline on the buyer themselves. “…it does not ensure that [institutional buyers] can regularly bid higher than strategic investors , but it helps [them] to proceed smartly and win deals in which they are more likely to generate value for the limited partners.”

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The necessary financial discipline of an institutional buyer, while in some ways a disadvantage, actually benefits the buyer in bidding and negotiations. This in turn can be a boon to a seller.

Less exposed

Similarly, institutional buyers might not be as deeply exposed to the industry as a trade buyer, which might be a cause of concern for some.

However, they are able to compensate for this through their rigorous financial analysis skills, as well as their resources: private equity firms have a “desire to learn” about the company and the industry, and an “ability to conduct efficient due diligence” throughout negotiations, something that a trade buyer may find difficult given their direct involvement and stake in the industry, as well as their current business interests.

Put simply, institutional buyers are potentially more materially capable of seeing the forest for the trees due to their detachment from the industry itself.

“Typically, financial buyers are extremely sophisticated in terms of deal structure and diligence,” writes PwC in a report. “In order to achieve their targeted investment returns, they will generally finance the acquisition with significant leverage (ie additional debt). As a result, they are more sensitive to issues such as management quality and depth, sustainable EBITDA (earnings before interest, taxes, depreciation, and amortisation), and free cash flow.”

What is your exit strategy?

The choice depends on your sale plans and exit strategy. Selling to a trade buyer will usually involve relinquishing any control or involvement in the company, as trade buyers generally seek to put their own teams and directors in place.

However, if this doesn’t align with your exit plans (if you want to sell most of the company and take a step back, but still want to be involved in some capacity) institutional buyers can give you the opportunity to remain involved in the business as a stakeholder.

Kevin W. Bader, an associate at MelCap Partners, LLC, explains: “Many times in a leveraged buyout, financial buyers will require that they have a controlling stake in the business. However, there’s often an opportunity for the seller to co-invest back into the new business alongside the buyers, in effect rolling over some of the equity.

“If the investment is successful, the seller has a portion, usually a minority stake, which gets sold down the road. We call this a ‘second bite at the apple,’ and it can be a very powerful wealth creation opportunity for the seller.”

As highlighted in a Mercer Capital article, while a financial buyer may have the means to purchase a company, they do not necessarily have the expertise to run the business.

As such, financial buyers will usually welcome management to stay and manage the business, and often they will require it as a component of the deal. More and more deals are being structured where part of the consideration paid is tied to an “earn-out” where the seller will receive additional money if certain, predetermined goals are achieved in the first few years following the sale.

David Falzani is president of Sainsbury Management Fellows.