Why strategic investors pay more

John Wagner - working capital peg

Acquiring new leadership

In the broadest scope, there are really only two types of acquirers for your business: 1) strategic acquirers that will fold an acquisition into their existing operations, with an aim to achieve synergy, and 2) non-strategic acquirers that are buying a company simply to enjoy the cash flow of a portfolio company. This second category of acquirer, the non-strategic type (often a private equity group) can easily become a strategic investor if they acquire, say, a collection of retail outlets, and treat them as a “platform” on which to build. They might add “bolt-on” companies, like a distribution company, or a lumber mill, or a plant to produce decking, siding, or roofing.

Why draw a distinction between these two types of acquirers? The reason is that they pay different multiples of EBITDA when making the acquisition. The strategic acquirer will typically pay a 1X higher multiple of EBITDA than a non-strategic. (We will look at the value implications of that in a minute.)

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When our firm engages a client, we are always working for the sellers seeking to be acquired. In the parlance of the industry, that’s what’s called a “sell-side rep,” and any sell- side rep worth their salt will run an analysis early-on to estimate the value of the company they are taking to market. (This is done as much to set expectations of the seller as it is to establish an acceptable target range of what to expect from an acquirer.) That valuation estimate typically means searching a database of recent deals to see the con- temporary multiple of what’s been paid for similar companies. (Our firm subscribes to GF Data for this deal information; there are many other similar services.) When we look at the multiple of EBITDA recently paid in an acquisition, we always add 1X to that figure if the buyer is a strategic acquirer.

The strategic acquirer will pay more simply because they see an immediate opportunity to leverage the new acquisition to accelerate growth, leverage synergies, and basically make more money with the conjoined operations than these companies can make working independently. For example, it only stands to reason that a deck manufacturing company might see the potential synergies—e.g. higher margins, cut- ting out the middleman—if it were to buy a series of decking outlets stores, where they can offer their house brand. That’s a classic strategic acquisition. Next, the deck manufacturer that owns the retail outlets might see a compelling reason to own a trucking and logistics company, which would obviate the next natural acquisition of…well, you get the idea. This is how empires are made.

What are the value implications of a strategic acquirer versus a non-strategic acquirer? It’s simple math. Let’s say a company that seeks to be acquired is booking, for ease of math, $5 million in EBITDA. If a non-strategic acquirer would purchase that company at 5X, they are paying $25 million. If a strategic acquirer is making the acquisition at 6X, they are paying $30 million, a $5 million positive lift for the seller. This higher value is achieved simply because the strategic acquirer can do more with the business it is acquiring than, say, a private equity group that simply wants to harvest the cash flow and let the acquisition sit there as a stand-alone portfolio company.

A final reason that strategic acquirers pay more is that they tend to want to hold on to their acquisition, folding it into an integrated operation. Strategic acquirers have a bias for the long game. A private equity group/non-strategic, almost invariably, wants to acquire a company, build it up over time, and sell it down the road for a higher value, typically after 3-5 years. They don’t have much of an attachment to the company in the cold calculation of the right time to sell it to achieve their target of return on investment.

Bottom line here? Shop your company among strategics first, see if you get a nibble (or a bidding war!), and then shop to the non-strategics in a second phase of outreach

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