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Strategic Buyer

Guide to Understanding Strategic Buyers in M&A

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Strategic Buyer

Strategic Buyer in Mergers and Acquisitions (M&A)

A strategic buyer refers to a company – i.e. a non-financial acquirer – that attempts to purchase another company.

Because strategic buyers are often in the same or a related industry as the acquisition target, the strategic can benefit from synergies.

Synergies represent the estimated cost savings or incremental revenue arising from a merger or acquisition, which are often used by buyers to rationalize higher purchase price premiums.

  • Revenue Synergies → The merged company can generate more future cash flows from the increased reach in terms of customers (i.e. end markets) and greater opportunities for upselling, cross-selling, and product bundling.
  • Cost Synergies → The merged company can implement measures related to cost-cutting, consolidating overlapping functions (e.g. research and development, “R&D”), and eliminating redundancies.

A sale to a strategic buyer tends to be the least time-consuming while fetching higher valuations since strategics can afford to offer a higher control premium given the potential synergies.

Revenue synergies are usually less likely to materialize while cost synergies tend to be realized more easily.

For example, shutting down redundant job functions and reducing headcount can have a near-instant positive impact on a combined company’s profit margins.

Industry Consolidation Strategy

Often, the highest premiums are paid in consolidation plays, where a strategic acquirer with plenty of cash on hand decides to acquire its competitors.

The reduced competition in the market can make these sorts of acquisitions very profitable and can contribute to a meaningful competitive advantage for the acquirer over the rest of the market.

Strategic vs. Financial Buyer – Key Differences

While strategic buyers represent companies operating in overlapping markets, a financial buyer seeks to acquire the target company as an investment.

The most active type of financial buyer, especially in recent years, has been private equity firms.

Private equity firms, also known as financial sponsors, acquire companies using a substantial amount of debt to fund the purchase.

For that reason, the acquisitions completed by PE firms are termed “leveraged buyouts”.

Given the capital structure of the post-LBO company, there is a significant burden placed on the company to perform well in order to meet interest payments and repay debt principal on the date of maturity.

That said, financial buyers must be careful with the companies they acquire to avoid mismanaging the company and causing it to default on its debt obligations.

As a result, transactions dealing with financial buyers tend to be more time-consuming because of the amount of diligence required, as well as obtaining the necessary debt financing commitments from lenders.

The objective of a strategic buyer is to create long-term value from the acquisition, which can stem from horizontal integration, vertical integration, or building a conglomerate among various other potential strategies.

Strategic buyers usually enter negotiations with a unique value proposition in mind, which rationalizes the acquisition.

The investment horizon for a strategic is typically longer. In fact, most strategics merge the companies entirely post-deal and never intend to sell the company unless the transaction falls short of expectations and destroys value for all stakeholders, resulting in a divestiture in such a case.

In contrast, financial buyers are much more returns-oriented, and it is part of their business model to exit the investment typically in a five to eight-year time frame.

From the perspective of the seller, most prefer exiting to a strategic rather than to a financial buyer when seeking to undergo a liquidity event due to shorter diligence periods and typically higher purchase prices paid.

Private Equity Trend of Add-On Acquisitions

In recent times, the strategy of add-ons (i.e. “buy-and-build”) by financial buyers has helped close the gap between the purchase price offered between strategic and financial buyers and made them more competitive in auction processes.

By making add-on acquisitions, which is when an existing portfolio company called the “platform” acquires a smaller-sized target, this enables the financial buyer – or the portfolio company, more specifically – to benefit from synergies, similar to strategic acquirers.

Strategic buyers are interested in integrating the target company into their long-term business plans, and add-ons enable the portfolio companies of financial buyers to do so, as well.

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