Private Equity and Strategic Buyers — A Distinction Without A Difference?

According to Pitchbook Data’s 2011 Private Equity Breakdown, there were 5,994 private equity-backed portfolio companies at year-end 2010.  According to a recent survey Axial conducted interviewing its private equity customers, 57% of the respondents indicated that their portfolio companies were actively looking to grow through acquisitions, while over 80% of the respondents indicated that their portfolio companies would opportunistically review acquisition opportunities.

Why does this information matter to business owners?  Because the most likely strategic buyer for your business ironically might well be a private equity firm instead of a Fortune 2000 corporation.

We speak with thousands of medium-sized business owners and M&A Advisors every year.  They discuss the importance of identifying strategic buyers in addition to financial buyers as part of running a well-rounded sell-side M&A process. In particular, they cite the following reasons for wanting to work with a Strategic Buyer:

1. 1. Strategic Buyers tend to be able to pay more because of revenue or cost-based synergies and lower costs of capital
   2. Strategic Buyers can move more quickly because they have industry expertise and will understand things right away
   3. Strategic Buyers have multiple considerations when buying a company, whereas financial buyers are purely focused on ROI (return on investment)

What business owners and to a lesser extent M&A Advisors appear to under-appreciate is how significant the private equity community has become as its own strategic buyer category. In addition to having over $400B of committed but undeployed capital that must be deployed in the coming years, private equity firms collectively own almost 6,000 private companies.

Part of the reason why private equity firms’ portfolio companies grow through acquisition is to take advantage of what is called “multiple arbitrage,” which means that as a company grows in terms of its overall size and EBITDA, the multiple it can acquire in the open market rises, all other things being equal.  In other words, if two companies are essentially identical in terms of products, markets, and team, but one has $4M of annual EBITDA and the other has $12M, the latter will fetch a higher multiple on exit just because its size makes it less risky.

But another key reason driving private equity-backed portfolio company M&A is the opportunity it presents to the private equity firm to put out more capital productively.  Let’s say a private equity firm buys a business for $50M and pays for the business 50% with equity and 50% with debt. Let’s say that 2 years later, the acquired company has an opportunity to acquire a competitor for $25M. This presents a great opportunity for the private equity firm:

1. Because of the initial acquisition they made, they already have a management team in place
2. They are already up to speed on the business because of the due diligence and ongoing portfolio company monitoring
3. They can deploy more of their fund capital into an opportunity that is likely to be substantially less risky than investing in an entirely new company and management team

It’s for these reasons that if you’re a seller and you’re evaluating different potential buyers, finding a private equity-backed portfolio company can be a win-win for you because:

1. They have money to put to work
2. They have a management team that can help integrate the businesses post-transaction
3. Because they are making the acquisition through their portfolio company, they have the posture of a strategic buyer

For sellers using Axial, researching potential private equity-backed strategic buyers is something you can do for free.  There are also different online databases such as Private Equity Info, PEDatabase, and others that you can query. Regardless of how you do it, make sure you have a process for identifying the private equity-backed strategic buyers.  There are thousands of private companies owned by private equity firms and our survey makes it clear that over 50% of them are actively looking to make add-on acquisitions as part of their growth strategy.