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What is a strategic buyer?

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What is a strategic buyer?

A strategic partner is one that acquires or invests in another company in the same industry in which it is already operating in order to increase its value by generating synergies. The investment is made because the strategic investor believes that the two companies combined will be greater than the sum of the two separate companies and seeks the integration of the acquired entity for long-term value creation.

Since more value is expected to be derived from the acquisition than the intrinsic value of the acquired company, the strategic partner may typically be willing to pay a higher price to close the deal.

strategic partner
Baker Tilly GDA

Why associate with a strategic partner? - Synergies as a basic objective

There are many reasons for entering into a transaction with a strategic partner, but one of the main objectives is the maximisation of the value of the company, i.e. the creation of shareholder value. This can be achieved through the purchase of a company that together with the acquirer ends up having a value greater than the price paid for it in the acquisition.

The question arises: How can a company be worth more than what it cost to buy it? When the value of the new company resulting from the combination of two companies is greater than the sum of the two companies separately, a synergistic effect has occurred.

When studying a transaction of this type, the project is studied taking into account the synergy effects that are expected to be generated. It is therefore common for part of the value generated by synergy effects to be paid in the price as a premium. Therefore, by paying this premium, the acquiring company is already handing over part of the synergies that it expects to obtain, but does not yet have.

How are synergies generated?

The value generated from synergies can come from these 3 main areas:

  1. Market: growth, competitive position, level of competitor intensity, barriers to entry and exit, substitution risk,...
  2. Organisation: leadership, skills and/or talent, product / technology differentiation, sales channels, customer base,... Can economies of scale be realised in production?
  3. Financials: revenues, profits, growth rates, cash generation, solvency, ...

A financial investor, on the other hand - with the exception of those who carry out build-up strategies - will integrate the business into another company. He analyses the investment opportunity of a solitary company in which to make a minority investment. A financial investor is adept at creating short-term, long-term value for the company and thus securing a return on his investment.

Both the strategic buyer and the financial investor analyse the business in detail, but the strategic buyer focuses more on possible synergies and integration capabilities and the financial investor focuses on the ability to generate liquidity and increase profits.

However, there are not only these two types, but sometimes a strategic buyer has more of a financial objective or the other way around, such as in the case of add-ons.  

Main reasons for acquisition

In the following, we will look at a number of economic reasons - which produce a synergistic effect with a high degree of certainty - for a merger or acquisition and thus reasons for a strategic partner to buy out:

Horizontal integration and operational synergy

Horizontal mergers or acquisitions are those in which the merging companies are in the same industry. Operational synergy is achieved through revenue enhancement, cost reduction or often a combination of the two.

  • Increased revenues: by creating new products or services arising from the merger, new revenues are generated in the long term. The product range can be expanded, joint distribution channels can be better utilised or the reputation of one of the brands can be leveraged. This is called REO (Revenue-Enhancing Opportunity).
  • Cost reduction: Operational synergy in this case comes from economies of scale. The company's fixed costs will remain the same as a whole, but the average unit cost decreases due to a higher production volume.
  • Market power and antitrust law: Market power can be achieved in three ways: product differentiation, barriers to entry and market share. Through a horizontal acquisition, market share can be increased. Antitrust laws may prohibit certain mergers if there is a danger that the combination of companies will have too much market power.

In this case, as the companies are usually competitors, care must be taken as to how and when relevant information is shared.

Economies of vertical integration

In vertical integration, a distinction is made between fordward integration (the company moves closer to the final consumer) and backward integration (the company moves closer to the original supplier). Mergers or acquisitions The reasons for this are different, for example:

  • Acquisition of technology used in one phase may be useful for another phase of production.
  • Reduced risk of supply disruption, especially when the supplier's market is small.
  • Elimination of contractual costs
  • Reduction of payroll costs, pricing or advertising costs
  • Reduction of communication costs and coordination of production (just-in-time production).

International expansion

When the acquiring company is interested in expanding into another geographic area by acquiring a company in the same activity/sector. In such cases, it is important to have a good understanding of the extent to which the local market requires a different approach.

Elimination of inefficient management

There are companies that are not managed efficiently. If a company with an efficient management thinks that another company could be better managed, its objective might be to buy it in order to change the way it is managed and thus increase its value. The acquiring company will have to make sure that it is really poor management that is the factor leading to low profitability, because there can also be many other factors that do not allow a company to be profitable.

Untapped tax advantages

Tax synergies exist when the merger of two companies results in a reduction of tax payments. Thus, the tax burden of the two companies together is lower than that of the two companies separately. The most common tax synergies are:

  • Loss compensation
  • Tax concessions
  • Revaluation of depreciable assets
  • Tax savings from complementary cycles

Mergers as use of surplus funds

There are companies that generate a large amount of funds and have liquidity available for investment, but lack opportunities to reinvest them profitably in their own business and do not want to distribute them as a dividend. In such a case, it may be worthwhile to undertake acquisition transactions if this can generate a return for the company's shareholders.

Combining complementary resources

This type of acquisition refers to the fact that the development of the acquiring company requires something that the company to be acquired has or owns. This is the case of many acquisitions of small companies that have some kind of technology by large companies that find it easier to buy a company that has the technology they need than to develop the technology or product themselves.

There are also cases where such acquisitions have been seen due to the need to find good managers.

Advantages of selling to a strategic buyer

Selling to a strategic partner can have its advantages, especially for SMEs, for the following reasons:

  • The strategic buyer is willing to pay a higher price for the business than the investment partner, given that a large part of the profitability it will obtain will be from the synergies created by the combination of the two businesses. In addition, the fact that they do not need the former owners for day-to-day management will lead them to increase the price they are willing to pay.
  • The strategic partner has its own management team and may therefore be less dependent on the acquired company's team. In this sense, it may require less linkage after the transaction.
  • Because a strategic buyer operates in the same industry, it tends to accelerate the closing of a company sale transaction when the buyer is a strategic partner. The process of gaining a good understanding of the business to be acquired is expedited, although this does not mean that the buyer does not take a good look at all the details of the company to be acquired.
  • For both customers and suppliers, a change of ownership of a company is always a sensitive time, as the likelihood of changes in relationships increases. When the new owner comes from the same sector, i.e. is familiar with the product and the challenges within the sector, it is easier for business relationships to be maintained. Often there is even the possibility of improving them by being able to offer higher quality products or a greater variety.
  • The strategic buyer when purchasing another company is looking for a long-term project, which gives more guarantees to the former owners that the business will be in good hands.

If you are looking for a strategic buyer, you can count on our service of capital raising or strategic investor.