The term “financial” buyer is often used in the context of buyout offers made by institutions including private equity firms, family offices, or investment arms of public or private companies. While private equity firms and family offices both fall under the umbrella of financial buyers, these entities often differ in their structure, investment objectives, and decision-making processes. In our next series, we’ve outlined a few of these differences, in addition to some of the key advantages and drawbacks to selling to these entities.
Institutional buyers, including private equity funds, family offices, and investment arms of public or private companies have historically been referred to as “financial” buyers (rather than “strategic” buyers). While many financial buyers exhibit some characteristics of strategic buyers (i.e. will incorporate some strategic premiums in their valuations), they will generally assess buyout opportunities without incorporating the potentially higher premiums afforded by strategic buyers. That said, selling to a private equity firm, family office, or other institutional buyer can involve different dynamics and considerations due to their distinct objectives and decision-making processes. Some of the key distinctions between private equity firms and family offices are outlined below:
Ownership Structure
Private Equity: A traditional private equity firm will raise a fund with multiple limited partners (LPs), which typically include institutions, pension funds, endowments, and/or high net worth individuals. The private equity firm pools funds from these various sources to make investments.
Family Office: Represents the wealth of a single high-net-worth family or a small group of families. They are often more flexible and less bound by external regulations compared to institutional investors.
Decision-Making Process
Private Equity: Decision-making involves multiple stakeholders, often with a more formalized and structured process. Investment decisions may require approval from various committees and boards.
Family Office: Decisions may be made by a smaller group of individuals, potentially the family members themselves. The decision-making process can be more agile and personalized.
Investment Horizon
Private Equity: Typically, private equity groups have a defined investment horizon (typically between 3 and 7 years) and are focused on a medium-term exit strategy, such as selling the company or taking it public.
Family Office: Family offices typically have longer investment horizons, as their focus oftentimes extends across generations. As a result, family offices have more patient capital and are generally less concerned with short-term returns.
Strategic Alignment
Private Equity: Driven by financial returns, the goal of a private equity firm is to optimize the company for a profitable exit within a certain timeframe.
Family Office: Considerations may extend beyond financial returns to include a desire for legacy building, social impact, or long-term sustainability. Family offices may be more open to supporting a company’s long-term vision.
Key advantages to selling to a financial buyer include:
- Financial Resources: Financial buyers typically have substantial financial resources, negating the need for seller financing, while also providing a business with the capital it needs for growth. In most cases, this results in a significant amount of cash at closing.
- Expertise: Financial buyers usually have experienced professionals who can provide strategic insight and access to valuable resources.
- Flexibility: The seller can retain a minority interest in the business if desired, thus allowing for participation in the future growth and success of the business. In many instances, “rolled” or retained equity can be a requirement, which some sellers may perceive as a drawback.
Key drawbacks to selling to a financial buyer include:
- Short-term focus: Private equity firms typically have short investment horizons. As a result, they may prioritize short-term financial decisions over long-term strategic decisions. Family offices have longer investment horizons and more patient capital. As a result, this drawback can be mitigated in a sale to a family office.
- Leverage: Transactions often involve the use of significant debt to finance the acquisition. High debt levels can put a strain on cash flow and increase the risk of the business. Significant leverage can also increase the focus on short term performance which may put additional pressure on the leadership team, and discourage strategic decisions in favor of tactical or short term decisions.
- Culture: Company culture can change dramatically post-transaction, particularly when ownership has different goals and objectives than the previous owners. If the business fails to meet the expectations of the financial buyer, additional pressure on the company and its leadership team can negatively affect employee morale and corporate culture.
- Price: Depending on the buyer’s current portfolio and strategic plan, the price paid by a financial buyer may fall short of what a strategic buyer is willing to pay if the financial buyer is not gaining any perceived synergies.
If you’re considering a sale to a financial buyer, or more likely, have been approached by a financial buyer like a private equity firm or family office, it’s important to understand who these parties are, their unique goals and objectives, and advantages and drawbacks to selling to a financial buyer. If you’ve been approached by a financial buyer expressing strong interest in your business, or just want to talk through your options, give us a call!