Is a Financial Buyer or a Strategic Buyer Better?

If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial buyer or a strategic buyer.

Which is better? Both have their pros and cons. Ultimately, though, it depends on your specific situation. Here’s a look at some of the factors you’ll need to consider when making your decision.

The Difference

A financial buyer is acquiring your future profit stream. So they will evaluate your business based on how much profit it is likely to make and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business. 

But there is a limit to how much they will pay.

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Photo: Nataliya Vaitkevich on

Financial buyers are playing the buy-low, sell-high game. So, they do not have a strategic rationale for buying your business. They also don’t have an army of sales reps to sell your product or a network of retailers where your product could be merchandised.

They’re simply trying to get a return on their investors’ money. They tend to buy small and mid-sized businesses using a combination of this investment layered on top of a pile of debt. Their goal is to buy your business on the cheap with the hope of flipping it five or ten years down the road.

Because financial buyers are usually investors and not operators, they want you and your team to stick around. As such, they rarely buy all of a business. Instead, they buy a chunk and ask you to hold on to a tranche of equity. That way they keep you committed.

A strategic buyer is a much different animal. Usually a larger company in your industry, they are evaluating your business based on what it is worth in their hands. They will try and estimate how much of their product or service they can sell if they added you into the mix. Because of their size, this can often lead to buyers who are willing and able to pay much more for your business.

Fast Growing Software Company Looks For An Acquirer

Tom Franceski and his two partners had built DocStar up to 45 employees when they decided to shop the business to private equity investors. The PE guys offered four to six times earnings before interest, taxes, depreciation and amortization (“EBITDA). But, Franceski thought the offer was too low for a fast-growing software company.

Franceski was then approached by a strategic acquirer called Epicor. As a global software business, Epicor had a lot of customers who could use what DocStar had built. Epicor offered Franceski around two times revenue—a much fatter multiple than the PE firms were offering.

The takeaway? Understanding the different motivations of these two buyers can be the key to getting a good price for your business.

Want to learn more? Speak with us about how we can help you think through the strategy of selling your company some day.

How Brainstorming a Shortlist of Potential Acquirers Can Pay Off

When David Perry started his video game company, Gaikai, he thought about all the companies that may want to buy it one day. In essence he was creating a shortlist of potential acquirers. And also creating a quick way to find a good fit.

Now typically when you think of startups, one word comes to mind: growth. So why would a business without any revenue or employees be thinking about potential acquirers so early? 

For Perry this is just “down-the track” thinking at work. Rather than waiting for the right opportunity, he wanted to drive the process.

The Strategy

Later when Perry was interviewed about Sony’s $380 million acquisition of Gaikai, he described his philosophy by using a moving train as an analogy. 

Think about a train full of people representing an industry, he explained. Most people are comfortably inside the train watching the countryside go by. There are some people scrambling behind the train, hoping to jump on.

Then there are a select few people who are obsessing over where the train is going and are constantly thinking about the upcoming stops along their journey. Perry described himself as one of the people thinking about where the train is going next, so it only made sense to him to have a list of potential acquirers from day one. 

Sony was in the bullseye of Perry’s dartboard of companies to sell to. So when his partner suggested they name their company Gaikai, a Japanese word that roughly translates to “open sea,” Perry agreed. 

He knew it would be the perfect fit for what he had in mind. He also knew he had an opportunity not just to create something unique but to build a connection to his target acquirer.

And while the word gaikai is hard for the average English speaker to pronounce, Perry knew the name would be irresistible to Sony. 

More Than Just A Name

Perry and his partners went further and named other parts of their product line with Japanese words. They also designed the company for the global gaming market, not just for American customers. It was a unique tactic that differed from the habits of video game makers at the time. 

Years later, when Perry was ready to sell Gaikai, he approached all the big video game makers about buying his company. Unsurprisingly, Sony was the most enthusiastic. They were thrilled to see the extent to which Perry and his partners had gone to make Gaikai fit Sony’s culture. 

The Takeaway

Visualizing the shortlist of potential acquirers when you’re making key decisions in forming your company is an excellent way to vet your next move.

Imagining how your potential acquirers would react to hear how you are thinking of evolving your company can inspire a more strategic lens through which to make big bets. 

Whether you are looking to sell soon or are years away from selling, the process of developing a shortlist of tomorrow’s potential acquirers will help you make better decisions today.

Want to learn more? Speak with us about how we can help you think through the strategy of selling your company some day.

What Your Birth Certificate Says About Your Exit Plan

In our experience, your age has a big effect on your attitude towards your business and how you feel about one day getting out. Here’s what we found: 

Business owners between 25 and 46 years old 

Twenty- and thirty-something business owners grew up in an age where job security did not exist. They watched as their parents got downsized or packaged off into early retirement, and that caused a somewhat jaded attitude towards the role of a business in society. Business owners in their 20’s and 30’s generally see their companies as means to an end and most expect to sell in the next five to ten years. Similar to their employed classmates who have a new job every three to five years; business owners in this age group often expect to start a few companies in their lifetime. 

Business owners between 47 and 65 years old 

Baby Boomers came of age in a time where the social contract between company and employee was sacrosanct. An employee agreed to be loyal to the company, and in return, the company agreed to provide a decent living and a pension for a few golden years. 

Many of the business owners we speak with in this generation think of their company as more than a profit center. They see their business as part of a community and, by extension, themselves as a community leader. To many boomers, the idea of selling their company feels like selling out their employees and their community, which is why so many CEO’s in their fifties and sixties are torn. They know they need to sell to fund their retirement, but they agonize over where that will leave their loyal employees. 

Business owners who are 65+ 

Older business owners grew up in a time when hobbies were impractical or discouraged. You went to work while your wife tended to the kids (today, more than half of businesses are started by women, but those were different times), you ate dinner, you watched the news and you went to bed. 

With few hobbies and nothing other than work to define them, business owners in their late sixties, seventies and eighties feel lost without their business, which is why so many refuse to sell or experience depression after they do. 

Of course, there will always be exceptions to general rules of thumb but we have found that – more than your industry, nationality, marital status or educational background – your birth certificate defines your exit plan. 

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Why You Shouldn’t Try to Market-Time the Sale of Your Business

Trying to market-time the sale of your business on external economic cycles is usually a waste of energy. Here’s why.

A few years back, I was speaking with a successful CEO in his fifties who runs a machine shop company that generates $8 million in annual revenues and over $1 million in profit before tax. 

Even though he was tired and nearing burnout, he was planning to wait another five to seven years before selling his business because he “wanted to sell at the peak of the next economic cycle.” [Editor’s Note: The article was written before the 2020 Presidential Election]

On the surface, his rationale seems to make sense. If you speak with mergers and acquisitions professionals, they’ll tell you that an economic cycle can impact valuations by up to “two turns,” which means that a business selling for five times earnings at the peak of an economic cycle may go for as low as three times earnings at a low point in the economy. 

The problem is, when you sell your business, unless you put the proceeds into a money market cash account, you have to do something with the money you receive. Usually that means buying into another asset class that is being affected by the same economic cycle. 

Let’s say, for example, you had a business generating $100,000 in pre-tax profit in an industry that trades between three times and five times earnings, depending on the point in the economic cycle. 

Furthermore, let’s imagine you sat stealthy on the sideline until the economy reached the absolute peak and sold your business for $500,000 (five times your pre-tax profit) in October 2007. You took your $500,000 and bought into a Dow Jones index fund when it was trading above 14,000 (remember those days?). Eighteen months later – after the Dow Jones had dropped to 6,547.05– you’d be left with less than half of your money!

Even though you cleverly waited till the economic peak, by the low point in the “Great Recession” on March 9, 2009, you would have effectively sold your business for less than 2.5 times earnings. 

The inverse is also true. Let’s say you waited “too long” and sold the same business in March 2009. And because we were at the lowest possible point in the economic cycle, you only got three times earnings: $300,000. Notice that’s 20% more than if you’d sold at the peak and bought an index fund at the top of the market. 

Just like when you sell your house in a good real estate market, unless you’re downsizing, you usually buy into an equally frothy market. Which is why timing the sale of your business on external economic cycles is usually a waste of energy. 

External vs. internal economic cycles 

Instead, we recommend timing the sale of your business when internal economic factors are all pointing in the right direction: your employees are happy, revenues and profits are trending upward, and there is still lots of market share for an acquirer to capture. 

When internal economic factors are pointing up, you’ll fetch a price at the top end of what the market is paying for businesses like yours right now, which means that – for good or bad – you get to use your newfound cash and buy into the same economic market you’re selling out of. 

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Track These Seven Key Performance Indicators

Acquirers love key performance indicators. Here’ why you should track them, even if you’re not planning to sell your company.

Baseball’s leadoff batters measure their “on-base percentage” – the number of times they get on base as a percentage of the number of times they get the chance to try. 

Similarly, doctors in the developing world measure their progress not by the aggregate number of children who die in childbirth but by the infant mortality rate, a ratio of the number of births to deaths. 

Acquirers also like tracking ratios (they call them “key performance indicators” or “KPI”) and the more ratios you can provide a potential buyer, the more comfortable they will get with the idea of buying your business. 

Better than the blunt measuring stick of an aggregate number, a ratio expresses the relationship between two values, which is what gives them their power. 

Whether you’re planning to sell your company in the near future or down the road, here’s a list of seven KPIs to start tracking in your business now: 

Revenue per employee 

What: Net revenues divided by the number of “full-time” equivalent employees (“FTEs”). The resulting ratio will be listed as a dollar value.

Why important: Payroll is the number-one expense of most businesses, which explains why maximizing your revenue per employee can translate quickly to the bottom line.

Business Insider estimated that Craigslist enjoys one of the highest revenue-per-employee ratios, at $3,300,000 per employee, followed by Google at $1,190,000 per bum in a seat. Amazon was at $1,010,000, Facebook at $920,000, and eBay rounded out the top five at $530,000. More traditional people-dependent companies may struggle to surpass $100,000 per employee.

Employees per square foot 

What: Calculate the number of square feet of office space you rent and divide it by the number of “full-time” equivalent employees (“FTEs”)

Why important: You can judge how efficiently you have designed your space. Commercial real estate agents use a general rule of 175–250 square feet of usable office space per employee. And, post-pandemic, this ratio will likely become even more important.

Sales per square foot 

What: Gross sales divided by the square footage of all your operating locations.

Why important: By measuring your annual sales per square foot, you can get a sense of how efficiently you are translating your real estate into sales. Most industry associations have a benchmark. For example, annual sales per square foot for a respectable retailer might be $300.

With real estate usually ranking just behind payroll as a business’s largest expenses, the more sales you can generate per square foot of real estate, the more profitable you are likely to be. 

Net Promoter Score – Ratio of promoters and detractors 

Fred Reichheld and his colleagues at Bain & Company and Satmetrix, developed the Net Promoter Score® methodology, which is based around asking customers a single question that is predictive of both repurchase and referral.

Here’s how it works: survey your customers and ask them the question “On a scale of 0 to 10, how likely are you to recommend <insert your company name> to a friend or colleague?”

What: The percentage of the people surveyed who give you a 9 or 10 are your ratio of “promoters.” Similarly the ratio of detractors is the percentage of people surveyed who gave you a 0–6 score. Calculate your Net Promoter Score by subtracting your percentage of detractors from your percentage of promoters. 

Why important: The average company in the United States has a Net Promoter Score of between 10 and 15 percent. U.S. companies with the highest Net Promoter Score include USAA Banking (87%),  Trader Joe’s (82%), Costco (77%),  USAA Auto Insurance (73%), and Apple (72%). Understanding where your company rates will give potential acquirers insight into the value of the customer base they may assume.

Customers per account manager 

What: How many customers do you ask your account managers to manage?

Why important: Finding a balance can be tricky. Some bankers are forced to juggle more than 400 accounts and therefore do not know each of their customers, whereas some high-end wealth managers may have just 50 clients to stay in contact with. It’s hard to say what the right ratio is because it is so highly dependent on your industry.

Slowly increase your ratio of customers per account manager until you see the first signs of deterioration (slowing sales, drop in customer satisfaction). That’s when you know you have probably pushed it a little too far. 

Prospects per visitor 

What: The proportion of your website’s visitors who “opt in” by giving you permission to e-mail them in the future.

Why important: Dr. Karl Blanks and Ben Jesson are the cofounders of Conversion Rate Experts, which advises companies like Google, Apple and Sony how to convert more of their website traffic into customers.

Dr. Blanks and Mr. Jesson state that there is no such thing as a typical opt-in rate, because so much depends on the source of traffic. They recommend that rather than benchmarking yourself against a competitor, you benchmark against yourself by carrying out tests to beat your site’s current opt-in rate.

The easiest way of increasing opt-in rate is to reward visitors for submitting their e-mail addresses by offering them a gift they’d find valuable. Information products (such as online white papers, e-books, videos or calculators) make ideal gifts, because their cost per unit can be almost zero.

Prospects to customers 

What: Similar to prospects per visitor, another metric to keep an eye on is the efficiency with which you convert prospects – people who have opted in or expressed an interest in what you sell – into customers. 

Why important: Conversion Rate Experts’ Dr. Blanks and Mr. Jesson recommend you monitor the rate at which you are converting qualified prospects into customers, and then carry out tests to identify factors that improve that ratio.

Conversion Rate Experts more than doubled the revenues of, the leading community for search marketers, by converting many of SEOBook’s free subscribers into customers. Techniques that were found to be effective included (perhaps counter intuitively) restricting the number of places available; allowing easier comparison between SEOBook and the alternatives; communicating the company’s value proposition more effectively; and simplifying its sign-up process. The trick is to establish your benchmark and tinker until you can improve it. 

To sum it all up, acquirers have a healthy appetite for data. The more data you can give them – in the KPI ratio format they’re used to examining – the more attractive your business will be in their eyes. 

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