There are two types of sophisticated buyers who specialize in buying medium-sized companies: Financial Buyers and Strategic Buyers. Financial Buyers raise funds from high net worth investors and institutions and use these funds to purchase companies, which they grow and then exit either through an IPO or by selling to a Strategic Buyer (and sometimes to another Financial Buyer). This type of investing is referred to as “private equity.” Financial Buyers are commonly known as private equity firms, venture capitalists, and hedge funds.
Strategic Buyers are simply larger companies who buy businesses as a way to “grow through acquisitions.” The intent is for the acquired company to be accretive to the earnings of the Strategic Buyer who is able to grow faster by buying the company than they could grow by developing a similar product or service from scratch.
Financial and Strategic Buyers form the Private Capital Markets, which complement the better known “public capital markets” (e.g., New York Stock Exchange and NASDAQ) as a source of capital. The majority of these sophisticated buyers specialize in acquiring companies in the Lower Middle Market (revenues between $10 million and $100 million).
The ability to access the Private Capital Markets significantly expands the scope of potential buyers who are willing and able to pay to acquire a medium-sized company. While an Initial Public Offering is a potential exit option, IPOs account for only 1% of market transactions compared to the Private Capital Market.
Over the last three years, Financial Buyers accounted for 30% of Private Capital Market transactions. Half of these transactions provided “growth” capital, which is invested into the company to drive growth initiatives and typically is not distributed to the business owner. However, there are exceptions. Depending on the circumstance and the lifecycle stage of the company, some proceeds may be distributed to the business owner. In other instances, smaller minority investors may be bought out. The other half of the transactions executed by Financial Buyers consist of outright acquisitions and majority recaps, both of which distribute funds directly to the business owner and investors.
Strategic Buyers are responsible for twice as many deals as Financial Buyers. These transactions are typically outright acquisitions. Many corporations, however, have created an internal “fund” they use as a vehicle for investing in private companies via minority or majority recaps. Larger private companies are responsible for 3/4ths of the deals compared to public companies.
The Private Capital Market is hugely beneficial to entrepreneurs by providing a source of capital for growth and liquidity, the latter equating to cash in an entrepreneur’s pocket.