Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / Why Strategic Buyers Pay Less Than Financial Buyers
Transcript
- Lucas: So there's a trade secret in M&A that most first-time sellers don't learn until it's too late — and it's this: strategic buyers, the ones who actually operate in your industry, usually pay a lower multiple than financial buyers like private equity firms. Luna: That sounds backwards. You'd think the company that knows your business best would value it highest. Lucas: You'd think. And sometimes they do — but not in the way you expect. Let me give you a concrete case. I was talking to a friend who ran a family-owned industrial coatings company in the Midwest. Revenue about 45 million, EBITDA around 7 million. They were courted by three private equity firms and one strategic — a larger coatings conglomerate that wanted their distribution network. Luna: Classic scenario. What were the numbers? Lucas: The PE firms all landed around 8 times EBITDA — so around 56 million enterprise value. The strategic came in at 6.5 times — about 45.5 million. That's a ten and a half million dollar gap on headline price. The family was ready to dismiss the strategic outright. Luna: But they didn't. Lucas: They didn't. And here's why. The strategic brought something PE couldn't: synergy. The conglomerate could eliminate overlapping costs — same ERP system, same sales force in certain regions, same raw material procurement. They projected 2 million in annual cost synergies within eighteen months. In their model, they weren't really buying 7 million of EBITDA; they were buying effectively 9 million. Luna: So their 6.5 times was on a different base. That's 58.5 million in their mental math. Lucas: Exactly. Plus, the strategic didn't need leverage in the same way. PE firms typically put 40 to 50 percent debt on a deal. That debt service creates pressure — cost cutting, headcount reduction, aggressive cash sweeps. The strategic had a much lower cost of capital. They could be patient. Luna: And that matters if you care about your employees or the company's long-term identity. Lucas: It matters enormously. The family's biggest concern was preserving the company's culture and keeping the senior team in place. The PE firms promised all that in their letters of intent — they always do — but the earnout structure told a different story. Luna: Earnout terms are where the real intent shows up. Lucas: Right. The PE firms wanted a three-year earnout tied to hitting aggressive EBITDA targets — 12 percent annual growth. The strategic offered a two-year earnout tied to retention of key customers and a smooth integration, with a base payment that covered 90 percent of the purchase price upfront. Less upside potential, but much higher certainty. Luna: So the seller traded headline price for deal certainty and cultural fit. Lucas: And in this case, it worked out. The deal closed in four months — the strategic didn't need bank financing or syndication. A pe backed deal often takes six to nine months and can fall apart during due diligence if leverage markets shift. In early 2023, we saw several mid-market PE deals blow up because debt financing got pulled. Luna: The strategic had cash on hand or a committed line? Lucas: They funded it from operating cash flow and a small revolver. That's another difference — strategic buyers often have built-in liquidity. They don't have to go to the debt markets at the worst possible moment. Luna: Let's talk about the earnout structure in more detail. The PE firms wanted a three-year earnout with aggressive growth targets. The strategic offered a two-year earnout based on retention. How did the numbers compare? Lucas: The PE earnout was designed for a 20 percent upside — if the company hit a 9 million EBITDA target by year three, the sellers would get an additional 4 million. But if they missed by even 10 percent, the earnout could pay zero. The strategic earnout had a 1.5 million pool, paid out if the company retained at least 90 percent of top customers and the CEO stayed for two years. Luna: Much less binary, much more achievable. The strategic was essentially paying for continuity, not moonshots. Lucas: Exactly. And there's a broader principle here. Strategic buyers often have a different time horizon. A PE firm typically holds a company for five to seven years, so they need to create an exit event. That means they're incentivized to compress growth and maximize EBITDA in a short window. A strategic buyer is buying for the long haul — they can afford to invest in R&D, enter new markets slowly, and keep the brand intact. Luna: But not all strategic buyers are created equal. Some are just as ruthless as PE. Lucas: That's true. You have to look at the buyer's history. If a strategic acquirer has a track record of acquiring companies and then hollowing them out — cutting the sales team, moving production offshore, rebranding everything — then the cultural promise is hollow. But if they have a history of bolt-on acquisitions that kept the acquired brand and team intact, that's a good sign. Luna: How do you do that due diligence as a seller? Lucas: Talk to the CEOs of companies they acquired three, five, ten years ago. See if those people are still there. Check if the acquired companies still have their own websites or customer service lines. Visit them in person if you can. The seller's banker should be able to arrange those conversations. Luna: And what about the working capital adjustment? That's another place where strategic and PE buyers often differ. Lucas: Big time. Working capital targets are a common source of post-close disputes. PE firms tend to set aggressive working capital targets — they want a low baseline so that if the company's receivables and inventory are normal, they get a purchase price reduction at closing. Strategics are often more relaxed because they're not financing the deal with as much debt. In our coatings case, the PE firms wanted a working capital target of 12 million, which was actually below the company's historical average of 14 million. The strategic set the target at 14 million. Luna: That's a two million dollar swing right there, effectively narrowing the price gap by a fifth. Lucas: Exactly. So the headline gap narrowed from 10.5 million to maybe 6 or 7 million when you factor in the working capital difference. And then the strategic's lower cost and speed of execution tipped the scales. The family ultimately chose the strategic, and eighteen months in, the CEO is still in place, the company's revenue has grown 8 percent, and the earnout paid out in full. Luna: It's a good outcome. But let's be honest — not every seller has that option. Many companies don't attract strategic interest, or they operate in fragmented industries where PE is the only game in town. Lucas: That's fair. If you're a niche manufacturer with no unique technology or distribution moat, PE might be your best option. But even then, you can choose between PE firms based on their sector focus and operating style. Some PE firms are hands-off and let management run the business; others install their own CFO and push for aggressive margin expansion. Luna: And the earnout structure is still the tell. Lucas: Always. Look at the earnout metrics. Are they tied to things you control — like customer retention, gross margin, or contract renewals? Or are they tied to things you don't — like industry multiples at exit, which are market dependent? The best earnouts are based on operational metrics within your influence. Luna: One more thing: the role of the investment banker. In the coatings deal, did the banker help the family see the strategic's hidden value? Lucas: Absolutely. A good banker doesn't just run an auction and take the highest number. They model out the probability-weighted value of each offer. The PE offers had a higher headline but lower certainty — maybe a 70 percent chance of closing, given financing risk. The strategic had a 95 percent chance. So the expected value of the strategic was actually higher. The banker showed that math to the family. Luna: And that's the real insight for sellers: don't just look at the multiple. Look at the probability of closing, the speed, the working capital terms, the earnout structure, and the cultural fit. Lucas: Right. And also think about what happens after the deal. If you plan to stay with the company, are you going to enjoy working with the buyer? If you're planning to leave, what's the transition plan? Those are worth more than a turn or two on the multiple. Luna: Speaking of things that are worth more than they appear — Lucas, this podcast is ad-free, and that's because a small group of listeners supports it directly. If these conversations have helped you think more clearly about a deal you're working on, or even just given you a framework for the next time you hear about an acquisition, consider chipping in. Lucas: Yeah, it's a simple thing. A handful of listeners go to buy me a coffee dot com slash fexingo, and that's literally the economics that keeps this show going. No ads, no sponsors, no tracking. Just people who find value here, supporting it so others can too. Luna: Right. And it stays that way because of you. Alright, back to the deal table. Lucas: So where does this leave a seller who's evaluating offers today? I think the framework is: rank your priorities — price, speed, certainty, culture, and post-close role. Weigh each offer against those priorities. And don't be afraid to walk away if a strategic buyer's culture is a bad fit, even if the numbers look good. Luna: Because a bad cultural fit can destroy value fast. I've seen deals where the seller stayed for two years and then quit because they couldn't stand the bureaucracy. Lucas: And that's the irony. If the seller leaves early, the earnout doesn't pay, the buyer loses the institutional knowledge, and the whole deal becomes a disappointment for both sides. So the best deals are the ones where both parties are aligned on what happens after closing. Luna: That brings us back to the importance of due diligence — but this time, due diligence on the buyer. Lucas: Exactly. Sellers should interview the buyer's integration team, ask about previous acquisitions, talk to former owners. And they should be honest about their own expectations. Do you want to stay for five years or five months? That changes which buyer is right for you. Luna: So the punchline for this episode: the highest offer isn't always the best offer. Look beneath the headline multiple at the earnout, the working capital target, the financing risk, and the culture. Sometimes the strategic buyer who offers less upfront gives you more in the end. Lucas: And if you're that family-owned coatings company, you might end up with a deal that lets you sleep at night. That's worth a lot.