Private equity buyouts vs. M&A: What’s the difference?

M&A

Satu Teerikangas
Senior Lecturer in Management at University College London


The global volume and value of merger and acquisition (M&A) transactions has rocketed over the past decades. While initially fueled by trade buyers (i.e. industry or sector focused enterprises seeking renewal, expansion or diversification), the role of private equity (PE) purchases has increased significantly since the 1990s.

The M&A scene today boasts two kinds of acquirers: (1) industrial or trade enterprises on the one hand – such as Shell, Cisco or Siemens – and (2) private equity players on the other hand. As an academic researcher on M&A who has studied both transaction and acquirer types, I found that the research and practice on M&A is largely divided into these two parallel fronts – trade vs. private equity purchases, with a surprising lack of debate as to the similarities and differences between these acquirer transaction types.

This leads one to ask – how do the two acquirer types differ in their approach to acquiring and ownership?

To answer this question, I’ve identified four basic differences between the two acquirer types based on industry-academia research jointly conducted by University College London and Mercuri Urval International1.The two acquirer types operate along different and distinct approaches toward ownership: in acquisitions, private equity players act as professional investors, whilst industrial buyers operate in M&A transactions as organizational integrators. Though the two acquirer types might revert to the same investors and targets of purchase, their purpose of existence, business model, acquisition approach and processes differ markedly from one another.

Difference #1: Business models and operating logics

Industrial enterprises and private equity firms operate along different business models. This has consequences on the acquisition approach that the two acquirer types adopt:

  • Industrial enterprises provide products and/or services to the benefit of customers. In this operating model, acquisitions are a means to expand into a related or new product or geographic area. Acquisitions are rarely the core modus operandi of an industrial enterprise. For industrial buyers, acquisitions offer a route to a synergistic, quasi-permanent product/service/market/capability addition to their existing business portfolio.
  • Private equity players are professional investors in enterprises. Their operating model relies on making the right purchase, and enhancing the firm’s value over a given time frame in order to secure a financially sound exit. Private equity owners are thus characterized as short to medium-term business developers and transformers, whereas industrial owners purchase firms that fit their industrial logic and corporate renewal strategy.

Difference #2: Pre-deal focus and the role of the purchase

As the private equity players’ business model revolves around purchasing and selling firms, making the right firm purchase is of paramount importance. In the pre-deal phase, they appear to over-perform their industry peers with respect to the discipline and the maturity of their acquisitive approach. In my research with Mercuri Urval International2, we found that private equity players differ from industrial acquirers in that they operate with and acquire within focused, niche strategies in well-defined market segments. This allows them to undertake a long-term, focused, structured and relationship oriented approach to sourcing future deals. Private equity firms keep an eye on the entire set of potential target firms in their strategic niche markets, and start to build relationships with future target firms long before they become available for purchase. Given the centrality of right investments to the private equity players’ business model, due diligence analyses are meticulous. This approach to sourcing and analysing targets for purchase differs from industry buyers that are on average much less structured in their pre-deal approach. Notwithstanding, a large variety of industry buyers exists; whilst the larger listed firms act as serial acquirers, engaging in strategic acquisition programs for expansion, smaller-sized and privately-owned firms tend to pursue a less structured approach to acquiring.

Difference #3: Post-deal execution – integration vs. governance

Also post-deal strategies differ between the two acquirer types:

  • Industrial buyers need to decide as to the degree of post-deal integration to be sought. When sought, integration is the responsibility of business leaders and middle managers through e.g. integration teams and integration programs. The key question concerns how to amalgamate the two (or more) previously separate organizations strategically, organizationally, culturally and technologically.
  • In contrast to integration, the post-transaction phase is focused on governance and ownership in private equity owned firms. Private equity players enact their ownership via cooperation between the board, the portfolio firm’s management team (or CEO) and the involved private equity partner. The board of directors is actively involved and the support that the portfolio firm receives from a PE board is considerable. As owners, the PE firms are proactive, intense and demanding. If integration occurs, integration between the many portfolio companies that the PE player owns is sought.

Difference #4: Defined vs. infinite time horizons

A further difference is found as regards perceptions of time. For the two acquirers, the investment process has a different timeframe and duration. Whereas for PE-owned buyouts, there is an end in mind; however, industrial buyers purchase with the goal of ongoing or maintained ownership. Consequently, the two forms of ownership differ with respect to mode of exit. In PE buyouts, exit is a goal upfront; it is discussed throughout the buyout process. For industrial buyers, the focus is on settling for a quasi-permanent relationship through organizational integration. The business becomes divested, when it is no longer strategically viable to keep it in the firm’s business portfolio. Thus, the terminology differs: it is exit in the PE world and ownership or divestment for industrial firms.

Want to learn more about trends in private equity? Stay tuned for a four-part series in partnership with pmX on the increasing importance of the human element in private equity buyouts. In the meantime, take the Transformational Change Self-Diagnostic to see how your project preparation and planning stacks up against industry peers and best practices.

References

1Faulkner, D., Teerikangas, S., & Joseph, R. (Eds.) (2012). The Handbook of Mergers and Acquisitions. Oxford: Oxford University Press. 744 pages.

2Teerikangas, S., & Mercuri Urval International. (2012). Private equity buyouts – Cracking the human element. Mercuri Urval (International) Global Series. 24 pages.Please contact the author s.teerikangas@ucl.ac.uk for your electronic copy of the report.