Financial Investors

Financial Investors: Return-Oriented Capital Providers in the Transaction Market

Financial investors play a central role in M&A activities. Unlike strategic buyers, they are not primarily interested in operational control or synergy potentials of a company but focus on the financial return on their invested capital. Their goal is to achieve the highest possible profit through targeted investments, active value enhancement, and the subsequent resale of their stake.

Business Model and Investment Strategy of Financial Investors

Financial investors appear in various forms that differ in investment strategy, investment volume, and time horizon. The main types include:

• Private Equity Firms: These raise capital from institutional investors and high-net-worth individuals to acquire direct stakes in privately held companies. The focus is on majority ownership and active involvement in management with the aim of increasing value.

• Venture Capital Firms: They invest in young, innovative growth companies, mostly in the technology sector. They consciously take on higher risks but aim for disproportionately high returns in successful cases. Besides capital, they often provide industry expertise and networks.

• Family Offices: These manage the wealth of one or several affluent families and allocate it across various asset classes. They often invest more long-term and risk-averse than other financial investors but also prioritize attractive returns.

• Hedge Funds: They often pursue shorter-term, opportunistic strategies, including complex instruments such as derivatives or short selling. In the M&A context, they mainly act as activist investors, exerting pressure on management to enforce special distributions or a sale.

Despite these differences, all financial investors share a strict focus on financial metrics and return targets when selecting and managing their investments. Typical investment criteria include:

• Growth Potential: The target company should operate in a market with high growth rates and demonstrate above-average growth itself, either organically or through acquisitions.

• Scalability: The business model should be expandable without a disproportionate increase in capital or personnel. Standardized, automatable processes and products are in demand.

• High Cash Flows and Margins: High, stable cash flows and profit margins are crucial for capital returns. Companies with capital-intensive business models or operating in highly competitive markets are less attractive.

• Optimization Potential: Financial investors seek companies where targeted measures such as cost reductions, process optimizations, or buy-and-build strategies can create value.

• Exit Perspective: The eventual sale of the stake is considered even before entry. Companies that can be sold well to strategic buyers or through public markets are preferred.

To meet these investment criteria, financial investors often take on significant risks. High leverage ratios, complex transaction structures, and radical restructurings are common. Accordingly, return expectations are high: Private equity funds typically target annual returns of 20% or more.

Transaction Types and Value Creation Approaches

In practice, financial investors pursue various approaches to acquiring and enhancing the value of companies:

• Leveraged Buyouts (LBOs): The majority of the purchase price is financed through debt, which is later repaid from the cash flows of the acquired company. The leverage effect can significantly increase equity returns—albeit at the cost of higher risk.

• Management Buyouts (MBOs): The existing management team acquires the company’s shares, usually supported by a financial investor. The advantage lies in the management’s intimate knowledge of the company and their motivation through entrepreneurial responsibility.

• Buy-and-Build Strategies: Initially, a platform company is acquired, which is then expanded by targeted acquisitions of usually smaller companies. The goal is to achieve a higher valuation through synergies and economies of scale than the sum of individual companies.

• Carve-outs and Spin-offs: Business units are separated from existing corporations and continued as independent entities. Financial investors often succeed in upgrading previously neglected business areas through targeted management and investments.

• Turnaround and Special Situations: Some financial investors specialize in companies in crisis situations, such as those near or in insolvency. Through fresh capital, operational restructuring expertise, and tough measures, they attempt to reverse negative trends.

While these transaction types vary, the levers financial investors use to increase the value of their holdings are similar:

• Strategic Realignment: Under the leadership of financial investors, business models are often adapted, product portfolios streamlined, and new growth areas developed. Divestitures of entire business units are not uncommon.

• Operational Efficiency Improvement: A primary focus is usually on improving processes and systems to reduce costs and increase profitability. Typical measures include centralization, automation, and outsourcing.

• Leadership Development: Financial investors place great importance on a capable, highly motivated management team. This often involves replacing executives, introducing variable compensation models, and implementing leadership development programs.

• Active Cash and Working Capital Management: Strict management of receivables, payables, and inventory reduces capital tied up and increases free cash flow. Non-core assets are often sold.

• Optimization of Financing Structure: Financial investors leverage their expertise and negotiating power to secure debt financing on favorable terms. Optimizing interest expenses and taxes also plays a significant role.

By simultaneously applying these value-enhancing levers, financial investors often manage to significantly increase the profitability and enterprise value of their holdings within a few years. The holding period typically ranges from three to seven years—after which the company is sold and the profit realized.

Significance for the Transaction Market

Financial investors have sustainably shaped the M&A landscape over recent decades:

• Growing Market Shares: In many industries and regions, financial investors now account for a large share of transactions. Studies show their share in Europe is around 40%, and in North America even over 50%.

• Rising Purchase Prices: Due to intense investment pressure and competition among financial investors, valuations for attractive target companies have increased significantly. Purchase prices exceeding 10 times EBITDA are no longer uncommon.

• New Transaction Structures: Financial investors have driven many innovations in M&A, such as secondaries, club deals, or LBO structures. They have also strongly influenced the professionalization and standardization of processes.

• Catalyst for Consolidation: In many fragmented industries, financial investors have often initiated market consolidation and cleanup through active buy-and-build strategies.

• Changing Corporate Cultures: The return- and result-oriented approach of financial investors has also entered many family businesses and corporations. Concepts such as value enhancement, efficiency, and variable compensation have gained significant importance.

For company sellers and M&A advisors, it is essential to understand and leverage the opportunities and particularities of transactions with financial investors:

• Due to high competition and return targets, attractive purchase prices are often achievable. A professional, competitive process design is crucial.

• Financial investors value a clean legal and financial foundation. Thorough preparation of the company and sales documents is indispensable.

• Compared to strategic buyers, financial investors often act faster and more straightforwardly. This can be advantageous for a swift, confidential process.

• After the sale, a high degree of change and professionalization in the company is to be expected. Sellers should anticipate and communicate this openly.

• The short-term return goals of financial investors do not always align with the interests of other stakeholders such as employees, customers, or suppliers. Sensitivity is required here.

In summary: Financial investors have become indispensable in the M&A landscape. They have fundamentally changed the rules and possibilities—for companies, sellers, and advisors alike. Understanding their mindset, goals, and approaches is now essential for every M&A professional.

At the same time, financial investors should neither be demonized nor glorified: They are neither the "locusts" that drain companies dry nor the sole saviors that put every company on a path to success. As is often the case, it depends on the individual situation.

What matters is to see financial investors for what they are: rational, return-oriented investors who set high standards for management, transparency, and performance. Those who adapt to this and actively leverage the opportunities can realize attractive deals with financial investors—and thus successfully sell and develop companies.