When a private equity (“PE”) buyer considers whether a particular company may make a good potential acquisition, it puts a lot of importance on a number of things that other buyers may put less emphasis on. Some include:
[Editor’s Note: Please also see the related article Selling to Private Equity Buyers and the webinars “What is a Private Fund?” and “Alternative Assets Part 1: Investing in Venture Capital, Private Equity, and Hedge Funds.“
This is not to suggest that these things are not important to any potential buyer, but you may expect a PE buyer to be more focused on these items than other buyers. Why is this? The first bullet, above, is an easy example to address: PE firms typically want to keep most senior management in place whereas a strategic buyer (i.e. a competitor) may have at the top of its agenda the termination of people who would be redundant to personnel the strategic buyer already has. So, as an owner or senior manager of a business which is considering selling itself, you need to make an honest assessment of these things.
A private equity buyer will almost always look to the ability to leverage the seller’s asset base. This serves two primary goals:
While the investment interests of private equity buyers stretches across the entire spectrum of industries operating domestically and globally, there are certain critical components to bring a private equity buyer to the table:
A PE buyer brings many benefits to a sale process.
Private equity funds typically can move very fast because they typically have streamlined investment committee vetting processes. From the initial screen of the target to the signing of the purchase agreement, most private equity buyers thoroughly examine the seller’s financial conditions and provide continuous feedback as to any concerns arising from the process. It is this streamlined process that often enables a PE buyer to move more quickly than the marketplace in assessing a target and making an investment decision.
A PE buyer may also be more inclined than other buyers to assist a seller in “taking money off the table” (i.e. sale of a significant minority or majority equity stake. Private equity firms exist to find growth or value investment opportunities, quickly assess the situation, move to invest capital expeditiously, help improve operations, and ultimately, exit through a sale or initial public offering.
A PE buyer also may have higher risk tolerance when evaluating whether to invest in a company, enabling it to differentiate itself from other buyers competing to acquire the company. For example, if a target has had historical positive cash flow but has recently encountered an operational or macroeconomic issue that has caused a downturn in cash flow, a PE buyer may be comfortable with the company’s growth prospects and asset base to support its acquisition thesis.
Finally, PE buyers often look to partner with management and incentivize them with equity in the new company so that all parties’ interests are aligned. A sale to a private equity buyer may allow an owner to not only realize liquidity in his business but may also provide her with potential future upside in a larger, more profitable entity that she may not have achieved with a PE buyer’s capital – both financial and human (private equity firms bring a lot of experience to any business).
There are certain risks and/or potentially negative aspects of selling to a private equity firm. First, the seller should not expect to maintain control of the business – whether in respect to operational control or equity ownership. Many private equity firms realize and value the contributions of senior management and understand that the best way to motivate a senior management team/employee base is to provide equity ownership in the newly formed company. However, the equity percentage awarded or reserved for management and employees is usually limited to 5% to 15% of the overall equity. Often, PE buyers will allow senior management to co-invest alongside them up to a certain cap on ownership (e.g. 20% of the overall equity).
Second, not all private equity firms are created equal. While the vast majority of PE buyers are interested in the growth and continued success of the business and its employees and not just the return on its investment, there are PE firms out there in which the acquisitions of companies is nothing more than a means to a financial engineering end. Significant headcount reduction/forced turnover of senior personnel, selling-off of core or non-core assets and highly leveraging the business (i.e. leveraging the asset base of the business to “swap out” invested equity for third party debt) are but a few examples of red flags in a PE buyers history of ownership when a seller is considering what PE buyer to sell to.
Lastly, although the sale of your company may be a new and potentially exciting opportunity for a business owner to monetize the value of his or her hard work, it is not a new experience to PE buyer. Sellers need to approach any sale transaction to a PE buyer with eyes wide open. There are no “handshake” deals. Sellers should consider arming themselves with dispassionate third party advisors; whether it be counsel, a consultant or investment banker. Third party advisors can help with negotiating strategy, keep a buyer “honest” by imparting third-party professionalism to the sale process and should help ensure that the seller is obtaining the best deal possible.
The obligations of the seller, both contingent and secured/unsecured, will factor into the risk assessment and ultimate valuation assigned by a private equity buyer. Understanding the payment cycle of the company will help provides insight into the financial health of the seller, and it is a reflection of management’s philosophy as to how it operates its business.
A seller that has acutely managed its obligations shows the financial discipline PE buyers look for when evaluating investment opportunities.
As the goal of any investor is to generate a return on capital, PE buyers are keenly focused on a company’s operating costs and growth prospects. If management has not made certain cost cuts, it should be ready to explain why not, and the strategic plan for implementing them.
The target’s industry and market position are also key considerations a PE buyer assesses when evaluating a target. A seller in a growth industry that provides a niche service or produces a unique product with significant market share are sure to attract the attention of a PE buyer. A target that serves as either a platform investment, as an add-on, or that rounds out a geographic or product footprint is one that will garner value from a PE buyer. In other words, as a seller, you should take the time to understand why your business may be more valuable to one PE buyer over another. Having deep insight into your industry and competitors will strengthens your company as an excellent investment opportunity for the PE buyer.
Private equity buyers look for a specific type of opportunity. In order to market your company to PE buyers, the team you assemble to assist in the transaction should be astutely aware of the hard and soft metrics by which PE buyers evaluate companies. If your financial house is in order, you understand your company’s value propositions and position in the market, have an experienced and trustworthy management team, and can articulate a road map to greater growth and profitability, your company will look more attractive to a PE buyer.
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Michael J. Gorman is a Director of SSG Capital Advisors. Mike is a skilled restructuring professional with expertise in advising middle market companies facing financial and/or operational challenges including bankruptcy proceedings. He has completed over 40 sale and restructuring engagements, involving mergers and acquisitions advisory, complex valuations, financial restructurings and private placements of debt and…
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