As discussed in prior emails, there are numerous buyer candidates to purchase privately-held companies including corporations (strategic buyers), management (management buyout), individuals (seeking to purchase/operate a company), and private equity groups (“PE Groups”). Let’s delve further into what it means for the owner to sell their company to a PE Group.
PE Groups are categorized based on their acquisition criteria including: i) industries of interest, ii) size of the company, i.e., revenue and operating cash flow, iii) stage, i.e., seed, early, growth, mature, iv) geography, v) healthy or distressed, vi) ownership, i.e., family, entrepreneurial, corporate – spin-off/orphan, vii) management continuity, i.e., in-place management or the need to identify new senior leadership, viii) is there a consolidation strategy in the industry, ix) can the company benefit from operational consulting initiatives, x) ownership hold period, among others. As is evident, each company will be attractive only to a subset of the PE Group universe.
In considering a sale to a PE Group, there are a variety of additional items for the owner to ponder. Should the company be positioned as a “platform” or an “add-on acquisition?” Often this decision is based on the scale of the company and if there is an existing infrastructure that can support the acquisition of additional companies.
If the company is positioned as a platform, are there acquisition opportunities that can immediately increase the scale and breadth of the company? Some PE Groups will only consider investing in markets in which there is a clear path to a consolidation strategy.
If there are already several PE backed companies consolidating the industry, the company may be more marketable as an add-on acquisition. In this case, is the owner comfortable with the idea that their management team and administrative employees may lose their jobs shortly after the transaction closes? Similarly, some production jobs may be at risk if the facility is shuttered.
What is the exit strategy for the PE Group? Throughout the acquisition process, the PE Group will inevitably be evaluating the opportunities to realize a return on and monetize their investment three to seven years into the future. Similarly, is the owner comfortable with another sale of their company in three to seven years?
Finally, PE backed companies typically have more extensive reporting requirements and have more regular and structured board meetings than are currently in-place. The increased structure may be a large cultural shift for the company and an adjustment for employees.
Significant benefits to selling to a PE Group include the opportunity for the owner and their management team to reinvest/invest alongside the PE Group. In this case, the owner will have the opportunity to realize the proverbial “second bite at the apple” and management will have the opportunity to own stock in their employer.
Many managers have become millionaires by investing alongside the PE Group in a transaction. It should be noted that many PE Groups will not acquire a company if management will not co-invest with them.
In addition to management making a direct investment in the company, PE Groups typically structure generous management equity incentives such as profits interests, phantom stock, stock options, and stock grants. Some or all of the equity incentives typically vest based on the passage of time or the realization of financial objectives. In many cases, the equity incentives only have value in the event of a liquidity event.
PE Groups provide significant financial resources to the company. PE Groups are willing to invest in a variety of initiatives that the owner was not willing to consider due to age or risk profile. Investments can include acquisitions of businesses or product lines, the purchase of new production equipment, the addition of new senior leadership, the addition of sales people, and IT upgrades, for example.
Finally, as mentioned above, PE Groups will establish an active board of directors. PE Groups have extensive relationships in many industries to identify strong board member candidates with differing backgrounds, areas of expertise, and contacts. These board members will support the company and the management team as they investigate new business opportunities, seek to enter new markets, and make acquisitions. They can also make introductions to new customers.
In conclusion, the PE Group buyer can be a terrific option for an owner considering the sale of their company. The owner must determine though whether the PE Group model is right for them, their company, and their employees. As with any transaction, the owner must proceed with “eyes wide open” to understand how the PE buyer, or any buyer, approaches these transactions both before and after the closing.
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