Selling Your Business to a Private Equity Group
When it comes time to sell your business, you have several pools of buyers to consider. You can sell to your employees, friends or family, an individual entrepreneur, or another business in your industry (strategic buyer). There’s another much smaller set of buyers frequenting BizBuySell’s marketplace with much deeper pockets: private equity groups.
Whether you’ve already been contacted by a private equity group or are just researching your options, this article will give a brief introduction to these groups, their motivation, and what to expect when selling your business.
What Are Private Equity Firms?
Private equity firms are financial companies that invest in established businesses to drive future growth. Private equity investors purchase companies to make them profitable over a short period of time, usually three to five years. In contrast to a strategic buyer (like a larger company) that acquires a single company, private equity investors normally invest in multiple businesses.
Unlike a venture capital firm that typically invests in startups with the goal of bringing them to an initial public offering (IPO), private equity firms work with established public and private companies with a track record of financial success and a strong business valuation. Today, private equity firms operate in multiple industries, from high-tech and retail to healthcare and manufacturing.
What Is the Goal of a Private Equity Firm?
The goal of a private equity group is to increase revenue for their portfolio companies and eventually sell them for profit to other private equity groups or through an initial public offering (IPO).
To profit from a final sale, private equity investors buyout business owners to revamp a business model to drive top and bottom-line growth, usually through streamlining operations, restructuring human capital, improving products and services, and enhancing market differentiation. This process, called recapitalization, enables the private equity firm to increase the business valuation of the company in preparation for sale.
How Do Private Equity Firms Make Money?
Ultimately, private equity groups make their money through the sale of the company they’ve invested in over a period of time, usually 15%-20% of the final sale price. Because interest payments on debt are tax deductible, this “carried interest” enables private equity firms to make a profit regardless of whether or not the company they sell is profitable.
However, crafting an exit strategy that maximizes the business valuation of the company improves the profitability of a buyout from an equity investment and limits the negative aspects of some buyouts, such as layoffs. A growth-centric strategy also serves as an incentive for business owners.
What Types of Businesses Do Private Equity Firms Invest In?
When deciding whether or not to invest, private equity investors conduct extensive due diligence to assess the company’s financial performance, opportunities for growth, current cash flow and debt, management team, and brand strength. They’ll also often look for synergies with other portfolio companies they own and sometimes broker mergers between similar companies.
While a private equity buyer most commonly invests in private companies, they also will work with public companies and sometimes take them private. It’s more common that they’ll work with larger enterprises, but small business owners can also leverage private equity funds.
How Are Private Equity Firms Funded?
Private equity groups hold pools of investments from high net worth private investors, usually from pensions, endowments, insurance companies, family offices, or other personal wealth funds. These investments represent the equity that investors leverage for direct buyouts of private and public companies as part of the recapitalization process.
While less common than in the past, sometimes private equity firms will use debt to finance an acquisition in what’s called a leveraged buyout. In this case, the private equity group will take out a loan with an investment banking firm for a majority of the purchase. The firm will then use its own equity for a small percentage of the overall purchase.
What Are the Advantages for Business Sellers?
There are two types of sales when it comes to a private equity investment: a full buyout and a majority buyout. In a full buyout, private equity firms acquire 100% of the business and transfer all assets to the investment firm. This often involves a total leadership change and a significant overhaul in business operations, headcount, and strategy. The benefit for the seller, in this case, is the direct transfer of money in exchange for the company, enabling the seller to retire, invest in new ventures, or pursue other opportunities.
More commonly, private equity will do a majority buyout where they purchase, say, 70%-80% of the overall business, while keeping the original management team in place. In this case, business owners can stay on for a longer period of time while using the private equity investment for the recapitalization process.
This enables the business owner to continue influencing the company’s products, operations, and strategy and maximize the value of the private equity investment. They can then sell their remaining shares later at a higher price in what’s called a “second bite.”
What Are the Disadvantages?
Some private equity firms simply act as financial investors, while others want to be actively involved in the day-to-day operations of the business. While many private equity firms align strategically with their customers and invest with the intent of growing the business and making it more successful, there are some firms that have a reputation for cost-cutting, staff reduction, high fees, and overly aggressive and unrealistic goals. For larger companies, private equity is known for dividing up business units and selling them off as separate entities to garner a profit, which ultimately negatively impacts the seller.
Before selling to a private equity investor, consider whether they’ll operate as a strategic partner that’s likely to invest over a longer period of time, as opposed to a short-term, opportunistic sale that’s focused more on PE profit than long-term value. The key to a successful buyout for both parties depends on the private equity’s history, current client, industry specialization, and deal structure. Ensure you do your research.
Turn to Trusted Advisors
If you've been contacted by a private equity group about buying your business, make sure you have an attorney, CPA, and intermediary on your side. You will benefit from experienced professionals who will give you dispassionate advice about the best course of action. To find local business brokers and set up consultations, see BizBuySell's Business Broker Directory.