Private equity groups (PEGs) currently have an abundance of un-invested capital and are more actively pursuing new investments. For this reason, PEGs are becoming as important as strategic buyers to a business owner looking to sell. Sellers of middle market businesses should be aware of the unique characteristics that come with partnering with PE firms. Here are four to consider:
PEGs acquire companies as either new platforms or add-ons to current investments. It is important to understand a PEG's rationale for acquiring your business, as that can often drive all areas of a deal, from the buyer's objectives to how transactions are structured. A PEG acquiring your business as an add-on to one of its current portfolio companies is more akin to a strategic acquirer and will likely have a slightly different outlook than a PEG acquiring the business purely as a new investment (platform).
Most PEGs use leverage to enhance returns and provide additional access to capital for growth. Additionally, many PEGs also like to see shareholders retain a minority equity stake in the business to align the sellers with the buyer for driving future growth and to effectively put a seller's future growth story to the test. Given these two traits of the new capital structure, it is important for sellers to understand how much leverage is being placed on the business and whether that leverage could overburden the business and put their retained equity at significant risk.
Sellers should perform due diligence on their potential partners, including understanding what value they bring beyond just capital. Does the buyer have operating resources? How well have they performed historically? If they have other investments, have other partners had positive experiences working with the PEG?
Understanding not only the capital structure and a PEG's value creation model can reduce the risk a seller has with retained ownership. It can also provide the opportunity for sellers to gain a very attractive "second bite of the apple" when exiting alongside the PEG in the future.
Depending on whether the buyer is acquiring your business as a platform or add-on, it may have different objectives, particularly relative to the seller. A PEG acting more like a strategic buyer is seeking synergies. Will it want to retain existing ownership? Does the PEG plan to consolidate facilities? As the seller, do you want to retain equity in the business? Developing the right set of questions based on your objectives for the transaction is critical to understanding whether a PEG is the right partner for a deal.
PEGs, particularly ones investing in a new platform, can bring challenges to the transaction process. Due diligence tends to be more exhaustive as PEGs want to be as smart as possible about what they are investing in. Additionally, the need for bank financing, which some cash-rich strategic buyers may not come with, adds another layer of complexity and scrutiny for deals. A seller should understand what approvals a PEG will require to close a deal, what conditions (obtaining bank financing, investment committee approval) are contingent for closing the deal, and what the expectations are for diligence and timing.
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Avondale's Sameer Pal contributed to this article.