If you run a successful, fast-growing business, chances are that you might encounter private equity firms interested in buying your company. Many of us regularly get marketing letters and e-mails from them indicating how amazing and valuable our businesses might be were we to sell.

While that can be a thrilling development for an entrepreneur, it's worth knowing how those private equity firms think about you and your business--and how they will try to maximize their investment--before you take the plunge in selling to them.

The first thing you should realize is that most PE people are bankers and investors--not operators. They've never sweated making payroll or doing the dirty work to fix margins like you have every day of the week. Many of them will have MBAs and other advanced degrees from big-name schools. They are smart and analytical: they love spreadsheets. Which means they might understand your business as a financial entity, but not in the way gut-level way that you do.

So before you decide to sell to a PE firm, there are three common behaviors you should be aware of about how they will act to help maximize their return on investment. 

1. They take of themselves first. The best PE firms never overpay when they buy a business. They use their analytical skills to buy intelligently. But just as importantly, they always structure the deal in a way that helps them make money. That might mean they get preferences when there are payouts or load the business up with debt to ensure great returns for their capital.

Once the business begins to make serious money, for example, PE firms are notorious for issuing themselves significant dividends--sometimes equal to the amount of capital they invested in the business. Why would they do something like that? The short answer is because they can.

2. They know when to sell. Very few PE firms buy a company with the intent to keep it over the long term. Their goal is to sell the firm, sometimes to another PE firm, for more than they paid for it as a way to generate a return for their investors, usually in 5 to 7 years after their investment. That means that if a PE firm buys you, they will often look to find ways to generate short-term profits as a way to drive up the value of the company. That often means they can force you to make decisions and take actions that aren't in the best long-term interests of the business.  If you aren't willing to make these moves and try to protect your firm, they go to their next option.

3. They will fire the CEO. When PE firms begin courting a business they want to buy, they will often say all the right things--including how much they value the current management team. They will tell you they just want to become partners in helping you grow the business. But research on deal data tells a different story: the majority of CEOs are terminated in the first year after a PE firm buys a company. One reason this happens is that if a company isn't performing as well as the investors want, or the PE firm overpaid for their investment, they need a scapegoat.  But most of the time, it's a disagreement about what is right for the business.

For example, I was recently working with a CEO of a company who sold to a PE firm. The CEO was a seasoned entrepreneur with 30 years of experience who had grown the company into a multi-hundred million dollar business from nothing. In this case, the PE firm who bought the business had to fight off several other suitors, so they overpaid and then loaded the business with debt. A year later, the company reported soft financial results--which put enormous pressure on the PE partner who sponsored the deal. So he decided to fire the CEO and bring in a new guy as a way to help justify his decision to make the deal. To be fair, the CEO had basic disagreements with the  ownership about the path forward and wasn't being too cooperative in the effort to improve the figures.

However, it isn't all doom and gloom.  Many entrepreneurs make the transition to private equity ownership well and have an incredible experience.  The key is an understanding of the motivation of the new ownership, moving with pace on issues of importance and building trust that you and they are aligned (mostly).

The point is that if you are interested in selling your business to a PE firm, first understand that their motivation is to generate the very best return they can on their investment and you need to be aligned with that or risk your position. And to do that, they will rely on these three blunt-force tactics to do that.

Published on: Mar 20, 2018
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