If you own a company, you've probably received a call or a letter from a private-equity firm. You may even have received dozens of such inquiries, most of which contain much flattery about your business and how they might be interested in buying your business.

While getting these inquires can provide a nice ego boost, and some validation for all your hard work, I am sorry to report that it's all part of a marketing campaign. That said, investors are constantly on the prowl to invest in the right kinds of businesses--and one of those might be yours.

That's why one of the questions I get asked all the time by entrepreneurs is whether or not they should sell their company to a private-equity firm and is it a victory or a defeat when they do.

The short answer is: it depends. Let me explain.

For those of you who don't know what a private equity firm is, it's essentially a business that raises money from investors in a fund that will last around 10 years. These investors, who might range from wealthy individuals to pension plans and insurance companies, seek a return on their money that exceeds the average stock market return. You can think of them as savvy bankers who will do debt and equity deals.

To provide that kind of healthy return, private equity investors are constantly looking for companies who have good management teams, operate in growing markets, and who have tons of upside. The only thing these companies lack is enough capital to take advantage of all the opportunities ahead of them--which is where the private equity comes into play.

In exchange for their capital, a private equity investor will take a partial ownership of the company--either a minority or majority stake. Then, in five to seven years, they will seek a return on that investment (the time frame depends on how old the fund is as well)--either through a total sale of the company or by selling their stake to a strategic or financial buyer. That's how they provide a substantial return to their investors.

But it's important to note that private equity investors rarely buy 100% of a company and let the newly wealthy founder walk away to pursue their next adventure. Rather, these investors usually want to buy a partial majority stake in the business while keeping the founder around to continue to scale the business by chasing down all those opportunities they couldn't before, while increasing the value of the company in the process. So much for immediately retiring to a warm and tropical location.

There is another catch as well: if you sell a stake of your company to a private equity investor, you are also bringing on a business partner. They will insist on some level of involvement or control of the business--through board seats or provisions in the operating agreement--that will allow them to keep a close eye on their investment. That's why it's also essential for entrepreneurs to choose wisely when it comes to their investors. Ideally you should be looking for those who have experience in your industry and has good behavior in good times and bad.

So how do you know if selling to a private equity investor is right for you?

First off, if you're happy running a profitable company that's growing and you have plenty of cash to chase opportunities, then selling might not be right for you. And that's great; congratulations!

Also, if you want to exit your business entirely, you'll need to look at private equity and other options--which is a topic I'll discuss in a future post.

One great reason to sell, on the other hand, would be if you see lots of opportunities for growth that you simply can't pursue on your own. Many entrepreneurs dream big where they want to disrupt entire markets and industries--which can be difficult to do without access to a large amount of capital depending on the business model.

It can also make a lot of sense to sell if you are interested in taking some money off the table and into your pocket while also getting the chance to build up the value of your remaining equity stake with the help of the influx of capital. That could truly be a win-win scenario for both the entrepreneur and their investors. Many times, that second bite of the apple can be as large or larger than the initial partial sale.

What's interesting is that some people have the view that selling to private equity is somehow an admission of defeat--that the company couldn't make it on its own. But this would be a rare circumstance. Think about it: if you were an investor looking for above-average returns, why would you invest in a failing company? Even experts in turning around companies, which is a specialty within the private equity sector, readily acknowledge how hard and unpredictable that job is.

That's why when most private equity groups look to invest, they are looking for great management teams who are chomping at the bit to grow and chase down every opportunity they can. Rather than an admission of failure, this is more about issuing a challenge to see how much more you can accomplish if access to capital is no longer an issue.

So when it comes to question of whether or not you should sell to a private equity investor, ask yourself what you want your legacy to be. Are you satisfied with where you company is headed or will you regret leaving some opportunities on the table and need the influx of capital to truly change your industry? Either way, you are declaring victory.

Jim is the author of the best-selling book, "Great CEOs Are Lazy". Grab your copy on Amazon!

Published on: Jul 19, 2016
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