As the M&A market has become increasingly competitive, Private Equity Groups (PEGs) have become more aggressive in their outreach to business owners. We have received an increasing number of calls from business owners who have been contacted directly by PEGs. These owners are asking us if they should entertain discussions with the PEG, or if it is ultimately going to be a waste of their time. To answer to this question, let’s first start with some background…
What is a Private Equity Group?
PEGs are investment firms that acquire or make equity investments in privately held companies. Their financial backing comes from many sources including pension funds, wealthy individuals, financial institutions, etc. The PEG raises a fund of committed capital to invest in companies that meet the criteria outlined in the fund’s charter. PEGs commonly make an initial “platform” acquisition in an industry, and then grow the business through the addition of capital and add-on acquisitions. PEGs have hundreds of billions of dollars of buying power and are aggressively seeking acquisitions.
The Private Equity Group Operating Model
The typical PEG operating model is to acquire a company, grow it, then sell it. The time horizon for their ownership is generally three to seven years. Most PEGs model a return on their investment of about 20% per year when factoring in the purchase price of the company, the additional capital investment, and the final exit valuation. Since PEGs are investors, not operators, they typically rely on existing management to continue to operate the company. This may be an ideal situation for an owner who is interested in divesting a majority interest in the company, while at the same time continuing to operate the company and participating in the continued growth of the business. This also means that current employees will play an important role in the company after the transaction is completed.
Private Equity Groups Will Do Partial Buyouts
In addition to acquiring 100% of the company, PEGs will also structure transactions where they acquire anywhere from 51% – 95%. In a very simple scenario, here is how a partial buyout works. Consider a company that has a value of $50 million. The PEG would pay the owner $40 million for an 80% interest in the company, while the seller would maintain a minority 20% stake. If the transaction is financed with debt (which is usually the case) the ownership percentages would be different but the concept is the same. In addition to providing a liquidity event for the owner in the amount of $40 million plus an ongoing salary, the owner would continue to run the company, participate in the increase in the value of the business through his/her minority holding, and be released from personal guarantees.
Transaction structures such as this provide significant benefits to both the PEG and seller because each brings something to the transaction that the other is lacking. The PEG brings money which allows the owner to diversify his/her personal wealth and secure his/her financial future, while the owner provides continuity of management with an incentive to perform.
Should You Talk With the PEG?
If you are considering talking to a PEG that has contacted you directly it is important to ask first whether the PEG has a specific interest in your company or whether their outreach is just a general solicitation. Also, inquire about how many transactions they have completed, the size of those transactions, and the source of the PEGs funds. If you get satisfactory answers to your questions then it never hurts to talk. Here at CenterPoint about half of our transactions in the past 15 years have been sold to PEGs, and we include PEGs in almost every sale process that we conduct. In our experience, however, the best outcomes are not achieved through one-on-one discussions with a buyer, but rather through competition and an organized process. Hiring a qualified M&A advisor to run a competitive process which includes private equity groups and strategic buyers results in the highest purchase price and most favorable terms.
Want to learn more? Give us a call at (818-593-7907). We’re always happy to talk.