7 Things to Consider Before Selling to a Private Equity Firm

Have you recently received an offer from a private equity group or know someone who has? 

Your initial thoughts may be: 

Who are these guys? What are they like? 

If I were to sell my business to them, what is the process like? Where do I start?

Private equity firms are some of the most sophisticated financial professionals out there. Their sole focus is buying businesses, making them more profitable, generating a return for their investors, and exiting, often within a 3-5 year time frame.

We want to ensure you aren’t left to swim with the sharks without any protection. This article will cover seven things you should consider before you sell your business to a private equity group. 

Let’s jump in. 

1. The PEG’s Level of Sophistication

Some private equity groups are not very experienced, whereas others are established and have a high level of sophistication. Regardless of the PEG’s experience, they are usually well-educated and knowledgeable about business acquisitions. 

When you encounter a PEG buyer, you will want to be prepared. Before you enter into due diligence with them, make sure your financial books and records are clean. They will have an accounting firm perform a quality of earnings on your financials to confirm the earnings you’re representing are correct.

One thing to note is that many PEGs reach out to business owners without a merger and acquisition (M&A) advisor because they’d prefer to have a proprietary deal. Most experienced M&A advisors will advise you to avoid proprietary deals because it reduces your negotiating power and your ability to get a competitive price for your business. 

However, that is not to say that you should never sell to a PEG - but you shouldn’t hop in the ring without having your advisor help you understand what kind of deal you're getting and without multiple buyers driving the price up. 

2. Deal Structures That Are Common With PEGs

If you sell your business to a PEG, two of the most popular deal structures are a majority recapitalization (majority recap) or a full buyout. A majority recap allows you to sell a majority of the business while retaining minority interest and staying on with an equity stake in the company. 

If you are interested in staying on for a little longer to get a “second bite of the apple” from selling your minority stake in a few years, the PEG can help you achieve this.  

To determine if your goals align with the PEG’s, consider if you want to sell your entire company or remain with the business for a few more years and only sell a portion of it. If you only want to sell a portion, you should think about what level of management you would be comfortable with. 

3. Does the PEG View Your Business as a Platform or Add-on? 

The PEG may view your business as either a platform or an add-on for their portfolio. A platform is a company that will serve as the foundation of their investments in that industry. An “add-on” or “bolt-on” company is one that would be “added on” to a platform company they already own as part of their portfolio. 

If your business is considered a platform, the PEG may need to do in-depth research to get comfortable with your industry. This could lead to them having a lot of questions in due diligence.

If your business is considered an add-on, the PEG would act more as a strategic buyer in this instance. 

4. What is The PEG’s Typical After-Sale Involvement?

Some PEGs will be passive, financial investors, whereas others will be actively involved in the day-to-day operations. 

The level of the PEG’s involvement comes into play when you sell your business via a majority recap and retain part ownership since you’ll be involved on a day-to-day basis. 

Make sure that their management style fits what you would be comfortable with by working with your M&A advisor to get to know the buyer during the courting process. 

As an entrepreneur, it can be tough going from running your business on your own to being an employee for a larger group. You need to be honest with yourself and consider “Am I comfortable being an employee?” That question will help you decide what type of sale is right for you.

5. How Long Does The PEG Hold Companies?

PEGs often hold businesses they acquire for 3-7 years. However, we’ve seen as short as one year and as long as 20 years and beyond. Different PEGs have their own average holding period based on their goals and how they’re funded, but it typically boils down to their return on their investment (ROI). 

If they can get a significant ROI for their investors in only 3 years, they may sell it quickly. However, if they need to hold the business a bit longer to receive a better ROI, or if they plan on pursuing a longer-term add-on strategy, they might hold the business longer. 

Since every PEG is different, work with your advisor and ask PEGs what their average holding period is. This will matter when you are doing a majority recap since it will dictate how long you will be able to continue working within the business before they sell.

6. How is The PEG Funded?

Some private equity groups will have funds available to purchase your business right away, while others will need approval from their investors before they will have the funds to buy your business. The different ways a PEG may be funded include: 

• Committed capital - the PEG has already received money from their investors and they have available funds to put towards buying the business right away.

• Pledged capital - the PEG has investors who promise to fund them if they find a good investment. In other words, they have to receive permission from their investors to fund the deal, which could derail the deal after an offer has been signed if you're not careful.

• Blind pool - the PEG finds a suitable investment and receives money from a group of investors and pools it together to purchase businesses. 

As a seller, the best-case scenario for you is if your PEG buyer has committed capital. Committed capital allows the PEG to move forward with the deal without having to loop in investors on all decisions. 

7. Is The PEG a Strategic Buyer?

If the private equity group that is considering buying your business already owns a platform company in your industry, their platform company is a strategic buyer, which changes the dynamics of the deal and whether they’d be willing to pay you a premium for the business. 

This will affect you the most if you do a majority recap because there will be two layers of management you will encounter.

Instead of reporting to just one management team if you were to be bought as a platform business, you'd be reporting to both the management teams of the platform company and the PEG's management team. 

If the PEG owns a strategic, you should ask yourself if you are comfortable sharing sensitive information about your business with them. If they are a close competitor, you may want to have them meet with your advisor first to go over only high-level financial information.  

If you are flexible with your selling goals and would be open to a PEG/strategic buyer, this could turn out well and offer you a premium for the business. However, if you do not want to be managed by the PEG, this additional layer of management could prove to be an issue.

Sell Your Business to a PEG With Confidence

By knowing a private equity group’s level of sophistication, type of funding, level of involvement, holding period, common deal structures, and how they view your business, you will be better prepared when selling to them. 

An M&A advisor will be able to help you get the best price and terms from a PEG and can help you prepare for their intense due diligence process.  

If you don’t know what a private equity group is or you want to form a better idea of what type of buyer they are, read our blog “What is a Private Equity Group?” 

At MidStreet, we vet private equity buyers every day and help our clients get the best price and terms for their business. Call us today to discuss the different types of buyers for your company.