THE LURE OF PRIVATE EQUITY
by John Leighbody
When an individual business owner begins thinking about exit strategies, one often-mentioned option is the potential sale of the business to a Private Equity (PE) firm. Despite the seeming enthusiasm of many bankers, investment advisors, lawyers and accountants, there is a harsh reality to Private Equity that business owners should understand before they decide to pursue this path.
The first thing a business owner must recognize is that PE firms review hundreds, if not thousands, of "opportunities" on an annual basis. On average, in a good year a typical PE firm might do a grand total of five transactions. And that is a generous number. Do the math, and you can see that the odds are against you from the beginning in getting a transaction completed.
It is true that PE firms are sitting on a great deal of capital, but they are extremely judicious in how they spend their money. If you visit a PE firm's website, you will notice they list the criteria they use in order to evaluate an investment. If your business does not have the attributes they are looking for, you will not be considered. Quite frankly, most businesses do not match their criteria.
Another issue you will arm wrestle over is value. You and your advisors may have a good idea of the value of your company, but in the private equity world they will have some very different ideas on valuation. Most likely, it will be lower than yours!
Another obstacle in front of you is time. Time and again PE firms claim that they are different, don't want to waste time, and will get you an answer sooner rather than later. There may be some firms that work this way, but not many. You can expect a fast no and a very slow maybe. First they will examine your financials for the past three to five years (these should at least be reviewed if you do not have them audited.) Then they'll develop a list of questions and, if satisfied with your answers, begin the due diligence process. This is an extremely tedious process, and very time consuming for the owner, especially if there are several firms vying for your company.
For the sake of discussion, let's assume you have gotten the attention of several PE firms, submitted financials and entered into the due diligence process, met with the principals of the PE firms and are awaiting a LOI (Letter of Intent). At this point you have expectations - and typically the LOI leaves you short of breath. The number is below your expectations. The PE firm justifies its actions, and usually for reasons you never even considered, such as the economy in Europe, a drop in multiples due to potential tax increases, etc. There is hope, however: an earn out(getting extra money if certain benchmarks are met within a period of time) which will get you close to your number, but in order to meet these benchmarks you will need to stay engaged with the company...so your exit is set back.
Now, does this happen all the time? Of course not, but this is more the norm. While PE might be a good option for some businesses, it is not a solid option for most businesses for the reasons mentioned above. If you are evaluating exit strategies for your business, don't get overly enamored with Private Equity as an option.