What’s Your Exit Strategy? Understanding Private Equity Groups
Selling your business may not be on your mind now, but every owner needs an exit strategy.
As a result of The Baby Boomer Effect, over 60% of privately held U.S. businesses will change ownership over the next 10 years. Increasingly, the exit strategy of choice will be a sale or recapitalization to a Private Equity Group (PEG), rather than to family members, management or a competitor. There are currently more than 2,700 U.S. based private equity groups, all aggressively in acquisition mode, and they have billions of dollars available to them for investment.
What is a private equity group? A private equity group is a group of individuals whose mission is to purchase portfolio companies, usually privately held, own them for 3-7 years and sell them at a significant profit, producing greater returns than those achievable from holding a typical portfolio of public stocks. The PEG generally returns approximately 80% of the profits to their investors, who put up the acquisition capital, and they retain the balance for their efforts. Private equity groups have been highly successful in their mission to buy, grow and resell companies for significant ROIs. Therefore, there is naturally a lot of money flowing into private equity funds, and there are constantly new PEGs being formed. Even as we continue on a slight economic downturn, private equity funds continue to grow, as the rest of the investment market sees very low returns.
As the private equity market crowds, PEGs are beginning to acquire smaller mid-market companies than before, to compete against fewer prospective buyers. Many of these groups will now consider acquiring companies having $1MM+ in annual EBITDA, and there are aggressive niche players even looking at annual EBITDAs as low as $500K. This trend is creating a tremendous opportunity for business owners who are looking to transition out of their company sometime in the next 10 years. To capitalize on this opportunity, it is recommended that you begin planning your exit strategy many years prior to your eventual exit.
It is important to understand that private equity groups are not in the business of running companies; they are professional investors. Therefore, if you do not have a management team in place capable of filling your shoes, you must either build that team or partner with a private equity group for an extended transition.
As a team of life-long entrepreneurs ourselves, the professionals at Viking Mergers & Acquisitions know that business owners often dislike the idea of becoming an employee after the sale. So why do so many of our clients choose to sell to a private equity group, even if it may require a multiple year employment agreement? Selling to a PEG is often a two-part transaction, called a recapitalization, where they purchase the majority of equity in the company leaving the seller with a minority share, which provides them with an incentive to continue growing the company. The PEG removes all of a seller’s liabilities and personal guarantees, often increases lines of credits, helps attack new markets, sometimes makes additional add-on acquisitions and simply does everything possible to capitalize on growth opportunities that may have not been possible without their partnership, contacts and experience. We have had clients make more on the sale of their minority equity interest on the second transaction than they did on the original sale of their majority equity interest. Most important to many of our clients, PEGs are often able to preserve the corporate culture of a company after their purchase, unlike strategic buyers who are much more likely to make changes in personnel, systems and policies.
So, where does this leave owners of small market businesses? With options and lots of them! Teaming with an experienced M&A advisor that has relationships with the private equity community and understands each of their unique parameters will allow you to capitalize on that opportunity. The key is working with a PEG that complements your goals, if a PEG is in fact the best means to accomplish those goals.
-Greg Ponder, Senior Advisor at Viking Mergers & Acquisitions