Last time, we discussed special purpose acquisition companies, more commonly referred to as SPACs, (“SPACs”). Today, we’ll discuss a similar, albeit more traditional, type of buyer that someone selling their business may encounter, private equity firms, (“PE firms”). In today’s article, we’ll discuss what PE firms are, as well as what considerations a seller should have when selling to one.
How Private Equity Firms Work
Similar to SPACs, a PE firm is a company that exists primarily to invest money in small businesses, in hopes the company will grow and eventually provide a big return on investment. However, there are some key differences.
First, PE firms aren’t shell companies like SPACs. They are established companies with a portfolio of businesses they have invested in. Furthermore, PE firms invest their own private capital, as opposed to raising money via an initial public offering (“IPO”) like SPACs. Another key difference is that PEs usually want the current owner of the company being purchased to remain with the company after the transaction. This is because PE firms don’t typically participate in the operation of the company, rather they support it with financial and human resources.
PE firms look for small, privately owned (although occasionally public), companies that are stable or growing in their industry. Using the PE firm’s funds, they purchase a majority share of the company, keeping current leadership in place until a later exit date, usually a period of 5-7 years.
Their goal is to grow the business during that time and receive a larger return on investment due to an increase in the company’s value. In exchange for the support they provide, PE firms will charge management fees on invested assets, as well as require a percentage of revenue. These fees are a main source of income for PE firms, although the actual fee structure can vary from firm to firm.
Whereas a SPAC looks to get a quicker payout by raising funds through an IPO, buying out a company, taking it public, and banking on massive growth over the span of 1-2 years; a PE firm generates revenue by providing current ownership with funding, resources, and guidance, in exchange for fees and other payouts. Unlike SPACs, it is a longer-term strategy that’s not as dependent on the final sale price at exit time. Having gone over PE basics, let’s now turn to what this could mean for a seller.
Considerations For Sellers
The most important consideration for any owner contemplating a sale to a PE firm is whether they wish to remain with the company after the transaction is complete. As mentioned above, PE firms generally want the current owner to remain with company until a later exit date since they aren’t involved in the day-to-day operations of the business. If an owner is planning to sell the company for the purpose of retirement or to move on to a different venture, a PE firm is likely not an ideal buyer for the business.
However, a PE firm is a great option for a small to mid-sized business owner who is ready to scale up their operation but may lack the resources to do so. Selling to a PE firm is often preferable to selling to a competitor and gives business owners a relatively simple way to get funding to grow their business. Furthermore, it circumvents the need for raising capital through an IPO, which can be an expensive and time-consuming process.
Overall, PE firms are a great option for an owner that is willing to get a smaller initial return from the sale of their business with the promise of a larger one down the road. Even though they won’t be majority owners, they’ll still continue running their business with the help of the PE firm until the exit date. It’s not without risk, as the later payout depends on finding another buyer, and on the company continuing to grow during the period after the initial sale. If an owner is willing to take that risk and remain, selling to a PE firm can have big upsides.
Conclusion
In summary, PE firms are companies that look to make money by infusing their private capital into small businesses, helping them grow, and eventually selling them, all while charging management fees and receiving a share of the revenue. They will often want current ownership to remain on board and the initial payout for the seller will be less, which is counteracted by the potential for a larger payout down the road.
If you are considering selling your business and would like help with identifying the right buyer, email sseck@seckadvisor.com or call 913-815-8481 to let us know how we can help you with your merger and acquisition needs today.