|
This article
is the first of a two-part series. The first considers the question
of whether or not private equity is a potential option for business
owners seeking liquidity. The second part considers the range of ways
to find private equity investors.
Part 1: Is private
equity an option for business owners?
A business owner’s decision to sell
his or her company or take on an investor partner can be wrenching
given their level of emotional and financial investment. Most business
owners take this step only once in their lives, and their choice will
have a sizable impact on themselves, their managers, employees and
community. The great news is that business owners have far more
choices today than ever before. CPAs as trusted advisors to business
owners can play a vital role in the decision-making process by
considering a series of basic questions for determining whether
private equity is an option that should be considered.
Should
business owners consider private equity?
If your client is considering selling
his/her company or needs to raise capital, you (almost) must consider
private equity as an alternative. In the early 1990s, private equity
was still a fairly small and highly specialized business. Over the
last decade, the amount of capital raised by private equity groups has
exploded. During the last three years, however, both the number of
businesses for sale and the volume of attractive entrepreneurial
business ideas have been reduced sharply from the levels of the late
1990s. This has placed tremendous pressure on private equity funds to
put money to work. As a result, late stage private equity funds (in
particular) have been extremely aggressive in their pursuit of
investment opportunities. Metapoint’s own experience reflects these
market realities: of the 23 companies we have sold over the years,
only one has been sold to a corporate/strategic buyer.
Is
the business or opportunity the type that is potentially attractive to
private equity groups?
With the explosion in the amount of
private equity available, investors today consider a far broader range
of businesses and opportunities than they did just a decade ago. The
best investors specialize in order to be successful in this
increasingly diverse and competitive environment. Several core
characteristics of the business determine which type of private equity
investor might be appropriate for your client’s business. The
following profiles reflect broad generalizations about the business
characteristics pursued by the most common types of institutional
private equity investors:
-
Venture Capital.
Candidates can have little or no revenues, but are most likely to
have high- technology-differentiated products that meet the needs of
huge industries or applications. Management strength is critical in
their evaluations given the central importance of execution to
successfully realizing explosive growth. However, some of the most
experienced, very early stage venture capitalists can be helpful in
building and recruiting key managers. Minimum investment sizes can
be as little as $3-5 million for national firms.
-
Growth Equity.
Attractive candidates have as little as $5-10 million in revenues,
may or may not be profitable, but should demonstrate growth rates of >20% per year. Industry opportunities don’t need to be as large as
in venture capital, and growth equity investors can get comfortable
with this smaller opportunity because the businesses themselves are
more proven. Growth equity investors focus on a mix of tech and
non-tech products and services. Management teams are typically
strong and almost complete, although there may be need for specific
role players. Minimum investment sizes are typically down to as
little as $3 million for national firms, but regional Small Business
Investment Companies (SBICs) will invest as little as $1 million.
-
Growth Recapitalization.
Attractive candidates have more than $10 million in revenues,
generate over $2 million in operating profits, and are growing 10%
or more per year. Businesses generally are low technology. Markets
tend to be somewhat more niche-oriented. While growth is important,
some level of stability and maturity is valuable because debt will
be used to finance the recapitalization. Management strength is
important but not as critical as with VC or growth equity. Growth
recapitalizations may involve transitioning an owner/operator away
from the CEO role to a specialized role such as sales or product
development. Equity investments may be as little as $3 million; but
because recapitalizations appear similar to complete sales, the most
relevant measure is transaction value, with minimums of as little as
$10 million.
-
Buyout.
Attractive candidates have more than $10 million in revenues and $2
million in operating profits, although it may be possible to find a
very few firms that will target companies even smaller (ours is one).
Growth is not necessarily a requirement since businesses are generally
low technology, mature and stable companies. Industries and
applications are typically very niche-oriented and smaller.
Management strength is not as important. Investors may be able to get
comfortable with their ability to recruit managers during a
transitional period given the relative stability of the business.
Equity investments generally are greater than $3 million, but it is
possible to find investors willing to invest as little as $1 million.
What Are the
Business Owner’s Objectives?
If the business
and situation is one that could fit into one of the investing styles
outlined above, business owners probably have a choice about whether
or not to consider private equity. For those business owners with a
choice, there are a number of objectives that private equity groups
are particularly well suited to address, as compared to strategic
buyers:
-
Confidentiality. Private
equity funds are not direct competitors of business owners and
typically have very small investment teams. The risk of evaluating a
potential sale or investment is much lower than it is with talking
with a corporate buyer.
-
Desire to
retain upside. Virtually
all private equity groups use structures in which business owners keep
significant ownership stakes in their businesses post-transaction, or
can use other structures that allow current owners to benefit from
future growth in value of their specific business.
-
Desire for
management team to get equity in business.
Private equity groups understand that the economic motivation of
management teams is one of the most powerful incentives available.
All investor types use structures that provide significant equity
stakes for key managers.
-
Desire for
business to remain independent.
Private equity groups understand that there are significant risks
associated with the moving operations; and, generally speaking,
maintain companies as independent entities retain their brand names,
etc.
If a business
owner’s company and objectives are well suited to one of the private
equity investing approaches and they prioritize any of the factors
outlined above, private equity is likely to be a very attractive
option. Should you have a client that could be a private equity
candidate, the second part of this series will outline the best way to
find a private equity investor.
|
