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This
article is the second of a two-part series.
The first considered whether or not private equity is a
potential option for business owners. The second part considers the range of ways to find private
equity, the factors that should be considered when choosing from these
options, and the criteria that should be used to select the right
private equity firm.
Part
2:
1)
What options
exist for identifying and approaching private equity groups?
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Direct
approach: By doing
basic Web searches or working through organizations like the
Association for Corporate Growth (ACG), it is possible to generate
a target list of firms whose criteria matches your client’s
business and situation. Private
equity groups are accustomed to talking with business owners as
well as their advisors and are easy to approach directly.
Some are actually quite personable!
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Business
brokers: These
individuals are typically compensated on a success fee basis — they receive a commission if and only if a business is sold.
These fees can be paid either by the private equity group
or the business owner. Business
brokers identify a few potential matching firms, develop a set of
background information on the company, and help to manage the
communication between the business owner and the investor during
the process. Intermediaries
and business brokers can be found through the International
Business Brokers Association (IBBA) as well as the Alliance of
Merger & Acquisition Advisors (AMAA) and the ACG.
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Investment
bankers: These firms
are hired by business owners and paid monthly retainers in
addition to success fees. Investment
bankers enter into exclusive relationships with business owners,
provide guidance on valuations, and develop background information
on the company and its relevant industry.
Once this is done, bankers contact several private equity
groups and run an auction process that is typically broader than
that conducted by business brokers.
Finding an investment banker is probably most easily
accomplished through 1) the Association for Corporate Growth or 2)
a Google search, probably oriented around the few larger cities
nearby. Investment bankers are a little more "high
end," so you tend to find them in larger metropolitan areas.
2)
What factors
should be considered as you decide how to identify and approach
private equity groups?
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Size
of business or capital need: It
is hard to attract investment bankers to consider small
transactions because success fees are calculated based on the size
of the transaction — small transactions generate small fees. While the “break point” has evolved over the years, it
is generally difficult to find investment bankers that will sell
companies with less than $10M in revenues, or raise less than $5M
in equity for growth equity or venture capital situations.
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Type
of transaction: Early
stage situations are generally handled directly with venture
capitalists. Companies
that are somewhat more mature (generating revenues, and perhaps
profits) that are looking to raise capital to support growth tend
to work though investment bankers.
Companies that are looking to sell typically go through
business brokers or investment bankers.
This seems to be driven by the preference of the various
types of investors.
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Willingness
to pay fees: Investment
bankers charge monthly retainers of $5,000 or more in addition to
their success fees. Business
brokers often charge only success fees and may not require
retainers. If your
client is not interested in paying fees, it is very easy to find
business brokers that will have their fees paid by the buyers — private equity groups are very willing to pay the fees themselves
simply for having the chance to hear about the investment
opportunity!
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Desire
to receive maximum value: Because
investment bankers run auctions, business owners may receive the
highest price if they go through a formal process. However, by contacting a few private equity firms, your
client is likely to receive an attractive market price.
Clients that decide to pursue a formal auction run by an
investment banker should be confident that the investment banking
fees will be less than the incremental value received for the
business.
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Complexity: This is a double-edged sword. If your client has a complicated situation, a strong and
experienced advisor will be more capable of helping in order to
explain these issues and recommend solutions. On the other hand, intermediaries and investment bankers
typically earn the majority of their income through success fees.
The less likely it is that a transaction will be
successfully concluded, the harder it will be to get the attention
of the best advisors. If
your client has a complicated situation, be sure that they have
strong accounting and legal advisors with expertise in the
specific issues that will be encountered.
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Level
of commitment: If your
client is sure about wanting to sell the company, paying a
retainer to an investment banker may make sense.
Otherwise, it may make more sense to use a business broker
or go directly to private equity funds.
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Confidentiality: For private business owners, confidentiality will be
critical for a broad range of reasons. Private equity groups, intermediaries and investment
bankers all sign (and adhere to) confidentiality agreements as a
matter of course, so you should either consider the standard
agreements that they provide or have an attorney who is
experienced in mergers and acquisitions provide an agreement that
makes your client comfortable. If you do not go directly to private equity groups, make
sure that you understand how your business will be marketed — how many groups will be approached, what they will be provided and
where (if anywhere) the business will be advertised.
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Desire
for a “buffer”: Keeping
the communication lines open can be critical when negotiating with
a private equity group and a skilled business broker or investment
banker can play a vital role in keeping things moving. In addition, it may be easier for both business owners and
investors to say things to each other indirectly that they could
not say to each other directly.
3)
Once you’ve
been presented with potential private equity firms, you and your
client will need to select a firm that fits.
Fit impacts both the likelihood that a business will actually
be sold, or receive the necessary investment, as well as your
client’s post-transaction satisfaction. Several factors impact this:
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Chemistry: The
personal dynamic that exists between the business owner and the
potential investor is important. Along the way to closing, surprises are bound to occur, and
the ability of the two parties to get along and find solutions
will be critical in overcoming them.
In addition, if the owners intends to remain involved with
the business after closing, personal chemistry will have a core
impact on their ability to make productive business decisions.
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Objectives: Business owners must know whether or not they wish to
retire, are determined that family members remain in critical
management roles, or if a private equity fund agrees with the
logic of a key business investment.
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Size: Business owners should know whether the investment required
would be large or small for the private equity investor. If the investment required is too large, the fund may have
difficulty raising or committing the capital.
Conversely, if the investment is very small, the private
equity fund may have difficulty dedicating appropriate human
resources to get to closing, and also not pay adequate attention
post-closing.
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Investment
type: The business
owner may have the best new technology idea in the world, but if
the investor only does buyouts, no amount of persuasion will
convince the private equity group to consider a different
opportunity.
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Business
type: Business owners
need to see parallels between the types of businesses that private
equity groups have invested in historically and their own. Firms that invest only in service or technology firms will
struggle to get comfortable with manufacturing operations and vice
versa.
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Access
to capital: You need
to find out whether or not the private equity firm actually has a
“committed” fund or if they will need to raise the capital for
the investment. In
addition, other types of capital such as bank debt will be
required. You and your client should explore the breadth of
the network of financing relationships that the private equity
group has.
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Experience: Business owners should focus on firms that have a track
record of completing investments and those that have been
successful building the value of firms with which they are
involved. If they have
a business that fits any of the private equity investing styles,
they will certainly have options from which to choose. There’s no need to learn the process along with their
prospective investor partner!
Metapoint
Partners is a 15 year old private equity group that has completed 27
buyouts of privately owned industrial or commercial manufacturers.
The companies that Metapoint has invested in have typically
been small by industry standards, with as little as $8,000,000 in
revenues and $750,000 in operating profits. Metapoint is currently investing its
fourth committed equity
fund, raised exclusively from a group of retired CEOs of Fortune 500
companies. Erik can be
reached at (978)531-1398x8 or erik@metapoint.com.
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