The following is adapted from The Private Equity Playbook.
You’ve built a business over many years and have finally decided you’d like to sell your company. You speak to trusted friends and personal advisors about how you should go about doing this (perhaps your lawyer or accountant), and before you know it, you stumble upon an important player in the private equity game: the investment banker. This role is also sometimes referred to in the industry as the advisor.
After researching and evaluating further, you’ll select someone to represent you in the sale of your company. The investment banker or advisor you hire will help you market your company and find potential buyers. They will help you get the business ready for sale by creating marketing material, and then once ready, the process will begin. They will usually outreach to potential buyers with a short teaser to gauge interest.
Initial conversations (known in the industry as “fireside chats”) may take place to generate interest with a select group of potential buyers. As the process unfolds, there could be upward of thirty buyers interested in your business.
One or two of the interested parties could be strategic companies, larger than yours, who are seeking to purchase your company, but for the most part, it will be private equity groups. It’s important for you to know how to evaluate these firms. How do you find the right one? What constitutes the best potential partner to work with?
In this article, we’ll look at five things to consider before selling to a private equity firm. This will demystify the process of selling and help you evaluate different firms.
#1: Price Isn’t Everything
Obviously, price is a big component when you’re selling your company. I’ve been involved in a lot of sales, either as a buyer or a seller, and can attest that many of the business owners focus only on price. Price is important, but it’s not the only factor.
In today’s world, it’s fairly common to run a limited sale process. Gone are the days of sending out two hundred investment books to potential buyers. The more common approach now is to target a small group, say thirty potential buyers, by giving them marketing material, known as your “confidential information memorandum” (CIM). The CIM is a document that outlines the company being sold, its history, products and services, customers, financial performance, management team, and growth strategies.
Out of thirty lookers, perhaps ten will submit an indication of interest (IOI). These ten will be given an opportunity to meet with some subset of your management team to receive a presentation about the company in person. Those ten potential buyers will most likely be asked to present refreshed bids as part of the sales process not too long after the management presentations are completed.
It is common to see a separation in the offers. You’ll have the lead bidders who really want your company and offer the most money. Then you’ll have the rest of the pack. At this stage, ten interested parties will likely become two or three.
The investment bank or advisor will work those buyers against each other to obtain maximum value. Soon after, you will receive one or more letters of intent that spell out salient terms of their purchase offer, and you are off and running!
Oftentimes, the business owner looks at price and picks the highest bid. If your goal is to sell and retire, this may be the right call to make. But if you care about your employees or are concerned about legacy, dive deeper into the potential buyers.
#2: Consider Sticking Around
You should also consider sticking around and not fully retiring.
It can be very lucrative to partner with private equity. You’ll get subsequent paydays when today’s buyer sells three to seven years from now. It’s possible to get secondary paydays that potentially can be even larger than the first, and if you are staying, price isn’t the only important factor; rather, it’s how the relationship between you and the private equity firm will be managed after the sale.
One thing to keep in mind: private equity firms may buy companies, but they invest in management teams. A motivated seller who wants to continue with the business is a positive for buyers. If your company is to become a platform investment, your staying on may in fact be critical to getting a deal done.
Transitions are OK, but stability for some minimal amount of time is absolutely necessary. Having a strong second person in command who can take over for you can be helpful to your exit, whenever that time does come.
#3: The Importance of Outside Counsel
Before you sell, you must engage competent legal counsel and tax advisors. Law, like practicing medicine, includes generalists and specialists. Buying and selling companies is a specialty area of legal practice. You’ll find most regional and larger firms have separate practices for business law with lawyers who specialize in transactions.
While billing rates may be higher than a generalist, using a specialist is the best approach when you’re selling an asset as large and important as your company.
These lawyers are experts and very efficient at navigating the complex purchase agreements to be negotiated as a part of the transaction. Oftentimes, you’ll actually spend more per hour but less in total, because the experienced business lawyer will take less total time and deliver a more thoughtful, well-balanced document in the end.
By the same token, using a competent accountant for tax advice can help you maximize the deal structure to limit your tax exposure and maximize the cash potential in the sale. Like attorneys, you don’t want to skimp on tax advice either! A top-tier accountant will pay for themselves in helping you plan for your windfall.
#4: The Hands-On, Hands-Off Meter
Private equity firms run anywhere on the spectrum between full hands-on and full hands-off. I’ve worked with firms that are very hands-off, which means interactions were mostly limited to monthly phone calls to review financial performance and quarterly board meetings in person to delve deeper into how the business is performing and the various initiatives we were working on. The hands-off firm leaves me to run the business, and they mostly stay out of the day-to-day minutiae. That’s not to say they are out of the loop completely, just less intrusive. On the opposite end, you have the hands-on private equity group. In these instances, I have experienced weekly phone calls with a subset of the board of directors. They provide me with to-do lists.
Again, there’s no right or wrong; it’s just a matter of assessing what kind of private equity group you’re dealing with and if it’s a good fit.
This is the time to be a little introspective about your own personality, how you like to operate, and how you want your future to look. There is an old saying among CEOs in private equity: “If your company isn’t performing, you are going to get lots of help. Want freedom and autonomy? Don’t require any help!”
If you’re a very strong-willed, entrepreneurial, type-A personality, where you say, “Nobody’s going to tell me how to run my business,” you will probably not thrive in a full hands-on environment. Whereas a person who likes a collaborative effort that provides encouragement will do well with a full hands-on firm.
No matter your role, you will most likely be an investor in this company, or at the very least the recipient of incentive stock, and you want it to do well. So if you don’t necessarily like hands-on, but the private equity fund is pushing you to excel and grow the company, it may not be a bad thing when it’s time to sell the company and get a payday down the road.
#5: Relations Lead to Success
Price is important. Key indicators are important. Hands-on, hands-off is important. So is your relationship with the key players. We’re not talking about the associate level, which may rotate in and out the door. Those relationships will change as the people change.
But the principal or vice president, and partner or managing director, they won’t change during the course of the investment. These positions are more stable in the private equity firm, and these people will often be there for the entire length of the investment in the company, so it’s worth considering, do you like that person? Can you get along with them? Can you partner with and respect them for the next three to seven years?
Relationships tie into the issue of governance. It is typical for a private equity group to put governance instructions in place for a company that they own or operate, and as a business owner, it’s important to look at how tight the governance will be.
Are you going to run the company as you’re used to, or is every decision now going to be micromanaged? If you have to jump through hoops, you won’t have the autonomy to do things as in the past. Opportunities might be missed, leading to failed outcomes.
Good relationships can helpful as you seek to find a balance that allows the company to operate in the ordinary course without approval but brings in input from the financial partner when appropriate. Here’s an example: the limit on what the CEO spends in ordinary course should be large enough to allow the CEO to operate the company.
But if he’s approving an expense that is not ordinary course, paying bonuses to employees—including himself—giving raises to senior staff, or selling a large fixed asset, the board of directors may want to approve. Governance should never be a big issue. If you have good relationships, everyone should be on the same page.
For more advice on selling to a private equity firm, you can find The Private Equity Playbook on Amazon.