Private equity

Selling Your Business To A Private Equity Firm: Seven Expectations

Recently, Kevin and his board of directors asked me to join them in a discussion of how a private equity (PE) firm will value its business and what to expect in their examination of the company. A few weeks earlier, a PE firm had approached Kevin stating that they were interested in purchasing his company to expand its portfolio of similar companies. They wanted to know if Kevin was interested in selling his company.

Kevin’s firm is 18 years old. Over the past three years, it has averaged $12 million in annual revenues and has averaged $2.1 million in earnings before interest, taxes, depreciation, and amortization (EBITDA). I gave Kevin and his board the following advice.

Author: Gary Miller
Author: Gary Miller

1. The PE firm's goal is the same as any other company — to make money. It looks for businesses that show clear growth potential in revenues and profits over the next three to five years.

2. Typically, PE firms buy a majority interest in a company, leverage its networks and resources to help make the target more successful than it was before the purchase. Then, they ultimately resell the company for a profit — usually after three to five years. This process can be likened to someone buying a classic car, restoring it, and then selling it for a profit.

3. PE firms determine a company’s true value through rigorous and dispassionate due diligence. A top-to-bottom examination of the company allows them to test their “going-in” assumptions against the facts. This examination provides a clear understanding of the business’ full potential and what it could be worth in the future. Such a tightly focused due diligence process builds an objective fact base by scrutinizing several factors that help answer the fundamental question: “Will this acquisition make money for investors”? Such scrutiny can help PE firms discover a compelling reason to pay more than another bidder — or throw up red flags putting the brakes on a flawed deal.

4. The PE firm verifies the cost economics of an acquisition. Veteran acquirers know better than to rely on the target’s own financial statements. Often, the only way to determine a business’ stand-alone value is to strip away all accounting idiosyncrasies by sending a due-diligence team into the field. Often they rebuild the balance sheet, profit-and-loss and cash-flow statements. The team collects its own facts by digging deeply into such basics as The cost advantages of competitors over the target company; and, the best cost position the target could reasonably achieve.

5. PE teams do not rely on what the target tells them about its customers; they approach the customers directly. They begin by drawing a map of the target’s market, sketching out its size, its growth rate, its products and customer segments; then it breaks down that information by geography. These steps allow the PE firm to develop a SWOTs (strengths, weaknesses, opportunities, and threats) analysis, comparing the target’s customer segments to its competitors’ customers segments, answering the following questions.

  • Has the target fully penetrated some customer segments but neglected others?
  • What is the target’s track record in retaining customers?
  • Where the target’s offerings could be adjusted or improved to grow sales and/or increase prices? And,
  • Can the target continue to grow faster than the market’s growth rate?

6. The PE firm’s due diligence teams always examine the competition. They dig out information about business strategies, operating costs, finances, and technological sophistication. They examine pricing, market share, revenues and profits, products and customer segments by geography. Normally, PE firms have a deep understanding of industry data so they can benchmark the target and its competitors. This due-diligence process is a powerful tool for unmasking the target’s fatal flaws.

7. PE firms take a long view, looking ahead to the time when they’ll be selling the company to another acquirer. With that in mind, the goal is to hit a three-to-five-year growth target, and build sustainable growth into the company’s DNA.

What can business owners do to increase their company’s values?

A business owner can emulate these same PE firm processes to increase his/her company’s value. Many owners know far less about the environments in which they operate than they think they do. As a result, they often don’t challenge their own conventional wisdom until it is brought to their attention by the potential acquirer. By then it’s too late to have maximized the company’s value.

By digging deep into the data, owners can discover their company’s full potential and the underlying weaknesses that could make them less attractive as acquisition targets. By examining the factors that drive demand and measuring products and services against competitors, owners can identify performance gaps that need to be addressed.

Looking at the broader picture owners should ask themselves:

  • What key initiatives will have the most impact on my company’s value in three to five years?
  • What are the customers’ future purchase behaviors, if we do nothing?
  • What technologies could disrupt my business?
  • What market changes could affect our market share?

These questions are hard to answer. The key is to define the future business environment for the company. Owners need to see what the facts say about the company and what levers can be pulled to create more value for their companies.

Gary Miller ([email protected]) is the CEO of GEM Strategy Management Inc., an M&A consulting firm advising middle-market private business owners. Read more of Miller’s blogs here.