Don’t let private equity misconceptions ruin a good business deal

When it comes time to sell your business, private equity inevitably becomes a hot topic of conversation.

I’ve had clients express many different views on private equity – some favourable, some not so favourable – and perceptions are often based on a variety of anecdotes, myths and misconceptions.

It doesn’t help that private equity (PE) got its start in the 1980s as the “leveraged buyout” approach. At the same time, Michael Douglas left a lasting impression on baby boomers when he famously portrayed Gordon Gekko in Wall Street. “I’ll be swimming with sharks” is the prevailing fear about getting involved with PE, but it’s not always justified.

In a typical PE transaction, you sell 75% of your business at today’s value and keep 25% to be sold in the future (the PE firm buys using a combination of equity and debt). After the transaction, you and your management team continue to run the business for the next five years. Together you expand the business over that time, then sell the company for more money, and everyone wins. That’s an oversimplification, but you get the idea.

The success of this formula has created almost 4,000 private equity firms globally, targeting almost every industry. And, given the large number of PE funds currently out there chasing transactions, it’s time to clear up the common misconceptions. Here are the top five we see in our advisory practice:

1) Private equity firms are all the same

Private equity suffers from a differentiation problem. Firms tend to get lumped together, when in reality their differences can be dramatic. The most important differentiator is the people. Business owners should never make a selling decision based on valuation alone and should always meet with a few firms to determine the right fit. The right PE partner should share your goals, support your growth plans and be a good fit for you personally.

2) There’s so much money out there, PE will buy anything (and overpay)

I wish this one were true, but in reality, private equity is highly selective and careful about valuation. In fact, most businesses are not a fit for private equity based on size parameters alone (for “platform” investments – meaning their first investment in a sector – most PE firms are targeting businesses with $5 million of earnings and up). For the most part, PE firms are financial investors, not operators. Without synergies or an existing investment in your industry, their valuations are bound by the reality of return requirements, cost of capital and growth expectations. While solid and competitive, PE valuations can be somewhat clinical.

3) PE will ruin my business with debt

This one can be a risk, but most reputable PE firms that enjoy successful partnerships with business owners will use leverage conservatively and intelligently. So, if the valuation from a private equity investor seems too good to be true, check the fine print. It’s probably due to soul-crushing debt assumptions.

4) When PE buys my business, I lose control and everyone quits or gets fired

It’s true that when you sell a majority (which most PE firms prefer), you lose technical control. However, consider this: they don’t run the business day to day, and the success or failure of the investment is essentially in your hands. So, who’s really in control? Good PE firms value the management team and people above all else (that is, in fact, who they’re backing with their money).

5) They’ll nag me more than my in-laws

Most entrepreneurs are not used to having a boss. The good news is that strong PE firms are not micromanagers. While reporting and governance structures can be an adjustment, my clients have found that oversight can create a better management structure and add value. After all, the CEO job can be lonely, and PE can bring senior and strategic insight to a private business.

In 2017, PE firms invested in an estimated 8,000 businesses globally, and they have more than $700 billion of capital to invest. The industry has evolved significantly from its early years. In my practice, about 45% of sale transactions involve a PE purchaser, so they’re an important category of buyers.

The right PE partner will offer more than money. A strong PE firm can enhance your management team, help find and fund new markets, and provide operational support and the equity capital needed to expand the business. So, rather than accepting misconceptions about private equity, it’s better to explore the options for yourself. 

Ken Tarry is co-founder of Sequeira Partners in B.C. He has more than 18 years of experience advising clients in Western Canada in diversified sectors on a wide range of transactions.