The Role of Private Equity Groups in the M&A World

When it comes to business sales in the mid-market, one of the most important considerations is who your potential buyer will be.

 

Your buyer may be a similar business. It may be the same size as your company, somewhat larger, or a major industry player. It may be located in your market, or it may be active in a parallel market and interested in expanding by acquisition. It may also be a competitor. To protect you, a business intermediary offers experience and an added layer of insulation when approaching your competition.

 

The second type of potential buyer is usually a private investor – typically a high net worth individual looking to purchase a project or an income generator for themselves. When dealing with private investors, you will find a business intermediary to be a useful filter; by asking a series of involved questions, they can distinguish buyers who know what they want from pseudo-buyers who are casually browsing the market.

 

The third (and sometimes the most significant) category of buyer is a “private equity group” (PEG). Often overlooked, PEGs are involved in more than half of the mid-market deals that occur.

 

Private equity groups are essentially groups of investors who have combined their collective resources, business experience and management skills to form an investment group capable of raising and investing significant sums of money. These groups typically purchase and manage several companies simultaneously. Not surprisingly, PEGs tend to be relatively sophisticated buyers that pose unique challenges to unprepared sellers.

 

PEG money comes from two chief sources: (1) the member investors and (2) lending agencies, based on the investors’ combined capital and the PEG’s existing investment portfolio.

 

In some instances, PEGs are publicly traded and draw on the associated funds for their investments. In 2006, U.S.-based PEGs set records when they raised $156 billion in new capital. Recent estimates put the global numbers at $400 billion available for investment; with leverage, that $400 billion could equate to nearly $2 trillion in buying power. While the exponential growth in the private equity market has slowed somewhat in recent months due to turmoil in the financial markets, the long-term outlook continues to be strong.

 

Types of PEG investments vary from group to group. In some cases, PEGs will make acquisitions as part of industry consolidation, commonly referred to as a “rollup”; sometimes they will acquire companies in synergistic purchases; and, in yet other cases, investments are made in order to provide a growing company with growth capital.

 

Industry rollups involve the acquisition of multiple companies in a certain industry. The acquired companies are then combined or “rolled up” into one master company. This allows significant and rapid growth, potentially profitable expansion across markets, and the creation of a larger market presence virtually overnight.

 

To illustrate: A PEG owns a $1 million company that it can sell for four times earnings. If the PEG owned a $10 million company, it could sell it for six times earnings. So, in order to maximize profit, if a PEG purchased ten $1 million companies for $40 million, it could combine them and re-sell the new company at six times earnings for $60 million, potentially making the PEG a $20 million profit.

 

Synergistic purchases typically focus on companies offering similar products or services. It may also involve the purchase of a supplier as a way for reducing material costs and assuring sources of supply. In the process, the PEG increases productivity by decreasing overlap and external costs.

 

One of the more diverse types of investments that PEGs make is the investment of growth capital. While typically offered in a number of different forms, its core purpose is to provide a growing company the capital it needs to expand past the “grow-or-go” choke-point. Growth capital investments can include purchasing partial interests as well as complete buyouts. These investments not only free up or provide additional funds for marketing, expansion, research and development; they also can provide skilled management resources, consulting, and increased credibility.

 

From the point of view of a seller, deals involving PEGs typically offer certain benefits that are not as common among other types of buyers.

 

Unlike other types of buyers that might be first-time or exploratory investors, PEGs are professional investors focused specifically on making money and closing deals. They don’t require special financing; can be relied upon for a consistent, professional approach; and typically bring extensive expertise to the table. These factors can significantly increase the speed at which deals close and can help to minimize unexpected costs.

 

Depending on the business and the PEG’s investment focus, a PEG may execute recapitalization investments; outright purchases; majority share acquisitions, in which the PEG takes over management; or minority investments, where the PEG invests but looks to the seller to continue to run the business.

 

PEGs look at each purchase as a piece of a bigger picture. As a result, most (but not all) PEGs have exit plans in place prior to the transaction. The typical holding period for most PEGs is between three and seven years.

 

When dealing with a PEG, the role of the business intermediary takes on greater importance. At IBG/Fox & Fin we utilize a database that contains over 4,000 PEGs – each having a unique style, preferred industries, investment requirements, and management footprints.

 

Due to the sheer number of PEGs out there, it is important that business intermediaries work as matchmakers, not salespeople. A successful deal not only results in the sale of a business, but it also requires chemistry both managerially and ideologically. In addition to our duties as business intermediaries we balance the playing field and ensure that the seller is fairly represented. Most PEGs have professional buyers on their investment team. The main job of those individuals is to investigate, pursue and negotiate the purchase and sale of portfolio companies. As a result they are very knowledgeable and skilled at finding and making the best deals possible when it is time to negotiate. Having a seasoned expert as a representative will not only maximize profit, it will avoid costly mistakes and misinformation.

 

Because virtually any desirable company may become a target for PEG acquisition, business owners who are preparing to sell should be prepared to respond to inquiries from these sophisticated, well-heeled buyers.