Characteristics, Criteria and Deal-Making

By Maurie Cashman

For the past several weeks we have been discussing various buy-sell agreements, culminating in the Texas Shootout last week. This week we’ll shift our attention to the various types of sales transactions and buyers that may be considered for your company should you decide to sell to an outside party. We will begin with Private Equity Groups or PEG’s.

Five Characteristics of Private Equity Groups:

1) A Private Equity Group functions by sorting through various investment opportunities, evaluating potential for return, negotiating the purchase of all or part of the company and putting the structure of the transaction together. After the closing, the PEG may act as a board member, management group or consultant to the purchased company.

• This relationship has come under intense scrutiny in the past few weeks due to a Federal Appeals Court ruling that utilized the active management relationship of a PEG to force it to honor pension requirements of a portfolio firm. This same doctrine could be applied to negatively impact their tax status. See this week’s news article by Bill McCartan, Partner at Bradley & Riley, for a more in-depth look at this critical issue;

2) Private Equity Groups usually hold their investments only long enough to maximize their exit value, typically five to seven years;

3) PEG’s seek high returns on investment, typically 25 to 40%;

4) Strong management teams are usually a critical component to a Private Equity Group since they are trying to leverage fast returns;

5) Most PEG’s exert varying degrees of control over their investments. Note this recent challenge however.

Criteria Attractive to Private Equity Groups

1. EBITDA of at least $1-2 million and up. Anything less typically does not warrant the time they must invest in due diligence;
2. Often do not purchase 100% of the company;
3. Generally focus on certain industries in which they have experience;
4. Require a business plan that allows PEG investment to quickly move the company to next level and generate 25-30% return on their investment;
5. PEG will insure that a management team is in place that can achieve business plan;
6. Look for a niche product or service with large upside;
7. Must have a well-defined transition plan to allow them to maximize value at exit.

Dealing With Private Equity Firms

Private Equity Groups have become a powerful force in today’s capital markets. If your business has the correct characteristics they should be considered if they can meet your objectives. However, as with any buyer;

1. Employ a strong transition team with experience dealing with Private Equity Groups. The PEG will have a crack team trying to drive a strong bargain;
2. Have your transition objectives firmly in place and communicate them clearly to the PEG;
3. Have your advisory team do reverse due diligence to insure that they are a good fit culturally, financially and strategically;
4. Clearly understand that the PEG management’s duty is to its investors; not to the seller, employees, community, suppliers or customers.

A Final Word

I have dealt with many Private Equity Firms and the majority are very good job at what they do. Be aware that the industry is in flux and under some pressure from regulators. If your deal is structured on future performance be sure that your advisory team is experienced and comfortable with the structure and advise you relative to your goals and objectives.

According to R Glenn Hubbard, dean of Columbia Business School, “Private equity firms have an impact on productivity. That doesn’t mean that people don’t lose their jobs. But the question of whether private equity adds value? It’s settled among economists.” For middle market firms Private Equity Groups are definitely an option to consider.