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WHAT TO CONSIDER WHEN PARTNERING WITH PRIVATE EQUITY

Given my experience as a former CEO of a private equity backed company, I have been asked by a number of clients to provide my insight on what its like to partner with a private equity (PE) firm. These are firms that raise investment funds through limited partnerships for the purpose of acquiring privately owned companies. In 2021, private equity firms accounted for 30% of all M&A activity, and this proportion has been steadily rising. As M&A advisors, we regularly interact with these firms as we seek out the right buyers for our clients. When our clients receive offers from private equity firms, they want to know what to look for (and in some cases, what to watch out for) in these opportunities.

Although the structure of different private equity firms might be similar, their style and strategy can vary greatly. Each PE firm has its own unique way of approaching an investment based on its operating model and past experiences. There are a number of factors that impact how a PE firm interacts with, manages, and partners with owners and management teams after the close of an acquisition.

A few key factors to consider and understand are:

• Type of acquisition - Is the business a stand-alone entity that will continue to operate on its own, or does the PE consider the acquisition an add-on to its existing platform investment? If the acquisition would create a new platform, the PE may have a goal of acquiring other similar businesses to aggressively expand.

• Ongoing management of the business - Does the owner/founder want to continue to be involved in the day-to-day operations of this business? What about the next level of the management team? If the owner wants to exit business operations entirely, it is important that there is a well thought out succession plan. In some instances, the PE will bring in its own CEO or other management team members.

• Type of PE firm – Does the PE firm have more of a traditional operating model with a 5-to-7-year investment time horizon? Is it an independent sponsor with longer investment horizon? Most private equity funds will need to sell their investments within a stated time period in order to realize a return for their investors, but some have more flexible arrangements.

HOW PRIVATE EQUITY CAN ADD VALUE

Aside from the capital a private equity firm provides, they will bring new perspective and operational changes as well. This can be valuable in a new partnership, or cause friction if the seller and PE are misaligned. For owners partnering with a PE firm it is important to understand how the firm thinks about the business, and their goals and incentives. Understand that a PE firm will seek to implement new processes and procedures and augment current operations by leveraging their experience. The best results come when a seller is open and transparent about how involved they want to be with the business going forward.

There are a few key areas that a PE firms will likely impact:

• Corporate governance – PE firms will set up a board of directors for new acquisitions or augment an existing board. The board of directors is responsible for overseeing the management and strategic direction of the acquired company, as well as providing guidance and support to its executive team.

• Operational improvements – PE firms can bring new systems, processes, and technologies to the privately owned business, which can improve efficiency, reduce costs, and increase profitability.

• Opportunity for future involvement by founders and owners – PE firms may be open to retaining owners or founders in executive or advisory roles, which can allow them to remain involved in the business while also benefitting from the resources and expertise of the private equity firm.

MY PERSONAL EXPERIENCE WITH PRIVATE EQUITY

In 2014, after leading the turnaround and sale of OutBack Power Technologies to a strategic buyer, I partnered with a private equity firm to lead its new portfolio company. In my particular case, I worked closely with an independent sponsor and was actively involved in the due diligence process. From the outset, the existing owner of the target company wanted to step away from the day-to-day operations of the business and take a more passive role. Since there was no successor within the organization, I was brought in as President and CEO to lead the company going forward. At close, the initial operating strategy was to organically grow the business over a 10+ year period of time by expanding outside its existing markets, improving financial operations, layering in new leadership, and taking advantage of the broader macroeconomic trends.

The reality was much different. Based on several factors including disruptions in the marketplace and emerging opportunities, we executed an add-on strategic acquisition within 10 months of the initial investment. This doubled the company’s revenue, diversified the customer base, and significantly increased the number of employees. We brought in new senior leadership in sales, finance, and operations and led the company through a period of high growth. Ultimately, the PE firm decided to take advantage of industry trends including a favorable M&A market and successfully sold the business to a strategic acquirer in just over 7 years.

From my perspective, partnering with a PE firm was a great experience that led to a successful outcome. Although there were many difficult conversations and discussions, the PE firm worked collaboratively with management, provided strategic direction, and supported the growth of the business. Throughout the duration of the investment, the PE firm was actively involved and continued to push leadership to drive operational efficiencies across the organization. For business owners exploring a sale, private equity firms may provide an excellent option for a mutually beneficial partnership. Since cultural fit plays an important role in the success of a short- or long-term partnership, sellers should be open and transparent in discussions with potential buyers to ensure that goals and values are aligned.

To hear more about Steve's experience with Private Equity, contact him at shumphreys@alexanderhutton.com.