|Wealth Management Perspectives
Private Equity Perspectives
As a business owner seeking private equity funding, you
need to consider many different things. Northern Trust’s
Robert Morgan, Mary Boehler and Robert Jank share
their expertise and advice on where to begin.
Q: What should business owners do to
prepare their companies before pursuing
private equity financing?
Morgan: You should hire good advisors
and make sure you have a good attorney
because you’re going to be involved in a lot
of negotiation. It’s also a good idea to hire
a business intermediary — whether it’s an
investment banker or someone experienced
in similar types of transactions — because the
intermediary will know what investors are
looking for and can help prepare a business
Boehler: To generate the best value,
clean up your balance sheet and get rid of
any unrelated or unprofitable lines of business,
which will streamline your company to
generate the best value. Negotiate contracts
with any managers you want to keep; private
equity firms are often looking for key managers.
Do everything you can to get positive,
Hire very sophisticated corporate transaction
attorneys or investment bankers who have had
experience negotiating with private equity
funds and their advisors. These funds tend to
have expert advisors on their teams, and you
want your team to be as strong as theirs.
Jank: Get audited financial statements as
early as possible; private equity companies
want statements they can trust. If you have a
privately owned company, bring any non-market
leases on family-owned real estate up to
market rate. Also, move any assets that aren’t
critical to the operation of your company, such
as a private jet or non-essential real estate, off
your books. It’s unlikely the private equity firm
will want or need any of those assets.
Q: How much time should business owners
realistically expect to spend on this preparation
Boehler: That, of course, depends on what
needs to be done. A year is usually a comfortable lead time, but a lot can be done in six
months or less, if necessary. Selling or spinning
out unrelated businesses may take up to
a year, financial audits, valuations and environmental
studies can be done in just a few months.
Q: Given today’s economic environment,
what advantage does private equity offer
a business owner over other sources of
Boehler: Private equity funds are still flush
with cash, so they could do a smaller equity
deal — up to $250 million — with just a little
bit of leverage. That’s a big advantage today
because the debt markets are so difficult.
Morgan: There aren’t many alternatives to a
change-in-control transaction. Private equity
investors tend to have a longer-term focus.
They’ll buy a company and hold it between
four and eight years. And in many cases, the
management team can maintain some day-today
independence versus if you sell your
business to a strategic buyer or a competitor
that would completely envelop the business.
Q: At what stage of development should a
business owner consider private equity
Morgan: There are certain private equity
firms that will invest in companies in all
different stages of development, from the
proverbial “two guys in a garage” who
need funding to develop their product to
the well-established, multi-billion dollar
business. It depends on the owners’ or the
entrepreneurs’ motivation for bringing in that private capital. In early stages, entrepreneurs
want to retain ownership, and the
capital is for growth of the business and to
build their product. In many later stages of
development, it’s often for a change in control
when owners want to cash out.
Q: Do certain types of businesses benefit
more from private equity investors? And
what types of businesses are private equity
investors most commonly interested
Jank: Private equity firms are interested
in a very broad range of companies across
various industries, stages of life cycle and
levels of success. While you may think they
would naturally be interested in a high
growth company, we’ve seen plenty of
instances where a private equity company
purchased a mature, slow growth company
to add to their existing platform or stable of
companies already competing in that space.
Boehler: If a business has solid earnings
and growth record and prospects, a unique
niche, current strong management who
would like to stay involved and the business
owner would like to keep some equity on
the table, a private equity buyer is a good
choice. Right now, private equity investors
are pursuing businesses in industries where
the fund has already invested in a platform
company, and the subject business is a
strategic fit. There is a fair amount of activity
with transactions of less than $150 million.
For example, scrap metals, industrial
and service businesses.
Q: What factors do private equity funds
consider before making an investment?
Jank: Private equity funds look at the predictability
of earnings, the growth rate of earnings
and whether they can verify the company’s
earnings. They’ll want to determine how much
of those earnings are reliant on the company’s
owner or certain key employees. Ultimately,
they’ll want to ensure that there’s a system in
place so the company’s profitability won’t suffer
too much if they lose that particular individual.
Also, if the private equity firm has a platform
of a certain type of companies, they’ll consider
how well your company fits in with their other
companies. Your company will be more
appealing if it fits their platform.
Morgan: From a returns-and-risk perspective,
most of the firms we work with are looking
to earn anywhere from a 25% to 30% return
on their investment, and they can get that in
several ways. They can improve the business’s
cash flow and continue to build the company.
Or, they can put a lot of debt on the business
and then deleverage it over time to produce a
return. In this instance, the valuation of the
business doesn’t have to change significantly,
but deleveraging it results in a good equity
return for the investors.
Q: In addition to giving up partial ownership,
what other considerations should
business owners weigh before entering
this type of relationship?
Boehler: Business owners need to understand
that they’re no longer going to make all the decisions for the company. But they
can expect much more discipline in management,
financial reporting and accountability.
Secondly, the private equity firm will focus
on building value in the business in anticipation
of a liquidity event within five to 10 years.
Morgan: It’s important to choose the right
partner that will do what you want to do
with your business. Sometimes price isn’t the
sole consideration. It’s also about how they’ll
treat the workforce, whether or not they’ll
move the headquarters, how they’ll treat
confidential negotiations and other issues.
Q: In addition to consulting with their advisor,
where else can business owners turn to
learn more about their options, how to prepare,
and what to expect when they’re
ready to pursue private equity funding?
Jank: They can rely on the three-legged
stool of their accounting firm, their lawyers
and their banks. All three have had experience
in working with other business owners who
have sold their companies. In addition, they
should talk to fellow business owners who
have sold to a private equity firm. No one can
give them a better perspective on the negotiations,
difficult decisions and emotional roller
coaster that they are about to encounter than
someone else who has experienced it.
Boehler: Northern Trust professionals
can serve as a neutral resource in helping
a business owner learn about the range of
options and negotiate the journey from preplanning