With high fees, leveraged debt and now the takeover of cherished public companies, Private Equity firms (“PE”) may be viewed as the new imperialists, dominating every sphere of the corporate world. So how does this translate within the emerging mid-enterprise (EME) market – that is, businesses with an enterprise value of £3-£50m?
Investors, who are desperate for returns and low debt costs, have boosted the level of PE funding to new heights, enabling them to look for buy-outs in all sectors. The question is, should you consider selling to a Private Equity firm? Our experience suggests that far from being imperialists, Private Equity firms generally provide a civilising force in the EME arena, as long as you can tolerate the spreadsheet – typically the weapon of choice for their conquest!
With private buyers partially distracted by Covid-19 and Private Equity firms sitting with available funds that are burning a hole in their pockets, valuations are highly comparable with the deal structure probably representing the biggest difference between a trade sale and PE investment. Typically, a trade sale will have earn-outs, whereas Private Equity firms will expect sellers to retain a stake in the business. This retained stake will potentially provide a significant upside and yield for sellers further down the line.
Trade buyers will often seek synergies and merge the acquired business into their existing operations whilst PE will bring capital to the table to drive growth, increasingly through acquisition investments or by expanding into new territories or products. Capital is the fuel that fires the growth, and without it, reaching the next level can be a real challenge, or takes too long, thereby missing the opportunity. Private Equity firms bring a real expertise in scale-ups – hence the ‘civilising’ influence.
The downside of PE deals is that high leverage increases pressure on cash flow and the team, which can result in team casualties. If you are a founder entrepreneur this can be very challenging to see but there is real value in the track record of 3-4 times (the desired bar) of any retained stake that a seller may keep as part of the initial buy-out. This means that seller entrepreneurs can get a great de-risk from the initial sale and a second material return on a later sale – typically 3 to 5 years after the first deal. With low yields in other asset classes, why not back your own business for growth?
The catalyst for growth is partially driven by expertise, which is facilitated by PE’s access to the best talent, but also, and as importantly, by the change in risk profile which drives the scale-up of the business after a private equity deal. With Private Equity firms having access to capital, they can take higher risks than the entrepreneurs to create double-digit growth.
Having sold the majority stake, if the entrepreneur or selling team stays involved, having cashed out on the initial stake, they too can now afford to take the same risks to go for scale-up. To reverse the point – how often do founders and private companies drive growth to a level of comfort (or profit) that creates an extremely comfortable lifestyle but with no requirement to scale up? Why risk the comfortable profit?
Much has been written about Private Equity firm’s expertise in bringing in the next level of management, but they also provide expertise in planning and perhaps ruthlessness on team capabilities. Yes – this all adds value, but is the real benefit to a PE sale the change in risk? Whilst the pressure may feel uncomfortable, it is this pressure that keeps us alive and therefore a majority sale of an EME can be a great way for founders and shareholders to embrace a scale-up knowing they have the initial sale de-risk safely tucked away. The business gets the chance to go for growth and the investor, seller, team and business model all have alignment in many PE deals.
When Private Equity deals are well structured, they are great for the economy as the scale-up drive’s growth, more jobs and taxes – as per the old saying – “money makes money”. Building a successful small enterprise takes vision and determination, however taking an EME to become a large company requires a different skillset and money, particularly in volatile markets. With Capital Gains Tax under the Chancellor’s eye, with their deal expertise and ability to be agile, PE may provide a better sale opportunity than a trade deal. Is it time to embrace the marching imperialists and build the empire?
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