A lot of people know that Harvard University’s $23B endowment fund is famous for consistently out-performing the marketplace, but far fewer know that one key to the fund’s success is its astounding 15% investment in private equity. Similarly, while many people know big-name private equity firms (“PEGs”) like Kohlberg, Kravis & Roberts (KKR) made famous by the book and movie “Barbarians at the Gate,” a considerably smaller number know that there are today thousands of small- and medium-sized PEGs focused on buyouts of small- to mid-sized privately held companies.
It’s been estimated that collectively these funds represent well in excess of one billion dollars in capital available for the acquisition of these privately held businesses. This is great news for the business owner whose firm is too large for the typical private investor, but too small to attract the KKR’s of the world. Until the emergence of this new and growing private equity marketplace, the owners of these firms were typically limited to selling to their employees and/or family members or selling to a competitor. Neither of these is an ideal option.
Selling to the kids or employees typically means an ESOP – Employee Stock Ownership Plan. Since it’s extremely rare that children or employees have sufficient capital to purchase the business outright, the owner is typically left with substantial debt. This means spending the next several years worrying about whether or not the company will flourish and meet its obligations. Unfortunately, all too often, the company flounders and it does not.
Selling to competitors is equally unattractive. Just alerting the competition that a company is for sale has serious potential for repercussions. Competitors can be quick to use the company’s uncertain status to go aftermarket share and key employees, often with devastating results. And even if they decide to buy the company itself, they almost never pay full value.
That’s what makes private equity so attractive: the opportunity to sell the company without assuming significant debt or alerting competitors. And contrary to popular belief, the prices paid by private equity are more than competitive with the prices paid by strategic buyers. In fact, the competition between private equity firms for acquisitions often pushes the dollar amounts to the very top of the scale.
So, what’s the hitch? Why doesn’t everybody sell to a PEG?
The answer is simply this: PEGs aren’t interested in running companies; PEGs are interested in investing in companies. That means that the company must have a management team in place or the owner must be willing to remain for a period of time while a management team is groomed and put into place. Sometimes, that time period can be protracted: PEGs know that the individual who got the company to the place that attracted their interest is often the best individual to ensure the company’s continued growth and success. It’s only natural that they want that individual to hang around for a while to hedge their bet in its future.
So, what does this mean to the owner of a business that could be targeted by the PEGs?
For an owner thinking about retiring in three to five years, now is the time to sell. By making a deal today, the business owner can have the best of both worlds: cash in the bank and a job until retirement that often comes with significant monetary incentives for growth.