Virtually any company may become an
acquisition target of these sophisticated, well-heeled buyers
By
Jim Afinowich
April 2008 —
When it comes to business sales in the mid-market, one of the most important
considerations is who your potential buyer will be.
Your buyer may be a similar business. It may be the same size as your company,
somewhat larger, or a major industry player. It may be located in your market,
or it may be active in a parallel market and interested in expanding by
acquisition. It may also be a competitor. To protect you, a business
intermediary offers experience and an added layer of insulation when approaching
your competition.
The second type of potential buyer is usually a private investor – typically a
high net worth individual looking to purchase a project or an income generator
for themselves. When dealing with private investors, you will find a business
intermediary to be a useful filter; by asking a series of involved questions,
they can distinguish buyers who know what they want from pseudo-buyers who are
casually browsing the market.
The third (and sometimes the most significant) category of buyer is a “private
equity group” (PEG). Often overlooked, PEGs are involved in more than half of
the mid-market deals that occur.
What Is a PEG?
Private equity groups are essentially groups of investors who have combined
their collective resources, business experience and management skills to form an
investment group capable of raising and investing significant sums of money.
These groups typically purchase and manage several companies simultaneously. Not
surprisingly, PEGs tend to be relatively sophisticated buyers that pose unique
challenges to unprepared sellers.
Where PEG Money Comes From
PEG money comes from two chief sources: (1) the member investors and (2) lending
agencies, based on the investors’ combined capital and the PEG’s existing
investment portfolio.
In some instances, PEGs are publicly traded and draw on the associated funds for
their investments. In 2006, U.S.-based PEGs set records when they raised $156
billion in new capital. Estimates for 2007 put the global numbers at $400
billion available for investment; with leverage, that $400 billion could equate
to nearly $2 trillion in buying power (“Private Money,” Fortune, February 2007).
While the exponential growth in the private equity market has slowed somewhat in
recent months due to turmoil in the financial markets, the long-term outlook
continues to be strong.
What Do PEGs Buy?
Types of PEG investments vary from group to group. In some cases, PEGs will make
acquisitions as part of industry consolidation, commonly referred to as a
“rollup”; sometimes they will acquire companies in synergistic purchases; and,
in yet other cases, investments are made in order to provide a growing company
with growth capital.
Industry rollups. Industry rollups involve the acquisition of
multiple companies in a certain industry. The acquired companies are then
combined or “rolled up” into one master company. This allows significant and
rapid growth, potentially profitable expansion across markets, and the creation
of a larger market presence virtually overnight.
To illustrate: A PEG owns a $1 million company that it can sell for four
times earnings. If the PEG owned a $10 million company, it could sell it for six
times earnings. So, in order to maximize profit, if a PEG purchased ten $1
million companies for $40 million, it could combine them and re-sell the new
company at six times earnings for $60 million, potentially making the PEG a $20
million profit.
Synergistic purchases. Synergistic purchases typically focus on
companies offering similar products or services. It may also involve the
purchase of a supplier as a way for reducing material costs and assuring sources
of supply. In the process, the PEG increases productivity by decreasing overlap
and external costs.
Growth capital. One of the more diverse types of investments that
PEGs make is the investment of growth capital. While typically offered in a
number of different forms, its core purpose is to provide a growing company the
capital it needs to expand past the “grow-or-go” choke-point. Growth capital
investments can include purchasing partial interests as well as complete
buyouts. These investments not only free up or provide additional funds for
marketing, expansion, research and development; they also can provide skilled
management resources, consulting, and increased credibility.
Other Benefits of PEG Deals
From the point of view of a seller, deals involving PEGs typically offer certain
benefits that are not as common among other types of buyers.
Professionalism. Unlike other types of buyers that might be first-time or
exploratory investors, PEGs are professional investors focused specifically on
making money and closing deals. They don’t require special financing; can be
relied upon for a consistent, professional approach; and typically bring
extensive expertise to the table. These factors can significantly increase the
speed at which deals close and can help to minimize unexpected costs.
Flexibility. Depending on the business and the PEG’s investment focus, a
PEG may execute recapitalization investments; outright purchases; majority share
acquisitions, in which the PEG takes over management; or minority investments,
where the PEG invests but looks to the seller to continue to run the business.
Closing Thoughts
PEGs look at each purchase as a piece of a bigger picture. As a result, most
(but not all) PEGs have exit plans in place prior to the transaction. The
typical holding period for most PEGs is between three and seven years.
When dealing with a PEG, the role of the business intermediary takes on greater
importance. At Fox & Fin we utilize a database that contains over 4,000 PEGs –
each having a unique style, preferred industries, investment requirements, and
management footprints.
Due to the sheer number of PEGs out there, it is important that business
intermediaries work as matchmakers, not salespeople. A successful deal not only
results in the sale of a business, but it also requires chemistry both
managerially and ideologically. In addition to our duties as business
intermediaries we balance the playing field and ensure that the seller is fairly
represented. Most PEGs have professional buyers on their investment team. The
main job of those individuals is to investigate, pursue and negotiate the
purchase and sale of portfolio companies. As a result they are very
knowledgeable and skilled at finding and making the best deals possible when it
is time to negotiate. Having a seasoned expert as a representative will not only
maximize profit, it will avoid costly mistakes and misinformation.
Because virtually any desirable company may become a target for PEG acquisition,
business owners who are preparing to sell should be prepared to respond to
inquiries from these sophisticated, well-heeled buyers. |
