If You Own a Business, You Need to Care About Private Equity
I know. You hear the phrase private equity, financial sponsor, or financial buyer and your brain just shuts down. If you own a business, you have probably gotten calls and emails from private equity groups and you are probably ignoring them. But if you are contemplating selling your business, you can’t afford to overlook them any longer. Private equity is the fastest growing segment of business buyers and they continue to drive valuations upward, effectively raising the tide for all business owners.
In the first half of 2017, which has seen a downturn in the number of M&A transactions overall, private equity groups continue to be aggressive purchasers. PE now makes up a larger part of total M&A activity, with sponsor-backed acquisitions growing steadily from 24.7% of all transactions in 1Q 2016 to 29.8% in 2Q 2017 (Source: Pitchbook). That means almost one third of all deal activity is private equity driven, and that’s a group of buyers that cannot be ignored.
So, no matter what you’ve seen in the movies or read in books, private equity groups make up a real buyer category and they should be viewed as a viable exit strategy for most businesses. When we are advising family-and-founder-held businesses about who the best buyers might be, they are often reluctant to included private equity groups. After all, most businesses have a competitor or two that has mentioned buying the business and there are sometimes other groups, customers or suppliers, that make sense. Ignoring private equity as potential buyers is a mistake. In many cases, they are providing similar, or high, valuations for businesses and if nothing else can be a source of bidding competition for the strategic buyers that might be interested.
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How Can Private Equity Keep Up?
Private equity groups keep raising money and then they have to invest it. There is no shortage of investors in this asset class and “dry powder”, or the amount of money private equity has to deploy, remains at record levels.
They need to buy businesses. This trend is fueled by lenders with loose requirements and high leverage levels that help the private equity groups win deals. Leverage and money invested in PE groups are creating supply.
High and rising sale prices for companies in the market are keeping the entire system in check. Private equity groups that pay these prices are forced to include more leverage in their transactions and accept lower returns than historically accepted, or they are forced to walk away from the transaction. Even when private equity turns away from a deal, the signal that someone, be it another private equity group or a strategic buyer, will have to pay a very high price to win the transaction has been sent.
At some price level, private equity returns begin to narrow so much that they lose their ability to differentiate themselves from other asset classes. Yet, they have continued to move to extremes and they compete with cash-rich, strategic buyers. This trend, combined with the fact that many private equity groups are beginning to model in a recession during their five to seven year holding period, has kept them in check.
This entire process is why, if you are a business owner thinking of selling your company, it is important that you or your advisors know what is happening in the private equity space. Even if your company is not a good candidate for sale to private equity, it can be a good idea to add them as potential buyers in the sale process, if for nothing else than to send other buyers a signal. They often have the ability to raise “the floor” of valuations received for a company.