If you’re like most U.S. businesses, you’ve probably put many of your long-term plans on hold during the past few years, waiting for the uncertainty to leave the market and value to return to your company. In the tough economic climate since 2007, valuations were affected across the board and a number of companies with major debt burdens took a fatal turn.
The financial uncertainty of recent years had another consequence, especially in the middle and lower middle-markets: a steep decline in mergers and acquisitions. Turmoil in the banking sector led to a shortage of credit, which made it hard for private equity firms to get the financing they needed to close smaller deals, which typically require a significant dose of lending.
But the slow pace of business has had at least one favorable result: Today in the U.S. there are nearly $400 billion dollars in private equity funds looking for a home, what market analysts like to call “dry powder.”
If you’ve weathered the worst of the storm but held off on your plans to sell, now may be a good time to revive them. After all, that “dry powder” won’t be around forever.
Still, just because private equity is more available now doesn’t mean investment firms are apt to throw it around—a good buy is a good buy in any market, after all. So before you rush off to put a down payment on a yacht or break ground on that vineyard you’ve always dreamed about, you might want to hold your company up to the mirror and see it as a potential investor would. What about it looks best? Where could it use a little touching up?
What private equity firms look for
When sizing up a company for acquisition, private equity buyers tend to start with obvious factors, including cash flow. Does your business generate revenue consistently, month-to-month, year-to-year? Since buyers are concerned above all with providing value to their investors, they tend to walk a line between bargain-hunting and settling on companies with the kind of demonstrated stability and strength that signal a bright future. While some private equity firms may be willing to take a look at businesses carrying a severe debt burden or showing negative growth, a good rule of thumb is that the healthier your business is, the quicker you’ll find a buyer.
Look at your degree of concentration. If you’re in manufacturing or distribution, are your sales limited to just one or two major customers? Private equity firms smile on businesses with a broad, diversified customer base. Companies that fill a niche or have product or service lines that set them apart are also more attractive to buyers.
Beyond product offerings or current market position, there are more personal factors that can affect your company’s curb appeal. Succession, for instance, is a prime concern for buyers. If you’re an entrepreneur who’s built a successful company through force of personality and your own good ideas, a private equity firm will want to know what your plans are for the immediate future. If you plan to move on, a potential buyer will want the details of your company’s succession plan and reassurances about the depth of its management pool.
When deal time arrives, private equity options are “infinitely creative and complex,” says Jeff Temple, partner at Acuity Capital Partners, a Chicago-based private equity firm focusing on the lower middle-market. Buyouts can be structured in a number of ways. Some companies, for instance, may be sold for EBITDA, all cash-at-close (though cash-at-close tends to be a less-common feature in smaller deals), while others sell for a multiple of EBITDA. Other buyouts can take the form of stock in the acquiring entity. Deferred payment, either in the form of an earn-out or seller note, is frequently tied a business’s future performance. In almost all cases, 5% to 10% of the purchase price is held back in escrow to back up the representations and warranties contained in the purchase agreement.
If you’re considering selling but have limited transactional experience, get some good advice. A knowledgeable consultant can help you navigate the various deal structures, arrive at a realistic valuation, and get the best possible outcome when it comes time for you to sign. “Talk to people you trust,” says Temple. “Look around your industry to see who’s completed other transactions. See who’s the most active in getting deals done.”
Remember, the economic winds may be blowing more favorably now than they have in a very long time, but in the end, a successful buyout depends not just on market health, but on good planning on the part of the seller, and that means you.
To learn more about the current private Equity environment as well as what to watch out for, view our recent web seminar “400 BILLION Reasons to Consider Private Equity.”
There are a number of reputable trust companies and banks that can manage your escrow prudently, but CSC Trust Company of Delaware goes further. We provide superior customer service, an attribute banks are not always known for. CSC Trust also provides private equity networking services designed to connect our corporate customers with private equity firms. Contact us if you would like more information about our escrow or private equity networking services.