In today’s market, if you’re contemplating selling your business you’re probably thinking of finding a strategic buyer for your business because they are likely to pay the most money. But there is a ton of money in private equity, PE, firms these days that they have become an attractive alternative for many entrepreneurs looking to sell their business as they seek to find places to put their funds to work. That raises plenty of questions from these would-be sellers around what will happen to the business if a PE firm buys it?
1. The first thing to know is that the PE firm will want to keep you, the founder, around after the sale. They will want you around for your ability to lead and continue to grow the business. It’s become common that PE firms include “earn-outs” as part of these deals as a way to tie your compensation from the sale to the continued performance of the company (you can read more about the dangers of earn-outs in my article on that topic). So, if you sell to a PE firm, plan to stick around. There won’t be fruity drinks on a warm island for you – at least not for a while.
2. The second thing to know is that you will eventually be fired (or quit). Wait, didn’t I just say that they will want you to stick around? While that’s true, the fact is that the characteristics that define great entrepreneurs-like aggressive decision making mixed with calculated risk taking – don’t mix well in corporate or PE environments, which are very conservative and analytical, like banks. They make their decisions based on detailed data, spreadsheets and analytics- which can get very frustrating for many entrepreneurs who know their business from the gut. It usually takes about a year before the noose starts to feel really tight around your neck. That’s why so many of those entrepreneurs choose to leave at that time; or get fired before then.
3. Another aspect to know about when a PE firm takes over is that they will but debt on the business. A lot of debt- perhaps four to five times EBITDA. That can be jarring since most entrepreneurs tend to be conservative when it comes to debt beyond maybe a line of credit to help deal with fluctuations in cash. But when you put that much debt on the business, it can constrain your ability to operate. PE firms do this because this is how they can maximize the cash return on the deal. By putting a small amount of cash up front and leveraging up the business with debt, they can get a much higher return on their investment. Be ready for this to happen.
4. PE firms will also kill your company’s sacred cows early on– those things that you have considered important to the running of the business which might not look as important to an analytical outsider. Everything will be on the table for analysis. A prime example would be if you have any family members working in the business that aren’t high performers. They won’t be there for long. Neither will any real estate, company cars, sports tickets, or, if you’re lucky, private planes you might have used the business to purchase. Those will all go away.
5. PE firms will also sweat your assets. While most entrepreneurs focus on their P&L statements, where they can see their margins and profits, many of them ignore the balance sheet or at least don’t manage it aggressively. PE firms will look to maximize everything they can using the company’s assets- especially if there is any cash. PE firms will also begin to aggressively collect any money due from your customers while, at the same time, stretching out the terms with your suppliers. If you have built up loyal relationships with your suppliers where you pay them every 30 days, expect them to now get pushed out to 45 or even 60 days before they get paid. The PE firms will also move aggressively to reduce any inventory you have on hand and to turn any hard assets you might have, like buildings or equipment, into cash. They would also generally rather you lease than own as way to maximize cash flows inside the business. From their point of view, a dollar off the balance sheet is as good as a dollar from business earnings.
6. PE firms will also pay themselves special distributions with any extra cash they can generate inside the business. A big reason PE firms prioritize cash is that the sooner they can get the money out of the business they put in, the more quickly they can begin to play with house money. If they put $10 million into an acquisition, as soon as they extract $10 million in cash, then the returns they can earn when they sell the business are infinite. That’s also why they will put so much debt on the company, because it allows them to minimize the amount of cash they need to invest toward maximizing their rewards.
Now, let be clear: PE firms aren’t bad. This is just the way their business works. And the best ones will actually find a balance between these factors involved with the business versus the money. But don’t mistake their ultimate loyalty: it’s to the money, not the business. Whenever the business isn’t aligned with the money, they will side with the money. So, before you sell to a PE firm, do your homework and understand what to expect and try to find a buyer that will tries to find that sweet spot between the needs of the business and their need to make money.