While the stated enterprise valuation for a business in a transaction is the “headline”, there are many additional factors that go into assessing the economics of a proposed deal structure, including:
- How much is paid at closing and in what form?
- Is a portion of the amount paid at closing value being withheld as an escrow?
- Is there a contingent payment (aka earnout)? This may create conflicting post-closing incentives for ongoing management (who were among the sellers) and the buyer and resulting dissention.
- What % of the business will the sellers and continuing management own going forward and what form will that ownership take?
- What are the provisions governing future relationships among the shareholders?
Professional legal, tax, and investment banking advisers are well-suited to assist in understanding these points in great detail.
Many business experts have observed that cultural fit is more important than skills in determining the success of a new hire. We believe an analogous idea applies to private equity investment: The fit between the entrepreneur / management team and the private equity investor is as important in choosing a financial partner as the transaction economics (and maybe more so). Fit obviously influences the quality of the entrepreneur’s experience during the years of collaboration that ensue post-transaction. But fit also impacts the economics for the entrepreneur in a transaction where he or she retains a significant percentage ownership in a transaction. A smooth collaboration between management and investor typically yields much greater business success and ultimately exit value for the entrepreneur.
So how do you assess fit? A lot of it comes from spending time together and relying on your well-honed instincts for understanding others. But to really get to know a private equity firm, we suggest you have detailed chats with other entrepreneurs with whom the firm has partnered in the past. At RLH, we have dozens of such folks for you to choose from, representing each of the past four decades of our investing history. By the way, you should try to chat with CEOs and owners from both successful and unsuccessful portfolio companies – every private equity firm has at least a few in the latter category.
How long does the transaction process take?
For RLH, the time from signed letter of intent to closing is typically 75-90 days. In some instances, it can be longer if the company does not have audited financial statements or has difficulty producing information about its historical activities. However, we often spend many months (or even several years) getting to know a company and being a sounding board and resource for its owners prior to working on a detailed letter of intent. This “getting to know each other” period provides a good opportunity for RLH and the owners to evaluate their cultural fit and to assess whether RLH can be a value-added partner for the business.
What happens during the pre-closing process?
We have two goals during this period:
- Learning a lot more about the business in detail so we will be well-informed partners with management. We seek to better understand the people, clients, solution offerings, competitive landscape, and operational processes of the business. This entails working with management to verify and further analyze already-provided data and to collect additional information.
- Working with management to develop a high-level roadmap for the business that can begin promptly after the investment transaction is completed. The roadmap is developed collaboratively through in-person discussions among RLH and management, capitalizing on management’s in-depth understanding of the business and RLH’s decades of experience helping successful growth businesses scale to the next level.