Preparation

Finding the right financial partner starts with preparation.

You deserve a private equity partner that’s aligned with you in vision and values. We’ve found that this alignment leads to the most rewarding results for everyone involved. Finding that partner begins with thorough preparation, so you know exactly what you’re looking for.

Define the vision

It’s best to begin by clearly defining what you want your business to become in five years, so you can find a partner that supports your vision, rather than imposing their own. Some questions to think about:

• What key initiatives must my company undertake to help achieve that outcome?

• What are the hurdles to that achievement, both internal and external?

• What are the market trends that could influence the company’s progress?

Organize your financial and operating information

Financial results matter because they are the scoreboard, and the underlying operating metrics help you and your financial partner understand how to optimize performance. We suggest: 

• Getting your financial statements audited by a well-recognized firm (for at least the most recent prior year, although more is better).

• Having a one-page dashboard of operating metrics that you routinely use to keep your finger on the pulse of your enterprise.

• Closing your books every month within two weeks of the prior month end and making sure that all accounts are fully reconciled.

Approaches

*All private equity firms are not created equal, nor do they offer equal experiences as partners.

Understanding the menu of options can help you narrow the field to the singular firm that offers the strategy — and day-to-day working approach — that best aligns with what you’re looking for. 

Specialist investors vs. generalists

• Specialist investors focus on a very specific type of business and can often provide more targeted support. Importantly, they tend to have a keen eye for what “good” looks like and drive very quickly to investment decisions.

• Generalist investors diversify their portfolio across a wider range of industries and can be good partners as well, but they frequently require more ramp-up time to assess a market and a company’s key value drivers. 

Organic growth focused vs. buy-and-build focused

• Organic growth is generated from new and existing clients, while “buy-and-build” strategies are based on growth through a series of acquisitions. 

Style in working with management teams (empowering vs. micromanaging)

• An empowering style gives management teams more freedom with which to execute strategy, while a micromanaging style is one in which the private equity team crosses the line into operations. 

Short-term vs. long-term focus

• A PE firm with a short-term focus will seek to rapidly deploy capital and then quickly harvest returns, in order to go out and raise new pools of capital. A long-term focus is one in which the PE firm has more patience and tends to think about the best interests of the business.

Relationship Checklist

To understand a PE firm’s approach, ask them:

• What do you know about my business and industry?
• What are your philosophies around growth and culture?
• Tell me about a deal of yours that didn’t go well.
• Can I speak to current/former CEOs with whom you’ve worked?

Other things to look for and consider:

• Longevity of relationships with team members and executives.
• Alignment between what they say and what they do.
• Watch how they treat non-Founder/non-management individuals.
• Are they good listeners? Do you feel heard?

Transaction types

*When it comes to transaction types, you have options.

The range of choices can make it challenging to select the best path for you and your business. Here are a few pros and cons for the more common transaction types to help you start thinking about what is right for you.

100% sale: Acquisition for cash by a larger business

Pros:

• Complete liquidity for all current owners

• Reduced responsibility for the future performance of the business 

• The company has access to more resources and customers

Cons:

• Loss of control over the future of the enterprise that you’ve built

• Uncertain career opportunities for your team members within a much larger organization

• Your team may need to assimilate to a new and different (and often more bureaucratic) corporate culture

• Very limited or no participation in future economic upside of the business (except to a small extent in the case of an earnout)

Majority Recapitalization

This is a transaction where you sell 51% or more of the business, which results in the new investor owning a majority of the equity as your partner.

Pros:

• Substantial liquidity for some or all of your owners

• Diversification of your personal wealth

• Potentially valuable insights from an experienced financial partner whose ownership interest is aligned with yours

• Potentially greater professional growth opportunities for the members of your team than in a complete sale

• Offers the founding shareholders a chance to participate in two liquidity events – one at the time of the private equity investment and the second in the transaction by which the private equity firm sells its ownership position. 

Cons:

• Relinquishing some aspects of control of the business

• Giving up some of the future upside of the business

• The investor will require an exit transaction at some future date, which ensures that another change of control transaction will occur

Minority Recapitalization

This is a transaction in which you sell less than 50% ownership in the business.

Pros:

• You preserve significant upside

• You maintain control over the business

• Sends a strong signal to investors about your faith in the future of the company

Challenges:

• Many PE firms seek control, so this approach could be less popular

• Deal structures are often more complicated

Economics

*There’s a lot more to a transaction than the valuation.

While that’s the number that gets the big headline, there are many other factors that go into a proposed deal, including: 

• How much is paid at closing and in what form?

• Is there a contingent payment (aka earnout)? This may create conflicting incentives for ongoing management (who were among the sellers) and the buyer, resulting in dissension.

• What % of the business will the sellers and continuing management own going forward and will that equity be treated equally to the new investors?

• What are the provisions governing future relationships among the shareholders?

We recommend consulting with professional legal, tax, and investment banking advisers to understand these points in greater detail.

Cultural Fit

*Cultural fit is critical — for both you and the business.

Fit obviously influences the quality of the founder’s experience during the years that ensue post-transaction. But fit can also impact the economics for a founder that retains significant ownership in a transaction. A smooth collaboration between management and investor typically yields much greater business success and ultimately exit value for the entrepreneur.

How do you assess fit?

A lot of it comes from spending time together, gauging their personalities, and relying on your instincts for understanding others. But to really get to know a private equity firm, we suggest you have detailed chats with other founders with whom the firm has partnered in the past.

Process

Every transaction has its nuances, but there are some well-defined commonalities of most transactions with a professional investor. 

How long does the transaction process take?

Assuming you choose to proceed with an investment banker-led process, it’s customary that from the time you engage an advisor to closing, it could take somewhere between 3-6 months depending on factors like market conditions and company performance during your interactions with investors. As mentioned previously, having your company information well organized in advance can shave weeks, if not months, off of the timeline.

What happens during the pre-closing, or “diligence” process?

The diligence process is a review of all areas of the business including Finance, IT, Legal, Tax and Operations. Investors will often retain advisors to help in their investigation of these areas who specialize in knowing what to look for. You should expect a lot of questions from these advisors, but a good investment banker should be able to help you pre-populate a database of information with some of the most commonly requested information items (aka a data room).

Funding the deal

*Understanding the role debt can play

Investors often fund a portion of the deal with debt, for the very simple reason that it can enhance their returns at exit. This decision can dramatically impact the management team’s experience, so it’s important to understand how your investor is financing their purchase price, and why.

• High debt levels can unduly stress an organization and make it more prone to the need for cost-cutting in order to satisfy lender requirements, or “covenants”. 

• Any hiccups in financial performance may result in tough conversations with the bank, penalties, and motivations to reduce headcount, all of which can affect morale and distract from growing the business.

• Low debt allows for more grace, permitting the flexibility to weather challenges without the fear of debt-driven repercussions.

What comes next

Hopefully, you won’t be in for a surprise.

Your experience post-transaction will be most influenced by the partner you’ve chosen. Ideally, if you’ve done your due diligence, you won’t be surprised by what unfolds after the papers are signed, but will instead feel motivated and supported in your pursuit of the next phase of growth.

If you’ve been strategically acquired:

Large organizations require standardized processes across divisions and business units, so an entrepreneurial business may find that, after integration into a large organization… 

• Responsiveness to clients diminishes

• The pace of innovation slows due to procedural requirements

• Flexibility to offer customized solutions is limited

• Passion for the business’ mission dissipates

• New compensation programs and incentives reduce team motivation and alignment

If you’ve partnered with a private equity firm:

Any firm will likely initiate changes in a portfolio company post-investment. The speed and variety of those changes will be firm-dependent, but you should have plenty of time during the transaction process to understand what to expect.