Last week, Frank called Phil and said, “I’m with a private equity firm and I want to buy your business.”
Phil was left stunned and confused. “Who is Frank, why did he call me and what is a private equity firm?” he wondered.
He asked one of his friends – who also owns a business – and her best guess was, “Don’t private equity firms buy businesses and sell them for parts?
This is a common misconception.
Many people have heard of private equity firms, but that doesn’t mean they know what they are or how they operate. Read on to learn private equity firm basics, and find out whether they could benefit your business.
What is a private equity firm?
At their core, private equity firms are interested in acquiring businesses that will eventually be eligible for re-sale at a profit – that’s how they make money for themselves and their investors. When handled properly, these arrangements can be beneficial for all parties involved.
Typically, a private equity firm acquires a company when the owner decides the time is right to convert his or her investment to cash. Many reasons can drive that decision, but they usually revolve around family and estate planning.
The firm pools the resources of wealthy investors and institutions and acquires all or a significant part of the ownership. Their goal is then to support management and grow sales and profitability.
Generally speaking, these acquisitions are relatively short-term in nature. Private equity firms expect to hold their ownership for a period of five to 10 years and then sell their ownership interest. They often use a leverage model in their planning, but anticipate generating a return on their investment that is above average for their investors. And they continue to look for good quality companies and are always buying and selling to meet their investment objectives.
Much like the companies they acquire, private equity firms come in different configurations and sizes. While each size has its own distinct strengths, smaller firms tend to provide sellers with a more personalized experience. It’s often easier for the seller to get a feel for exactly the kind of relationship they’ll enter in to with a small firm. This is an important consideration for the seller, especially if he or she will have a continued role in management. Smaller firms often employ a more laid back management style than larger firms, and they tend not to interfere in the day to day operations of the company.
Why consider selling to a private equity firm?
Selling to a private equity firm is a great way to reduce your financial risk and plan for the future, and it’s often a strategy I suggest to clients who are interested in selling. Although financial service providers can field inquiries from such firms and provide referrals, firms sometimes contact businesses directly. If you find yourself in a situation like Phil’s, make sure to consult with your accountant or financial advisor first. It’s essential to understand all of the implications involved with this type of arrangement before deciding if it’s right for you.
By Mike Taylor, CPA (retired)
This article originally appeared in the Summer 2015 edition of The Rea Report, our quarterly print newsletter. Check out the entire publication here. Or click here to subscribe today and have your copy of The Rea Report delivered to your desk or mailbox!