Despite some of the more recent negative reports lambasting private equity (and particularly leveraged buyouts), private equity transactions–when executed well–actually do add value, according to the research. The unfortunate aspect of measuring the macro value-add is that it is just that–macro. There may be a large net boon to shareholders down the road, but it can often come at the expense of employee pain, which never really looks positive as a poster-line on the nightly news or a headline on the New York Times. Certainly, private equity is not the poster-child for playing nice and many terrible examples exist where private equity firms have been disingenuous to companies and their employees. I also think that to be fair, private equity is often pigeonholed into one bucket of leveraged buyouts. To the contrary, private equity is actually a very broad term for an industry that engages in everything from minority and majority buyout/buy-in to complete ownership transfer. In doing so, they may provide small (or large) amounts of equity, mezzanine financing and or growth capital. In fact, the lines between venture capital, private equity and family office investors are completely blurred. In many cases, it is difficult to distinguish between them these days.
Private equity investors can work for you or against you. It depends on short and long term goals and if there is an internal fit for this type of capital. As companies weight the pros and cons of selling out to a private equity firm, they would be will advised to consider some of the following.
Loss of Control — Unless you are having a complete change of control and 100% sellout, a majority sale to a private equity group is likely to drive a founder nuts. In some cases, a company may even sell a minority interest where the private equity group would like to have a voice in the ongoing operations of the company. Even when this is the case, the original shareholders are likely to take issue with having another cook in the kitchen.
Differing Incentives & Goals — The incentives and goals of private equity vs. the founding shareholders may be woefully different. For instance, a founder may see the business as a means toward providing financial for herself and her employees in a way that creates a quality lifestyle. On the other hand, private equity buyers may see things quite differently. They may be more interested in reporting good results to their Limited Partners.
Employee Turnover — When new buyers come in they typically will try to do everything they can to not rock the boat. Despite their efforts, key employees may have issue with some of the items listed above and ultimately jump ship. This could be detrimental to the company’s ultimate performance.
Debt Burden — In a true leveraged buyout scenario, a private equity group could laden the business with a large amount of debt. Debt can put an unnecessary and costly burden on finance, operations and ultimately the viability of the business to remain as a going concern. If done irresponsibly, it could mean the jobs of those employees who have been loyal to the business for a long time.
Increased Sophistication — Private equity groups are typically run by MBAs with a breadth of experience in managing the finance and operations side of middle-market businesses. They often bring increased sophistication to even the most well-oiled companies. They also tend to look at things from a different perspective, allowing them to tweak areas that the original shareholders may have missed.
Networks & Growth — Many private equity groups who think outside the box may also have connections and ideas leading toward growth outside the box. In many cases they are able to help the business scale to the next level and sell at a premium. In the best cases, they are quite skilled at performing inorganic growth through buy-side M&A.
Financial & Operational Optimization — If there is one thing private equity are adept at, it’s optimizing a business. Even the most well-oiled machines can still benefit from some optimization.
Sellout Premiums — In the past, premiums were typically only paid by those in “strategic” shoes. Today’s liquid private equity market is following the Pareto Principle for deals. That is, financial investors looking for yield are paying premiums for quality private deals where they would not have done a year or two ago. In fact, many financial buyers–by virtue of some of the platform investments they have made–have morphed into strategic buyers in the way they think about growth within their group of investments.
Capital has a cost. Capital also has benefits. Many companies sometimes fail to see the qualitative components of both the cost and benefit of selling (wholly or in part) to private equity. Remember, private equity investors not only have skin in the game, their capital comes with the expertise of owning and operating other companies, many of whom are likely in the same sector. What has been your experience?