Your client is ready to sell its business or bring on a major investor and is fortunate enough to have more than one possible suitor. Included among those suitors is one or more interested private equity firms. Choosing the right PE partner is one of the most critical decisions for any founder or CEO, and the relationship will be for the long haul. Before your client elects to simply sign up for the highest valuation proposed, it should consider other factors to ensure that it selects the right PE partner for its business.
1. Determine the resources the PE firm can offer the client’s specific business. In addition to ensuring the PE fund will have appropriate (and accessible) capital available after the closing, the right PE investor will have resources to help your client’s business execute its strategic plan and maximize value. Your client should look at the gaps it needs to fill for its business and flesh out exactly how a particular PE firm is positioned to help it bridge those gaps. For example, does the PE have a wide-reaching network or industry-specific contacts for developing partnership opportunities or relationships or particular expertise or transaction experience that address the current business needs, future plans, and desired cost savings that your client wants to obtain? Your client should also understand how a particular PE will implement its growth strategies. Some PE firms have more rigid protocols they expect all their portfolio companies to adhere to, while others will take a more individualized approach on a company-by-company basis. Some PE firms are highly acquisitive, while others focus more on building from within each portfolio company. Your client should closely analyze how the PE’s approach fits with its business.
2. Understand the management style of the PE firm. Before selecting a PE firm, clients should learn how each potential firm manages its portfolio companies, and whether that management style aligns well with the business conducted by the client. How involved will the PE be in the client’s business? Do they micromanage? Do they plan on replacing executive management? Or do they take a more hands-off approach? How do they communicate? To help assess management style (as well as other due diligence items we describe in this article), the client should get references from other founders and CEOs who have partnered with the PE firm, including references from portfolio companies that were not successful post-PE investment.
3. Get to know the individual partners of the PE that the client will be working with. While a client may be drawn to the overall branding or general approach of a PE firm, his or her business will likely work closely with only one or two partners of the PE firm after the deal closes. Clients need to get to know these individuals. Do they like them? Can the client envision building a productive long-term working relationship with them? How well do their personalities and management styles mesh? These are important considerations because the selling founders and their executives will be spending a significant amount of time with those PE representatives in the future. If upfront the client finds there is poor rapport or that personalities or styles of the PE representatives do not match well, it is probably a sign to keep looking for a better fit, particularly if the client has multiple options.
4. Evaluate the PE firm’s track record for similarly sized businesses. Generally, clients will want to assess the PE firm’s performance over the short- and long-term, and specifically with respect to businesses that are similar to the client’s business from a size standpoint. Some factors to consider include the success of the PE firm’s funds during both strong and weak economic cycles, the fund’s capital resources, whether the firm has experienced high turnover among its partners (related to point 3 above, if the client finds someone at the PE firm that he or she is excited to work with but then learns that partners with the PE firm do not tend to stay on long-term, that could raise a red flag), and the type and number of transactions the PE firm has completed in the client’s industry space.
5. Obtain a clear understanding of the fund’s investment horizon and exit strategy. Make sure the client understands how long it will have to execute the post-closing strategic plan. Having an investment horizon that is too short for the client’s particular business could result in undue pressure to achieve revenue or earnings milestones that are unrealistic. Or perhaps the client is seeking to remain involved with the business for a longer-term, or envisions a quicker exit.
In any case, discussing the investment horizon with each prospective PE partner is needed to determine whether the client’s mutual vision and interests are aligned with the PE firm. Most PE acquisitions where the founders remain involved post-acquisition are “second bite at the apple” opportunities (meaning the founders retain a minority equity stake in the hopes of obtaining a second return on investment with the PE acquirer when it subsequently resells the business or goes public).
PE can be a great way for clients to not only cash out but to also help build an even better and more valuable company utilizing PE capital and other growth resources (and in turn provide founders with substantial upside on a subsequent sale of the business down the road).
However, PE is not all roses and riches. PE firms always negotiate hard as a matter of course. In addition, as part of their overall function and existence, PE funds and their principals will always be most beholden to “return on investment” over anything else. Clients should be advised in some way to never lose sight of this aspect of PE. It is part of the package. To that end, clients should understand and due diligence the pros and cons of an investment from, and the post-closing relationship with, any potential PE firm. This approach will give your clients the best chance of not only maximizing the value of the initial sale transaction, but also ensuring a good post-closing working relationship with the PE firm and the realistic likelihood of participating in a meaningful second bite at the apple sale in the future.
— Pat Linden is founder and partner at Linden Law Partners. He specializes in business and transactional law.