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Private Equity: Tying It All Together


Here is a quick summary of our series so far:

In Part I, we explored an overview of the private equity market and learned there are many different types of PE firms. This presents opportunities for a plethora of Middle Market companies in various industries and of different sizes.

In Part II, we examined the key qualitative characteristics for companies sought out by private equity. In general, private equity firms have a limited time horizon in mind, seek out a high ROI on their investments, and place value on factors such as control and existing management. Companies with strong management, dedication to the business, a focused business plan, and a competitive market niche will be more attractive to prospective purchasers.

In Part III, we discussed how valuation can drive deals including the concept of multiple arbitrage. In short, private equity looks to purchase a company, fundamentally grow improve the business, then sell it for a higher multiple than at which it was purchased.

In Part IV, we will discuss what all this means if you are currently a Middle Market business owner (or are an advisor to one).

Size Matters (Redux)

I’ve shown this chart before but it’s an important point to repeat that size does matter when it comes to attracting potential business suitors, including private equity. In the chart below (courtesy of the AM&AA), you can see that valuation multiples on average grow not in a linear fashion, but rather in step-fashion. The reason for this is that different size levels will attract certain characteristics of buyers. At the very low end of the range, Main Street businesses are usually only going to attract owner-operators. Given the limited financial power of prospective buyers, multiples tend to range at the low end. This usually encompasses business with revenues of $5 million or less.

At the next level up are companies with revenues in the $5 million to $30 million, which are generally referred to as the Lower Middle Market. As revenues grow, the companies will have greater ability to attract more buyers. Such buyers will have more ability to use leverage to make acquisitions than smaller companies, which helps to expand multiples. In addition, in this space there will increasingly be a larger amount of strategic purchasers who may pay higher multiples due to synergistic benefits or strategic reasons. Lastly, the ability to attract private equity can bring prospective new acquirers to the table. In short, the ability to attract more investors (especially those with more buying power), will lead to higher potential multiples. Thus, a growth strategy must always be a part of any exit plan to maximize your potential multiple and maximize the number of potential suitors.

Growth Matters

Since developing a growth strategy is important, it should be incorporated into a comprehensive exit plan. A growth strategy requires the following elements:

  • An understanding of the current valuation of the business;
  • The potential range of values at which the business might sell given market transactions;
  • The key value drivers of the business (what gives the company its value?);
  • A determination of what steps are required to grow the company and improve its value;
  • Prioritize these steps; and
  • Execute the strategy over a series of 90-day (or equivalent) increments.

A prioritized growth plan will help you make your company more transferable and sell for a higher multiple.

Infrastructure Matters

An automobile can look sporty and attractive on the outside but no matter how attractive it is on the outside, it still needs an engine to run. Similarly, a business can have an owner, a management team, talented employees, etc., but if it doesn’t have an infrastructure to support the running of the business, the execution of the company is going to be flawed. To be truly valuable, a company needs to separate ownership from the business, which creates transferability. Next, systems and processes need to be put in place to create scaleability.

Intangibles Matter

An attractive business will have some sort of intangibles that draws interest from other investors. Perhaps they have a unique way of running their business, or their products or services are highly differentiated from the market. Perhaps, the company has an innate ability to attract the best minds in industry to work for them. Best-in-class businesses have a certain “it” factor that may be hard to define, but it gives them a natural advantage over their competition and this makes them more valuable and sought after. Taking account of your intangibles and leveraging them to your advantage is your goal.

Key Takeaways

  • To become attractive to outside investors such as private equity, companies need to grow.
  • To grow, they need to develop a growth strategy. They then need to prioritize these action steps to successfully execute.
  • Companies need to create an infrastructure to support that growth. That infrastructure creates transferability and scalability.
  • Intangible qualities of a company will always differentiate it from its competitors and make it more attractive and valuable.
  • All of the above will make a company more valuable and transferable.


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