Selling a Small Business
By: Scott Dickes
We recently read Stage2Planning’s post “Is Private Equity For You?” The post points out some things that companies should consider before selling to a private equity firm. While we agree that business owners should think about what they want before selling their business, we don’t agree with some of the points the author makes about private equity. Below are the points we disagree with and why:
“These stakeholders might be your employees, suppliers, the community, or the customers of your company. Your job moves from only keeping stakeholders happy to maximizing the financial return of the company.”
These two things are not mutually exclusive. The majority of business owners work to keep employees, suppliers, customers, etc. happy AND they maximize the financial return of the company. This is not an either or situation. At Hadley Capital we think the company should do both.
“A private equity firm wants to usually hold your company for five to eight years and then find another buyer to cash them out with a very handsome return. This means you will have to grow your business very rapidly. While growing the business you’ll have to understand that you will need to do this with little cash because the private equity people will not want to put more money than their original investment into your company.”
At Hadley Capital our first order of business after acquiring a company is to “Do No Harm”. We make little to no changes to the business in the first year. We are not looking to make quick changes and then “flip” the company. Instead, we look to make a couple small changes each year. We also disagree that a company will have “little cash” to grow. When acquiring a company we make sure the company is well capitalized to support growth. We also often put additional capital into the company when making acquisitions.
“Are you aware of the capital structure of your company after you do a deal? A typical private equity deal will have five dollars in debt for every dollar in capital the new investors put into your company. Your company is now on the hook for this new debt.”
We would never do a deal with a 5:1 debt/equity ratio. Our typical structure is 2 parts debt to 1 part equity. It is also disingenuous to suggest that “the company is on the hook for this new debt”. In most of our companies, we own the business in partnership with management – we are all in this together.
“If you have a bad year the private equity firm you thought was in your corner may quickly move to being an adversary. Your agreement with the private equity firm is likely to have a take over clause. This means that if you don’t hit pre-arranged financial performance numbers you will be asked to leave and someone will take your place. Many private equity firms will tell you that everything will stay the same after they make the investment in your company. They will also say that their takeover clause is only reasonable since they have put so much money in your company. Private equity firms have learned that for them to get the financial returns they expect, they will often have to change senior management, including and especially the founder of the company.”
We determine who is going to run the company before the acquisition closes and we support management in running the company. We don’t put in a “take out clause” and the business owner goes into this process “eyes wide open”. For selling a majority stake in their business, they receive millions of dollars. In exchange for the millions of dollars the business owner gives up absolute control of the company but frequently retains a minority share in the business in order to get a proverbial “second bite of the apple”.
“Private equity might be the perfect thing for you. Before you take the plunge, spend some time running your company maximizing the return and economic value of your company. If you enjoy doing this, then private equity could work out well for you. If not, choose another path to having a liquidity event in your company.”
We think it is condescending to tell business owners to “spend some time running your company maximizing the return and economic value of your company”. The majority of businesses are already doing that (or at least trying!). Profit is not a bad word. Most business owners like to make one and we like to help them.
At the end of the day we always tell business owners to do research and due diligence on the buyer (private equity or strategic). It is the only way to get evidence that a buyer does what they say they do.