Here are some common misconceptions of sellers in private equity deals that might railroad your deal.
As the public markets gyrate and the M&A market becomes more attractive, it’s worth noting some common misconceptions of sellers in private equity deals that might railroad your deal.
1. Your IQ is lower – Buyers, particularly those in private equity (PE) firms, often burst onto the scene fresh off their Ivy League MBAs or consultant gigs at top-tier investment banks, with roots in bean counting, finance and business development. Buyers convince themselves they have an edge over sellers (and sellers often concede). But don’t let them intimidate you. Most buyers have rarely actually managed a business, managed people, or been responsible for the P&L. In fact, most buyers are looking at an industry on a part-time basis with substantially less experience than a seller who will often have decades of management and sector expertise. So give yourself a giant pep talk before meeting with buyers, and acknowledge and appreciate the background they bring to the table, but don’t underestimate the experience you’ve earned in the trenches.
2. You’ll take the money and run – Sellers, particularly the founders and owners of a business, care deeply about the future of the company. You’ve raised and nurtured your business from conception, watched it grow, and are not about to give it away to just anybody. As such, you will favor buyers who are actively engaged and plan to treat the employees and customers well versus buyers who do not appear to have the employees’ or customers’ best interest at heart. You care intimately about what happens to the business you’ve nurtured and may even want to pop in from time to time. So, work closely with PE firms that understand the value of reputation and together you’ll have a better chance for long-term success.
3. You care more about the business than the money – Although sellers care about the future of the business, you don’t care so much that you will dramatically reduce the price for a “nice” or “well-intentioned” buyer. First-time buyers (usually individuals) mistakenly believe that a likeable personality and flash of a friendly smile is the ticket to getting you, the seller, to accept a discounted price. In addition, you would not forego a high multiple for the business (greater than five times), even if that purchase price meant the business would face financial hardships in the future. It’s still a business and mostly about valuation.
4. The head honcho is easily replaced – Don’t let them trade your star player (and it may even be you). Small businesses and even large businesses without strong operating systems are highly dependent upon the key managers within the organization. If you are a seller who also serves as the manager or the president/CEO, you represent an enormous risk for the business going forward, a risk that should not be underestimated by buyers. And this is doubly important if your sale includes an earnout provision based on the company’s future performance.
5. Good managers are a dime a dozen – While there are tens of thousands of managers in the U.S., managers with the right experience within a given industry, and who are a good fit with the company’s culture, are challenging to find. While finding the right talent can take three to 12 months, a bad hire can take 18 to 36 months to correct. Be available to provide guidance when needed in the hiring process. Ultimately, the wrong manager in a transaction can be the one bad apple that spoils the bunch.
6. The business is a quick study – Every industry has its particular highlights and every business will have its own quirks. Sellers often believe that they can easily transfer their vast knowledge of the industry and the business to the buyers after a limited due diligence period. Education takes time and experience is earned the hard way. You can’t expect buyers to cram and then breeze through the final exam. Be patient.
7. Change up top won’t stir the pot – Businesses that undergo an acquisition or an investment by a private equity firm are still held accountable for achieving targeted financial results. As a seller, be sure the business has established budgets, sales goals, productivity requirements, and other operating expectations to avoid substantial cultural change post acquisition. The good news: managers and employees who are not accustomed to a more structured environment will adapt well in a performance-based setting.
8. Numbers don’t tell the whole story – Buyers are predisposed to spending a lot of time with the financials of a business and less time evaluating the actual operating systems or meeting with employees (Sellers also share the blame). While the numbers certainly provide a good overview of the cost structure of your business, they only present a partial view of the organization. Encourage your buyer to give equal consideration to the people, customers, brand, and other “softer” elements of the business before you pitch the entire package.
9. You can skip the detailed analysis – Resist the impulse of what feels like a good deal and do your homework to avoid seller’s remorse. Far too often, sellers will connect with the first company to offer a reasonable deal and accept too low of a price for it, giving buyers an advantage. Frequently, there are at least five to six companies with a similar business model in the industry. Larger industries that are fragmented have even more peers. Patient sellers who know they are in an attractive industry will investigate multiple buyers and locate the most well-run, highest-performing leaders that are at the top of the game. Emphasize discipline over gut feel.
10. Pinocchio won’t show up – Sellers often struggle to interact effectively with buyers due to education and experience gaps noted above. As a result, sellers can become distrustful of buyers, especially during the due diligence process when they rigorously examine every line item and scrutinize your business practices. It is also not surprising to find minor differences between what was presented early in the process and what is uncovered during due diligence or offered in the final term sheet. These gaps, if addressed properly, should not result in significant distrust.
Blackford Capital is a private equity firm based in Grand Rapids, MI, that acquires, manages, and builds middle-market manufacturing, distribution, and service companies, with portfolio holdings based in six states employing more than 800 people and combined revenues of approximately $200 million.
For more information, visit www.blackfordcapital.com.