Podcast: Private Equity Basics For Mid-Market Entrepreneurs

By Noah Rosenfarb
Published: June 15, 2015 | Last updated: March 21, 2024
Key Takeaways

Private equity buyers can be a great exit option for many middle market business owners. In this podcast, learn the basics of private equity and how to attract investment from these groups.


In this podcast, Tom D’Ovidio, partner at ShoreView Industries, talks about:

  • Common charateristics of private equity firms;
  • Reasons to have a private equity firm as a partner;
  • The process of doing a deal with private equity – how long it takes, what to expect;
  • Things business owners can do to be an attractive investment for private equity;
  • Best timing to communicate the sale of a business to key employees, customers, vendors and other stakeholders; and
  • Advice for selecting the right private equity partner.

About the Guest

Thomas D’Ovidio joined ShoreView in 2007 and has more than 15 years experience in private equity investing. He has served on many boards, working with companies across a diverse group of industries, including packaging, plastics, commercial and industrial product distribution, logistics, consumer products, niche manufacturing, building products and business services. Mr. D’Ovidio received a B.A. in Communications from Rutgers University and an MBA from Fairleigh Dickinson University.

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Read the Full Transcript Here:

Noah: Hi this is Noah Rosenfarb and with me today my friend and partner in Shoreview Industries, Tom D’Ovidio. Tom is an expert in private equity industry we are really excited to have him. He is with us today to share some thoughts around private equity and how private equity firms have really added value to owners and also to the economy. So Tom, maybe we can start off by telling our listeners a little bit about private equity firms in general. What are some of the things private equity firms have in common?

Tom: Good question Noah. Thanks for having me on the call also. Private equity firms are a company that aggregates capital from institutional investors and high net worth individuals for the purpose of investing that in businesses in various sizes, shapes, industry etc. What they do have in common is that all of them look to take investor capital invested in businesses and generate returns for their investors. Some of the differences they have is really based upon the investment philosophy, investment mandate. It’s like going to a doctor if you’ve got a heart issue, you go to a cardiologist. If you’ve got, you know, a broken bone you go to an orthopedic doctor. The same thing with private equity, different firms have different mandates. Some firms pursue earlier-stage technology deals,others pursue later stage businesses once they are profitable and have been around and then it goes even further than that. Some firms pursue manufacturing businesses, distribution businesses, healthcare businesses etc. So when looking as an entrepreneur – when looking for private equity capital they really need to identify a firm that really fits what they do as far as types of business, size of their business etc.

Noah: And why would an owner want private equity capital? Give me some reasons that people seek out a private equity firm to have as a partner.

Tom: Yeah, a few reasons. First and foremost, some type of liquidity event. That may be a management team looking to buy a business. The team does not have the capital to actually execute on the transaction and they need a partner to help them to facilitate that equity event for the owner himself or herself is running the business and they are looking to sell a portion of the business but stay on and run day to day operations and stay on for a meeting for peace. By way of example we’re working on a deal right now and the family business owner has no children or siblings involved in the business but really believes in the growth of a business going toward. He and his wife have most of their net worth tied up in the business and are looking to diversify so they want to bring on a partner that can buy a portion of the business and in this case it would be a majority portion, they are going to stay on for an influential minority ownership position but also stay on and run the business and then going toward have access to any additional capital that’s needed. They’ve got a partner to share on that risk they don’t need to commit 100% out of their pocket and going forwards. They needed to benefit from the value they’ve created historically and get equity paid on that but also take advantage of the value going forward and having a partner not only to share in the capital needs of the business but also a partner that can share some of their experiences from owning businesses and seeing businesses growing during their watch and hopefully accelerate that growth process.

Noah: So is it primarily those two components, either the management team needs money or the owners want some, as they take their chips off the table but get a second bite at the apple.

Tom: Yeah those are two primary reasons and there’s another example. It could be a divestiture of a large corporation looking to sell a division that just doesn’t fit with their strategic plans going forward and turn it into a private corporation and get private equity investors to acquire it. And that’s not just for large corporations, it could be a division of a privately held business, it’s not according to whether the owners taking the rest of the business looking for solutions. Someone would come in and buy that company, that division for example, can also be an owner looking for growth capital and they may want to buy a competitor; they may want to expand internationally; open up a facility in China or in Europe. They are looking for a partner to help fund that they do not want to reach in their own pocket and risk capital or equity and looking to bring in a partner willing to do that. The theory being 1 on 1 makes three so it’s worth the dilution because it takes the business that much farther.

Noah: So do you find that people are reaching out to you and other private equity firms? I would identify that I need private equity or is it other way around? Are you out trying to find owners and then you can put it all together.

Tom: The deals come to us from variety of sources and to private equity firms in general. First and foremost, investment banks will typically represent a company and help them market it for sell, that’s one way. Second is, companies- we identify companies through proactive efforts, meaning we will search with the development thesis around a particular industry or some type of criteria – it could be the size, the geographic location – then we will hire someone to help us proactively search around the criterion that we setup for that thesis. Third is, people reach out to us proactively, and sometimes that’s directly calls from business owners or it could be through one of their professional advisors or get a call from company’s accountant or company’s attorney. Often the sellers and financial planners will reach out. So it’s variety of sources but for the most part it’s either the company or someone representing the company officially in the sale or calling them directly or the company professional advisors and reaching out directly.

Noah: So once an owner has recognized that a private equity firm makes the best partner for them and solves their current problem. What’s the process of doing a deal? How long does it take? Who’s involved? What’s involved?

Tom: Deals can take anywhere from you know from 45 days to 90 days on average. And it really all depends on how prepared the company is. Most private equity firms were very skilled at executing deals – that is initially meeting the company, going to the initial evaluation, signing some type of non-binding letter of intent with the company, and them getting the deal to a closing. Most private equity firms are very skilled at that process and have the requisite 3rd party professionals – meaning they’ve got their lawyers lined up that they’ve worked with, they’ve got their accountants and they’ve got their other consultants that are needed to due diligence in business.

Owners typically haven’t gone through something like this and that’s really where we find sometimes the log jam. It is not that it is adversarial, it’s just the companies got to worry- their managements team got to worry – about running the business day to day. They’ve got to worry about hitting their goals and objectives and on top of it you got to add the diligence process or the sale. Usually 45 to 90 days is what we tell people depending upon the availability that management has to commit in the diligence process.

Noah: That’s a after the event turned into a dialogue and probably invited some potential acquirers or strategic partners.

Tom: Yeah, that is correct that’s once the letter of intent is signed. However if you are looking at how the process can be from the day the owner decides they want to sell or bring on a partner in the form of private equity investor. Or even a strategic investor until the day the money is on the table and the deal closes. That can be any worse 120 days or it could be as long as 6 months or sometimes even a year. Then I think it all depends on how motivated the business owner is and how quick they are going to work.

Noah: What would you say that comes to the biggest surprise to the owners and the deals that you are working on? Surprises in that it takes them more time to either get pass hurdles or surprises in the sense of they don’t just understand what was going to happen.

Tom: For the most part in making in the assumption that business owner has not gone through sale of another business before. I think the diligence process that really takes people by surprise and most entrepreneurs take their institutional knowledge of their business for granted meaning they’ve lived with the business for ten years, twenty years, maybe it’s been with the family and they know it like the back of their hand, this investor needs time to understand the business and sort of take the knowledge the seller has and really put that down into a form that they understand what they are buying. And that takes time, it takes people as well, it takes not only the private equity investor and the professional but typically bringing in to account for a quality of earnings, some analysis around the historical financials, and thorough having their attorneys work not only on the transaction documentation but also legal diligence understanding the entities that are part of the deal, understanding what’s going to be part of the deal, an asset deal, or a stock deal.

Any type of contracts you have to be developed with key management members as for employment contracts. All of that stuff takes time. Typically the private equity firm quickly brings on a consultant just to review the insurances and the benefits to make sure the company has adequate insurance in place and the proper benefits going toward. Sometimes we do customer studies or market study depending upon the private equity experience in a particular industry. All of that takes some time, most firms like ours are very skilled at moving all those items along in parallel but that’s why it usually takes 45 to 90 days once the letter of intent is done because you’ve got to get all those people in motion and make sure they are executing on those particular test.

Noah: What I found in my experience is that owners get shocked with how much they have to dedicate in resources in handling due diligence. One of the things we recommend is that business owners either undergo a mock legal audit and or a mock due diligence process prior to a transaction so that they have the flexibility or a little bit more control when they get to the real exercise hopefully they set up a data room they have thing stored in the right places. If it was able to put up together without the pressure of the deal. Have you seen any sellers that are prepared?

Tom: Oh yeah of course, we’ve seen many sellers that isn’t not their first round at this – they got into another business in the past and sold it and have this scar already from that process and they are much more prepared. Many of the members of their management team whether it be a CEO or a CFO that have gone through or generally stood enough to have the foresight as for what someone is going to be looking for in regards to the business or they will throw upon their professional advisors, their accountant and their attorney to help them prepare upfront but the more that the sellers can do upfront even before starting talking to a buyer or while their having those initial courting conversation with a potential buyer to get ready, the more it expedites the process in takes the pressure off the CEO or other members of the management for having to go through our drills. The last thing as an investor we want is disruption of management from day to day operations where they take their eye off the ball from running the business and missing that key strategic sale or the timing for the launch of that new product line. So really from our perspective if we feel the management getting stressed, they’re not prepared upfront, we’ll ask them to slow in down the process and recognize there’s only 24 hours in a day and you can’t expect someone to work all that time, so we recommend that they do some upfront preparation. If not, make sure that the transaction moves at a pace that allows them to accomplish everything they need to within the day, including the due diligence.

Noah: So for those owners that haven’t done this before and this would be their first time – What are the three things you would say every owner should do to put themselves farther ahead of the curve than probably a large portion of their peers?

Tom: First and foremost, I think it’s management. Do they have the right team to drive the business going forward especially if the owner is the one running the day to day and looking to step back as part of the transaction? Some owners will stay on for a minority piece but want a transition often to retirement meaning maybe not to run a day to day post-closing but sit up at the board level, keep their finger on the pulse of the business, be an advisor to the management team. So in those cases it’s important to have second tier team that is ready to take the range and lead the business going forwards. So I would say the best thing that an owner can do is to make sure that there’s someone sitting at that senior management team that is ready to take over the business. It may not be right at closing, it maybe a year or 2 after closing. Especially in circumstances when you have a key man risk in the owner who’s been running the business for 15 years or 20 years and God forbid they take a 2 week vacation and there’s chaos or they get sick, there’s chaos – so for us as an investor having that back stop there and someone that could take the range whether it be temporarily or in a longer term period this is helpful and really without that there definitely is risk that can impact value.

I think the other thing that owners should be discussing – what’s the plan for the business in the future and when I look at the business? They are looking to invest money today, have that business grow that, and when they sell the business down the road that investment is worth more and the only way it really happens that the business first being able to articulate a clear growth plan – then substantiate it with actionable items. And that growth plan could be expanding a product line, it could be geographic expansion whether be internationally or domestically. It could be a fragmented industry and head on acquisitions are possible and all those elements end up to a nice growth plan if you can clearly articulate those down to actionable items.

Noah: With respect to that growth plan, do you find that the owners that you speak with have a plan they developed? Or are they developing them specifically for you? Do you find that this is the plan and you were fulfilling their need for capital to achieve the plan?

Tom: I would say it happens both ways. We’ll come into a deal and the team will have the plan or the owner will have the plan that’s been developed not just because they are selling but because it’s the right thing for any businesses to have a road map of where you’ve been and where you are going. But often, they run the business less structured or less formal and they recognized if they’re going to sell it, they need to be able to communicate that you have to put the plan together for the next group. I would say half the deals we’ve seen have that as engraved into the culture as part of how they operate the other half are probably putting it together just for the process and to be able communicate to an investor that is potentially coming on board.

Noah: Another question that comes to me about being prepared revolves around financial statements and I know a lot of owners, they don’t want to have an audit done unless the bank requires it; they don’t want to have a review unless the bank requires it. So what’s your position on that? The information you get in terms of financial statements, accounting and things that you will get from an accounting back office. Is there anything that the owner should be conscious of if they are planning to do a deal in the next couple of years around their accounting functions?

Tom: Audited statements clearly are preferred however not always as you suggested there. We’ve done deals where there’s only been a compilation and it clearly raises the bar to due diligence from the stand point of the accountants that we send in. There are always diligences in their efforts but you’re ticking and tying a lot more things first. If it’s an audit, typically looking at the auditor work papers on the historical performance, and you are comfortable with the validity of the numbers, the credibility behind the audit first. If there’s no audit, it’s a compilation for example. The level of scrutiny has just gone up significantly because we almost have to recreate the process of an audit.

Noah: Is that impact value do you think or is it just impact time?

Tom: Well definitely it impacts on time because we as a firm, we need to invest and there’s some implications to value in certain circumstances depending upon what that exercise finds. I think would depend upon whether or not value needs to be addressed. So there’s certainly plenty of companies that do not have their accountants doing audits or even a review or taking that position because they have known the answers and maybe they don’t have the bank that’s going to dictate that in the family owned business. So there’s outside investors dictating that but they run the business with the same level of processes and procedures and the same level of scrutiny that you would find in many audited businesses or reviewed businesses. In those cases I would say they’re not going to be any type of evaluation issues.

However, often you do find that there’s a lot of adjustments that come out of that process; that accounting review process when they’re not raising their accounting standards up to an audit or review that do adjust value. There may be some things that maybe misclassified on the P&L or the expenses and the accruing; they may not be accruing appropriately. They may have a bunch of potential liabilities that need to be accrued for and it impacts their earnings. It’s tough to say that- I can’t say it happens all the time but certainly if the statements are compiled their definitely would be a bigger chance for some type of discussion around value, or of the impaired value. In review, I would say most of the time people are doing reviews they have the processes and procedures in place, it really translates into an audit however they just decide to not pay for that extra stuff because for some businesses, it is a big jumping cost to go from an annual review statement to an audited statement.

Noah: Switching gears a little in talking about the owners having conversation with their management team, their employees maybe, and their customers. What would you say are some of the best practices and maybe common mistakes that you’ve seen? When an owner signs a letter of intent to do this process and now they’re out trying to sell the new part on the team, describe what’s going on in their company. Give me a couple of stories maybe of how people either they’ve done it right or if they’ve done it wrong.

Tom: Yes, it’s a tough call to make as a business owner. We often sell businesses that we invested in and go to a sale process some place down the road after our investment and it’s always a point of discussion and debate as far when do you tell people internally and who do you limit that communication to; and then when do you tell your customers and vendors. Clearly people don’t like surprises. I can say over the course of many years of doing this that customers and key members of management don’t like surprises and I would always recommend to business owners that they don’t surprise people. The day a deal closes they call their largest customer and tell them or the largest customer hears it through an industry announcement.

What we recommend is that in order to not only have a fluid process to close but also generate information we are going to need as a private equity firm to get comfortable making their investment yet the owner needs to let the key members of the management in the tent to be able to have a due diligence process that’s efficient and effective.

As far as notifying customers we usually recommend they wait a little bit through the process, let us get our accounting diligence done. Let us get our financing or any bank financing we are bringing to the table, let’s get that done. Then allow us to go out and talk to customers and key customers and vendors. Occasionally we want to do that upfront and investors don’t want to do that upfront especially if there is a big customer concentration because there is no sense to go through all that work if the customer relationships is not stable because if you got a 25-30% customer in that business you can’t get comfortable there’s some instability around that relationship long term. It’s going to be difficult to get the deal done. So before we ask the sellers to commit the time and the resources with the 3rd party, they need to use to get a deal close and before we do that same thing commit out time and our resources. We typically like to check that concentrated relationship upfront but if there is a diverse customer-base and diverse supplier-base that usually can wait to the end of the telling of the process but that’s how it’s communicated to the customers and the vendors. It’ definitely a strategic message that usually will work with the owners on and let them know some things that we seen that worked well in the past and also let them know how to position us. I mean, you know, in the case of Shoreview we are not folks that come in and run day to day on the companies we invest in. We rely on the key management to continue to do that. Other investors have taken more hands on operating approach. The customers and vendors historically if they enjoyed their relationship with the company to date that level of continuity meaning “Am I going to be dealing with the same person, when I pick up the phone and call” that level of continuity helps in making sure that there’s, you know, you’ve got a happy customers or happy vendor on the other end of the transaction.

Noah: Yeah. Do you think most owners take a real hard to look at when and how they are going to tell people these things; they need a lot of coaching?

Tom: I wouldn’t say they need a lot of coaching. I guess a lot of them ask us and let the selling people know and when the sale let their HR department. At the senior levels, you know, those people that are key, the vice president of sales; they are sort of the lead sales employee of the business that we are going to want to talk to before closing, the person that runs the HR and sometimes and the CFO delegated as the HR person. We definitely talk to them before closing regarding some HR things. Typically the HR person handling insurances and benefits – we obviously need to understand those going into a deal. The CFO clearly needs to be the first person they tell right upfront only because they are typically the person that’s the keeper – that store the financial records; and the brains behind putting the budget together etc. and that’s typically the first area we delve into on a deal. Often the sellers will ask us, you know, “Hey how have you seen that done effectively” What have you seen that worked and what have you seen that doesn’t work?” and we certainly give our inputs.

Noah: Maybe Tom you can share some stories with our listeners. I think that’s one of the things that people like the most. Just hearing about some of your experiences of maybe different owners and describing either what they did right or what they’ve done wrong in terms of preparing the deal and or closing a deal, you know, finding the right partner. You tell me maybe you can share one or two stories with our listeners.

Tom: Yeah I would say that the biggest sort of lessons learned that I’ve seen over the years. I had been around finding the right partner and that goes both ways – it’s like a marriage if the marriage is going to have the best odds of working. Do the partners know each other? A process where buy a business owner and an investor like some of you gets to know each other and cultivating the right relationship making sure the personalities work; making sure the approaches work; making sure the styles work; and not everyone operates the same way. Some people are more heavy handed than others; and some people are more laid back on both sides of the table. Just making sure there’s a fit, personally I think it’s important especially a transaction where the owner plans to stay involved in the business either the day to day operating role as the CEO or at the board level. You want to make sure you get along with your partner. So I think that’s the sort of the first big lesson that I’ve seen, you know, over the years of doing this and that is making sure we picked the companies right and we picked the people that we are partnering with and vice versa.

Making sure that the people understand who we are and what we are about and how we operate and conduct ourselves. There’s no way to that other than courtship getting to know someone over a few dinners and few meetings, calling references is a must on both side of the table just so we would want eventually through the deal process to call customers and vendors and make sure that everything that the company said we’ve got great relationships with the customers and we’ve got great relationship with vendors, they love doing business with us etc.

We make sure all that checks out to encourage business owners to call references and not just the references that the private equity firm gives them. I mean typically say “here’s all the deal we’ve done in the past; the current portfolio and the past portfolio,” “here’s the professionals we’ve deal with – our accountant and our attorney, here’s the list and tell me who you want to call”. I’m not just going to give them 5 people, meaning if they asked for just 5 people I’ll get them 5 people. But we are not shy about calling all the list on the table and letting them pick who they want to call. If they want to call of them, that’s fine. It may take a little while to get in touch with all the people but certainly we want them to make sure that they are comfortable going into the relationship as well.

We’ve got nothing to hide I think from our perspective just as we’re going to ask for unrestricted access we have no problems giving the same in return with regards to due diligence that a seller wants to perform on the potential buyer. And I would say the other big lesson is to sort of understanding expectations of upfront and that is expectations of reporting a company, you know, it’s a privately held business and just one owner. They are not used to reporting to someone and not that I’m implying by any means that other firms had owners reporting requirements but just the mere fact of having to send someone a monthly financial and spend time talking to him about those financial as a partner. It’s different then the most of the individually owned businesses, our business owners are used to. Just understanding expectations going in to the relationship I think is important in both sides of the table; buyer and seller.

Noah: Those are great suggestions for people, the things they should be doing. What else you have to share with our listeners that they should be thinking about if they are investigating a private equity firms or a supporter?

Tom: Pick one that’s going to be a little accomplished; you know what you are looking for. If you are looking for someone that is, you know, has a particular industry experience or someone that got a broader operating experience, meaning if you’ve got issues with regards to your manufacturing plants and you are looking for an investor that can help you make sure that they are operating more efficiently, bring that experience to the table. You really have to cater your search for a partner to fit the criteria you are looking for them to fill. There is no difference with the example I gave earlier with the doctor. I mean if you have a heart problem you go to a cardiologist not to an orthopedic surgeon and I think the same thing that goes for business owners that are looking for a partner or a private equity investor to buy their business to really take the time to understand what you are looking for in that partner and then take the time to find the partner who meets that criteria.

In the example of Shoreview we’ve done a bunch of engineered product deals; we’ve done a bunch of niche distribution deals, some consumer deals. So we can bring those experiences to the table. We’ve done a bunch of deals that have successfully gone out and made complimentary acquisitions, add-on acquisitions after we’ve invested in those businesses. On average, most businesses do three add-on acquisitions once we make that initial investment. If that’s part of your strategy for growth or the business strategy for growth make sure you find a partner who’s been in there before, he’s done it successfully, and work with the team to help not only to identify those add-on acquisition opportunities but get them closed and also has the capital to follow on with if needed to get those deals done. So in my perspective that’s an important part of the process of business ownership to go through in their looking to identify a partner.

Noah: Great, well if any of our listeners have interest in learning more about Shoreview Industries and Tom D’Ovidio they can go to Shoreview primarily focuses on working on with companies that have EBITDA of $5 million to $20 million, so if that’s the deal for you as listeners and you’d like to go directly to Tom, feel free to reach out him through his website. Tom I want to thank you so much for joining us today and sharing your insight and thanks to all the listeners for joining us once again.

Tom: Thank you Noah.

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Written by Noah Rosenfarb

Noah Rosenfarb
Noah Rosenfarb, CPA/ABV/PFS has devoted his career to advising business owners on all things related to money. He is a Personal CFO and Holistic Wealth Coach at Freedom Business Advisors, which provides middle market business owners guidance on how to successfully transition out of the management and or ownership of their company. Mr. Rosenfarb is the author of EXIT: Healthy, Wealthy and Wise.

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