For a business owner, partnering with a private equity firm is a bit like getting married. While there may not be a clear consensus about how many months or years you should date someone before tying the knot, the experts tell us the answer is something like this: However long it takes to get to know someone thoroughly, to see someone’s best (and worst) sides, and to make sure future plans and goals are in sync. This same advice applies to selecting the right private equity partner.
The due diligence process is akin to dating — it allows time for both parties to get to know one another. Of course, it also provides time for a private equity firm to study certain financial, customer, product and other data about a company. But above all, the due diligence period is about ensuring the partnership will work. No matter the reason you’re selling — retirement, diversification or general liquidity — selecting the right partner can offer continued value creation for a lifetime.
So, what characteristics should a business owner consider when evaluating a potential private equity partner? Below are five areas that should be assessed during the "courting" process.
Businesses should feel comfortable sharing thoughts and opinions about their company with a potential private equity buyer. Especially in the “getting to know one another” stage, it is vital to the health of the ongoing partnership that you feel understood and appreciated.
The basis for good communication is trust and mutuality — and with trust comes the ability to speak honestly without feeling judged. If either party feels compelled to hide something because of fear of the other’s reaction, then this is likely not the right partnership. However, if a potential private equity partner is prepared to share information about the firm, people, habits, style, investors, successes and challenges, then you may have found the right partner.
We know that cash flow growth is a primary driver of value creation. While there are many methods used to boost cash flow and profitability — working capital optimization, capacity utilization and operational improvements are just a few examples — top line expansion, either through organic growth or add-on acquisitions, can drastically enhance investment returns. This is why private equity firms create a comprehensive financial forecast, which can come directly from management team input.
Huron Capital Partners models the specific impact that many operating and sales initiatives will have on earnings, investment returns and risk profiles. This financial model is then used as the foundation for the overall investment thesis and growth strategy. Being in agreement about this strategy is particularly important if you are planning to reinvest or “roll” a portion of your ownership from the sale of the company and sharing in the future upside.
In all of the platform acquisitions we’ve made at Huron Capital since 1999, all but two included some level of seller/management rollover. In fact, we encourage owners to reinvest with us and to that end, we prepare and share individual analyses on an open-book basis showing the math behind the projected value for all involved using the assumptions and results of our plans for future growth. Whether you choose to reinvest or not, establishing a shared vision for the company is crucial to moving a transaction forward.
Mutual respect, loyalty and integrity — the extent to which a private equity partner embraces and embodies these core values drives team dynamics and, ultimately, cultural fit. One inappropriate interaction or personality can negatively impact deal momentum or kill the deal outright. If any of the private equity firm’s representatives is missing one of these three values, communication stalls, distrust seeps in, and the relationship may quickly deteriorate. Consistency and predictability are as valuable to personality as they are to business earnings.
The Company You Keep
It’s true — the group you surround yourself with says a lot about your values. So, get to know a private equity firm’s team and network and decide for yourself if that’s the type of company you want to keep. Meet the operating partners, senior advisors, and former and current portfolio company CEOs.
Ask to meet as many of the firm’s colleagues as possible during the due diligence process, and do it without the deal team in the room. A private equity firm’s “extended family” is also important when it comes to appointing a Board of Directors, as a firm will typically rely heavily on its network to fill outside director positions.
Gravitate to a PE firm that involves an industry expert or operating executive during due diligence. We’ve found that business owners respond favorably to having a business owner peer involved early in the process. They have been in your shoes before as an owner and operator, and these individuals often end up becoming valued board members and trusted advisors for the management team after a transaction has been completed.
For Better or Worse
As a business owner, you understand that not everything goes as planned. The loss of a major customer, a product recall, supply interruption, inventory issues, a facility fire — these unforeseen incidents can have a profound impact on the revenue and earnings of a business. It is important to understand how a private equity firm deals with, or ideally, has dealt with these types of situations. For example, connect with the management teams of portfolio companies that have been faced with challenging situations and inquire how the private equity investor reacted and how helpful (or not) they were in resolving the situation. Understanding how a firm copes in both good times and bad is essential to ensuring you’ve selected the right partner.
To Summarize: Do Your Homework
While a potential private equity buyer is performing due diligence on the company and management team, business owners should also be doing due diligence on the buyer. What you learn during this process will very likely be determining factors in who is chosen to take to the altar. Sure, valuation and financial terms will always be important considerations, but you cannot ignore the one piece of advice relevant to both marriage and due diligence: Life is short — choose wisely.