Why private equity firms are eager to buy businesses

Timing is everything, or so they say.

We have witnessed situations in “hot” industries in which business owners say they are going to sell when their profitable business grows to a certain level of revenues — from, for example, $15 million to $20 million. Using current multiples being paid in the market for sought-after companies like theirs, they reason that when $20 million in sales is achieved, their business will command a value that will make them wealthy beyond their dreams.

Unfortunately, as the industry segment cools, at that $20 million in sales, their business may be, and often is, worth less than it was at the $15 million level. There is often little chance that their industry will be back in favor within a reasonable time period, forcing the owner to work until that time, if it comes, or just finally settling for less on the sale of their business.

There are typically three types of buyers for companies: strategic buyers; financial buyers; and individuals. The first two categories are the ones with the money and experience to provide a seller with the best opportunity to consummate a favorable transaction.

It appears many potential strategic buyers may currently be distracted, working on internal efficiencies and developing direct oversees connections and operations. It is also a fact that the bigger major corporations grow, the less interested they are in mid-size businesses. This has provided a unique opportunity for financial buyers.

Financial buyers – specifically, in this case, “private equity groups,” — are now focusing on mid-size companies with good sales channels and brands that may have aging owners with a desire for cash to reduce their investment in the company or to expand their business to remain competitive.

These companies are especially attractive if they may significantly benefit from having certain of their products, or portions thereof, manufactured overseas.

Accordingly, the private equity firms are quickly forming relationships with overseas manufacturers in China, India, Mexico and other low-cost countries, or are actually buying quality production houses in those countries for their own account.

As the private equity firms grow, they actually assume strategic characteristics in certain industries, having added various types of companies to their portfolio that may benefit from complementary acquisitions.

In 2004, approximately $300 billion of the deals consummated were undertaken by private equity firms. In order to provide an opportunity for reasonable future gains, many of these equity firms must deploy funds that they have raised from investors well within a 10-year period. Surveys indicate that approximately 50 percent of money raised by private equity funds during the heyday that ran through 1999 had not been deployed by the end of 2004, putting substantial pressure on firms to find and make deals in the near term.

Not just manufacturers

The competitive environment, which may involve bidding against other buyers, has forced equity firms to raise offers, reducing their returns and at the same time possibly limiting the amount of due diligence they perform on a potential target. On the other hand, private equity firms are generally able to make decisions and act faster than larger strategic firms encumbered with bureaucracy and strict acquisition policies.

A private equity firm will provide funds to growth opportunities totally or partially acquired, typically leaving strategy to the target company’s retained management team. If the prior owner stays on after the sale, it is often possible for that owner to share in operating profits or proceeds from a subsequent sale of the company. Another positive aspect of a sale is that the equity firm will usually not require the prior owner, who may still retain some ownership, to guarantee any additional outside debt assumed.

In addition to manufacturing, private equity firms also are showing significant interest in service firms and food -related enterprises that have growth potential and are not readily susceptible to foreign competition.

With interest rates rising, sellers once again have opportunities to invest their after-sale cash in safe vehicles with reasonable returns. They also will feel content knowing that so much of their net worth is not tied up in one asset — their own company.

Given the amount of private equity activity seen in the market and the attractive purchase prices and terms offered to sellers, it is definitely a “hot” time to consider selling your business.

George T. O’Brien is a managing director of G.T. O’Brien Inc., a professional mid-size corporate merger/acquisition and valuation enterprise based in Manchester. He can be reached at gtobrien@gtoco.com.