By Bruce Landau
The way private equity (PE) runs a business is vastly different from the way most owners run their business. A PE group prioritizes being rich; a family business prioritizes being king.
Speaking from personal experience, for more than 30 years, I worked at and ultimately headed a mid-sized family business. We manufactured, marketed, and sold healthcare apparel to resellers across the US and internationally. We also funded a business which we grew to a 150+ store nationwide chain of healthcare apparel stores.
When my brother and I ran these businesses, we looked at our leadership team and associates as our greatest assets. We constantly re-invested the company’s earnings into growing the businesses. We believed that by growing the businesses, not only were we increasing market share and profits, but we were also providing our associates with a challenging and exciting environment to incorporate the latest technology. This allowed them to grow their responsibility and skills, and kept everyone highly engaged.
We always evaluated each major capital expenditure by whether it was good for the long-term strength and vitality of the business. Likewise, as a family business, we consider our associates “part of the family.” So long as an associate is hard working, honest, and a team player, they have a future in our organization. This is how a king, albeit a benevolent king, would prioritize and run his estate.
Conversely, many private equity businesses look at how they can grow sales with as little investment in the business as possible. This mindset fosters thinking of associates as costs to be minimized, not assets to be maximized.
Instead of building a business for the long term, PEs look to outsource as many of the operations and functions as possible, thereby, minimizing capital expenditures and preferring a variable cost structure.
All private equity groups answer to their investors, who grade their investment primarily on high financial returns, not on whether the business fosters a supportive family-friendly work culture. PE groups focus on getting rich.
How to look at bank debt
While running our businesses, we prided ourselves on organically growing the business from annual earnings. By pacing growth to annual earnings, we grew at a slower and steadier rate (more turtle than hare).
Conversely, a PE owner will invest as little equity in the business as possible and borrow as much as possible from banks. The greater the bank debt, the higher return on equity (so long as the entity meets its bank covenants). Of course, if the company falls short on its bank covenants, the business is in jeopardy.
By conservatively utilizing bank debt, my family business missed out on potentially large opportunities. For instance, one can sometimes acquire smaller competitors, funding the purchase solely from bank debt generated by the target companies own earnings. Then, by adding the synergy of consolidating functions, you can improve your profitability with a very small capital outlay.
How to think about selling to PE
I am NOT saying that the PE model is wrong, there is nothing wrong with preferring to be rich than king. Additionally, PE firms can add value by sharing their wider experience learned from owning many different businesses in many different industries. Optimally, the PE firm brings its “bench of experts” to your business.
I am suggesting that the priorities and perspectives that a PE group possess are different from the priorities and perspectives of most private business owners.
PE Groups are much less concerned about firing long time employees, closing down plants or offices, or canceling long term vendor relationships. If it improves a line on the income statement or balance sheet, then it’s frequently implemented.
For better or worse, PE groups have no relationships with associates, professional advisors, vendors, or the community that has supported the business for years.
Sometimes having a fresh set of eyes with broad experience managing many different businesses in many different industries can be important to revitalize a business.
However, understand that the PE timeline (returning the fund dollars to the investors generally within 5-8 years) places intense pressure on the business to emphasize short term results at the expense of the long-term fundamental culture and structure of the organization.
Thoughts to consider when working with Private Equity
- Talk and learn from others about how they have worked with private equity
- Be mindful of what your PE group says about what they will do with your business during the “dating phase”. Find ways to understand if that will actually happen.
- Be mindful of other options you have to compare before selling
At Lift Insight and Capital Partners we have worked with and sold businesses to private equity as well as utilized other strategies to help business owners “take some chips off the table.”
We would love to share our experiences and resources to help you process this exciting, challenging, and important business and life decision: would you rather be king or rich (or a mix of the best of both)?
Interested in learning more? Contact us here.