Cash from a private equity (PE) firm used to purchase interests in a closely held business may allow some of the owners of a business to entirely exit the business. It can also help fund a management buyout of the existing owners, or simply allow one or more of the business owners to generate personal liquidity from the business while retaining some degree of ownership (“taking chips off the table”).

Preparing to Sell to a Private Equity Firm for Diversity

Before selling your business, it is important to prepare it for sale. Private equity firms are “financial buyers.” They look to acquire companies that are growing and have high margins and predictable earnings. Typically, a PE firm will seek to earn a return and then exit the business within a set period of time.

Retaining an experienced mergers & acquisitions advisor can help you maximize your outcome by helping you prepare your business for sale, evaluate offers, structure the terms of your sale and guide you through the purchaser’s due diligence review of your business.

Preparing the Business Financially 

Getting your company’s financial house in order is essential to receiving an optimal price upon sale. A private equity firm’s objective when purchasing a company is to generate a target financial return within a certain period of time. In the ordinary course of your business, you may not review your business’s financial reports in great detail; however, before buying your business, a private equity firm will. Consider working with your advisors to do the following before offering your business for sale:

  • Prepare audited financial statements. When the business was owned by one or a few owners, it may not have seemed necessary to have professionally prepared and audited financial statements. However, a PE firm may not risk offering a premium price for a company whose financial statements are not audited by a reputable accounting firm.
  • Consider obtaining a “quality of earnings” statement. As private equity firms are financial buyers, they seek out companies with solid and predictable earnings. It may be useful to go into negotiations with a quality of earnings (“QofE”) in hand to help minimize surprises, which may also lead to a better valuation for the company (or at least provide an argument for one).
  • Bring financial reporting up to industry standards. Closely held businesses may not have invested in the systems necessary to track their financial operations. As a result, financial reporting of accounts receivable, accounts payable, inventory and the like may not be timely, may be inaccurate or may simply not exist. A private equity firm will insist on having proper financial reporting and financial controls. Have industry standard financial reporting systems in place, with appropriate personnel to operate them, before engaging in discussions.

Preparing the Business Operationally 

Before buying, a PE firm will want to know that your business is stable and will operate properly (and profitably) at the time it is purchased and during the time the private equity firm owns it. A PE firm will review your business’s performance to determine if your operations are sustainable into the future. To prepare for this analysis, consider the following: 

  • Be sure your business has a stable customer base. Confirm that contracts with customers are binding and can be transferred to a purchaser. All contracts will need to be reviewed to determine whether consent to the transfer or the assignment of the contract is required if there is a sale, even if it is a partial sale. Also, if possible, renew contracts or extend them so that the buyer will obtain a client base that will support the business for some time.
  • Shore up your supply chain. The COVID-19 pandemic brought to light the fragility of worldwide supply chains and “just-in-time” supply management. Disruption to a supply chain essential to your operations could significantly impact profits and even the viability of your business. If possible, source essential materials from multiple suppliers located in different places (perhaps both foreign and domestic). Firm up long-term pricing, and consider using financial hedging.
  • Retain key employees. Clearly articulating the value of the management team and key employees can drive shareholder value in a sale. Incentivizing key employees to stay throughout the transition process will help drive customer retention, preserve value in the business and provide the buyer with enhanced operating knowledge. It can also result in positive outcomes for those key employees. It is important to have these strategic conversations with your private equity partner, as you consider entering into employment contracts with or providing incentives to your employees, to obtain alignment on the future direction and success of the business.
  • Protect intellectual property.  All businesses have intellectual property. Perhaps it is a patent, trademark or other right. Perhaps it is a process unique to your operations. It may be formal, like a patent, or informal, like the special way that you do what you do. If permitted by law, safeguard your business’s intellectual property in appropriate employment agreements and restrictive covenant agreements so that it isn’t used by someone else should an employee leave the company. Be sure your patents and trademarks are enforceable, and take steps to extend them if possible.
  • Be sure your operating structure matches your legal documents. Before talking to a potential buyer, be sure you are operating according to your formation and governing documents, such as your bylaws, charter or operating agreement. If necessary, update your documents to reflect your current structure. Be sure your official filings are up to date. Confirm that your company is qualified to do business in states where you are doing business. Company tax returns should reflect your current operating structure. Outstanding tax liabilities or filing fees may impact the purchase price. Amend all documents, and file new documents, as necessary.

Expectations 

As noted throughout, a private equity firm is a financial buyer, interested in obtaining a target return in a certain amount of time. The PE firm will be focused on partnering with you to drive revenue and lead the business. In fact, many shareholders experience a second financial windfall as the private firm sells its investment and seeks liquidity at the end of the investment life cycle. Oftentimes the “second bite of the apple” is bigger than the first.

You can expect change as you partner with a PE firm, which is why finding the right private equity partner is key to the ultimate goal of driving value in the business. Consider a potential PE partner’s industry experience, process for optimization and driving growth, and resources offered to its portfolio companies. Through the diligence process, it is important to align on the vision for the company and agree on key levers to take the business to the next level. While decision-making will likely move from unilateral to partnership, collaboration on the key value drivers should result in the best outcome for all. 

Expect the business’s balance sheet to change with additional debt and equity capital in the business through your PE partnership. A private equity firm’s intention through its investment thesis is to drive the growth and value of the business. As an added benefit, private equity firms have access to additional equity and typically will allocate incremental equity to enable further growth of the business. 

Understand the Transaction and Don't Go It Alone

Selling to a PE firm is a viable way to exit your business or reduce your ownership stake. Nevertheless, as with any important transaction, you should prepare in advance and understand what to expect when the transaction is complete. PNC has the resources, including concierge services for private equity firms and their portfolio companies, access to investment banking advisory services, and corporate advisory and private business strategists, to help you through the sale of your business. 

Learn More 

For more information, please contact your PNC relationship manager or the Financial Sponsor Coverage group at financialsponsorcoverage@pnc.com.

WHAT IS PRIVATE EQUITY?
There are many ways to categorize and define private equity firms. According to Harvard Business School Online, “[p]rivate equity firms invest in private companies by purchasing shares with the expectation that they’ll be worth more than the original investment by a specified date.”1 The way in which a private equity firm invests can vary, namely in one of the following ways:
  • Minority Investment: Invest in a noncontrol capacity to drive growth and revenue in support of shareholder and management vision.
  • Majority/Control Investment: Invest in company to fully support management while optimizing shareholder liquidity. “Control” is defined as ownership of more than 50% of the company.