Selling a Business Twice: PEGs

1 November 2021: Selling a Business/PEGs Part 2

At the end of last week’s post – Selling a Business Today: PEGs – your intrepid reporter mentioned that when targeting PEGS – private equity groups – as potential buyers of the business you’re bringing to market – there were considerations other than those mentioned in the post.

And such other considerations are both good and bad – and occasionally both at once – when selling a business.

But before getting started on some of those consideration, a little clarity about our topic is in order

PEGs, Family Offices and High-Net-Worth Individuals

In the Main Street Market of business acquisitions, where the businesses are generally “mom and pop” – businesses with valuations of up to $1 million or $1.5 million – the buyers are also generally “mom and pop”; individuals, spouses, a couple of buddies or a desperate parent hoping to find something for a wayward child to do.

But when selling a business – as either a business broker or business owner – once you get up into the lower Middle Market – businesses with valuations up to about $25 million or so, the buyers become more sophisticated and, as a result, the deals more smooth.

Though this is not a universal rule, generally speaking these buyers fall into one of three groups: private equity firms (PEGs), family offices and high-net-worth individuals. Each of these groups has large and small players. Our dealings are usually with the smaller ones.

As explained last week, private equity groups manage investment capital obtained from institutional investors or high net worth individuals to acquire equity ownership in one or more companies. They generally have a relatively short-term holding period – generally less than 10 years – and have to return their investors’ capital within a specified time period.

Family offices, on the other hand, generally have a longer term approach. Family offices are set up to manage a family’s capital and they have different objectives and motives. Needless to say, the term “family office” as used in our industry does NOT refer to Tony and Christopher.

High net worth individuals generally have at least $1 million in liquid financial assets – that is, assets that are either cash or “cash equivalents”, investments that can be turned into cash quickly.

This post is a follow up to last week’s on PEGs. We’ll tackle family offices and high net worth individuals at a later date.

PEGs as Buyers: Pros and Cons

We’re constantly receiving inquiries from smaller PEGs.

Because we work with businesses with valuations up to only about $25 million – and because we publicize that range – the PEGs and family offices that contact us are smaller ones. Not surprisingly, the financial descriptions they provide of the businesses they’d like to find are remarkably similar; revenue between $5 million and $20 million, DE between $500,000 and $5 million and geographically located in North America.

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As I explained last week, PEGs are serious buyers; well-capitalized and able to pull the trigger quickly. But they’re also picky. They want businesses that can scale.

PEGs, large and small, have plenty of money to spend and they have to invest it – fairly quickly because they have to return it (with a handsome ROI) to their investors in a fairly short period of time. PEGs acquire multiple businesses but they generally don’t have the in-house talent to run them.

They’re investors. As such, they look for businesses with solid management teams in place.

That fact brings up the first significant consideration for a business owner. A PEG will, very often, want the seller to stay on with the business.

The downside of this is that, if the seller is anticipating racing with the Big Dog in the next America’s Cup or re-stringing and tuning the guitars for Keith Richards on the Stone’s next world tour, such post-closing plans would be thrown into disarray by the arrival of a PEG at the door with a check that was large enough to get the immediate attention of some current members of the American Congress.

BUT!

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If the seller was young enough – and patient – this type of buyer could offer the seller the unique opportunity to sell their business TWICE!

How so?

Because the PEG has a relatively short turn-around time – and has to grow the businesses it acquires.

To effect that growth, a PEG plans to invest in the business in the hope of supercharging it.

Let’s Do Some Math

DISCLAIMER: The following is a simple example used only to illustrate in general terms how working with a PEG can offer the opportunity to sell a business twice – and it assumes that a business broker, one that know swhat the heck he or she is doing, is involved.

Our hypothetical business generates $7.5 million in revenue with Discretionary Earnings of $1.5 million. The business broker involved values the business at $3.9 million and suggests to the seller that they bring it to market at $4.25 million.

After some negotiation, the seller and the PEG agree to a value of $4 million. But the PEG wants the seller to stick around – and to be motivated enough to earn the PEG the proverbial “handsome return” mentioned earlier.

As such, the PEG offers to buy 90% of the business for $3.5 million (roughly 90% of the agreed value) provided that the seller stay to continue the grow the business for five years at which time the PEG plans to sell.

The PEG and the seller agree to a target valuation of $12 million and the PEG agrees to invest additional capital to fund that growth.

Assuming the growth target is hit and the business is acquired in a strategic acquisition – or by a larger PEG – the original seller, while being paid handsomely during the PEG’s involvement, cashes out a second time; for an additional $1.2 million.

The Downside

The downside to this is that the seller, once the PEG is involved, is no longer the boss. And even worse, is a minority partner in a business he or she started and grew from nothing.

This is a tough transition for many sellers and the danger is that somewhere along the line a disagreement on strategy might result in a level of acrimony that results in someone saying, “This ain’t workin’.”

If that happens, the seller, as minority owner, is in a tough spot. The PEG holds the cards and, depending on the terms of the operating or shareholders agreement, our seller may be escorted to the parking lot with a severance payment sufficient to buy a ham sandwich and a Coke at the dinner down the street.

The Bottom Line

If you’re selling a business that is large enough to interest private equity groups – and that’s almost any business with revenue of $5 million or more – advising the seller on this option – and its pros and cons – is important. It’s yet another aspect of managing the client’s expectations.

PEGs are serious and well-capitalized buyers that don’t have time to waste; they won’t waste yours. These characteristics generally makes them easy to work with.

But, as with all facets of selling a business, there are issues and aspects that can cause some concerns. Our clients must be made aware of the potential pitfalls as well as the possible upsides.

If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

Searching

This week’s “Searching” item comes from a family office-sponsored private investment fund looking for a lower Middle Market business with between $5m and $50m in revenue with discretionary earnings of between $1 million and $5 million in the traditional B2B services and healthcare spaces.

If any of you know of something that might fit, please let me know.

I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.

Joe

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