Private Equity and Family Businesses
03 October 2022: Private Equity and Family Businesses
Private equity firms are coming after family businesses.
That is a statement from no less an authority than The Wall Street Journal.
Although we’ve seen a modest drop recently in the number of inquiries we receive every week from them, private equity groups – PEGs” – have been active in our market – businesses with valuations of up to about $30 million – for the last six or seven years. We attribute this recent drop off to higher interest rates and, to a lesser extent, the spike in inflation.
But PEGs are still out there – and they’ve got money to invest.
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So, what are we seeing? First, let’s define what we’re talking about.
Private Equity
PEGs make these equity investments using various investment strategies including buyouts, growth capital and strategic acquisitions. Some PEGs bring their own management team to a deal and take the existing owners out completely. Others want to control the business they invest in but want the founders, current owners or management team to stay on and continue to grow the business.
Each PEG raises funds from investors and invests in businesses that meet the PEG’s investment criteria. PEGs are still flush with cash and they’re very active in the market looking for good businesses to buy because they have to either deploy their capital or return it to their investors. And PEGs are loathe to return their investor’s money uninvested!
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So, what’s the “family businesses” connection?
Private equity firms, long known for taking big companies private, have begun to shift their focus to smaller targets. One reason for this – according to the principal of a small investment firm – is that the best large companies have already been acquired, in my opinion a highly debatable proposition.
This past Summer, I was speaking to a group of business owners about what we were seeing in the business sale and acquisition market. In the audience was a principal of a New York-based “active investment management” firm. During the Q&A, he asked whether we were seeing any evidence that deals were getting smaller because larger “quality” deals were harder to find.
My response was that the pool of larger deals is constantly being replenished as smaller companies grow – either organically or through strategic acquisition. This constant replenishment is what has caught the attention of PEGs.
According to the Journal article, smaller deals – those requiring less than $50 million – generally provide better returns than larger deals and PEGs are targeting everything from small specialty manufacturers and distributors to health- and skin-care companies.
The Journal article described deals for a wine importer, a pet-food manufacturer, a workplace safety company and a research firm among others.
Of course, not all PEGs are investing in these smaller businesses. But the smaller ones are.
The PEGs that contact us are generally looking for businesses with up to $10 million in revenue and as little as $500,000 in EBITDA (discretionary earnings).
The Family Business Benefits – and Risks
One of the main benefits to the owners of a family business is that buyers often want to keep the family that runs the business on. This means that the selling family members generally retain a sizeable stake in the business. In fact, in some cases, the PEGs acquire less than 50%. (But they usually want to control the voting equity.)
In addition, the investment allows the firm to expand – through acquisition or organically – without the family owners putting their own capital at risk.
Another consideration is that the founder’s or owner’s children have no interest in the business – or lack the training to drive its continued growth. Bringing in a PEG allows, with the right deal structure, the owners to safeguard their legacy. It also allows them to benefit when the PEG eventually sells the business; which it is guaranteed to do.
But there are risks. And for the owners of family businesses, such risks are not limited to financial.
PEGs strive for efficiency; i.e., cutting expenses. While this can be accomplished by streamlining some tasks or combining others – such as accounting – with corresponding functions of the PEG’s existing stable of businesses, this often means cutting jobs.
In many cases, the family business is a major source of local employment, charitable giving and local sponsorship. Unless the terms of the deal strictly address these seemingly minor issues, those aspects – the local connections – may be in jeopardy.
The Bottom Line
Private equity firms are buying smaller and smaller businesses.
They often look for businesses that can complement those that they’ve already invested in. For instance, if they own a distributor of auto parts, they would be logical buyers of the manufacturers of those parts – the previous step in the supply chain – or the retailers of those parts – the next step in the supply chain.
But PEGs are also active in the roll-up arena.
A couple of months ago, the Journal did a story with the headline, “Private Equity Wants to Wash Your Car“, which focused on single purpose equity firms that are attempting roll-ups of car washes.
Now, this may not mean that Uncle Ernie’s Brushless 2-lane car wash is a target of a private equity firm but it does mean that Uncle Ernie’s would be a target of River City’s five-location car wash operation; and that River City would certainly be the target of several PEG’s focusing on rolling up car washes.
PEGs are buying and family businesses are becoming favorite targets. To take advantage of that fact, sellers and brokers need to know whether the family business – or any business, for that matter – they’re selling could be a PEG target.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
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.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
Searching For…
We’ve just been contacted by a small investment company looking to acquire U.S. West coast IT services and software services with minimum DE/EBITDA of $1.5 million.
If any of you know of something that might fit, please let me know.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 500 in the world. He can be reached at jo*@Wo*******************.com