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Selling a Business: Are Private Equity Group Still Buying?

20 June 2022: Selling a Business: Are Private Equity Groups Still Buying?

In several earlier posts, we discussed private equity groups (PEGs), what they are, how often we hear from them and how we work with them.

PEGs – along with family offices – have been voracious buyers in the M&A field for the past five years or so. But the investing environment has changed fairly significantly lately and, as a result, a few of the brokers in our network have been wondering how those changes might be impacting the PEG activity in our sector of the market –  businesses with up to roughly $30 million in revenue.

But first, I want to make sure that we’re all on the same page with what PEGs and family offices are and how they work. Here’s a brief summary.

Private Equity Groups

PEGs”, or private equity groups, are groups of mostly unrelated investors that have pooled their capital for the purpose of investing in bigger fish that any of the individual investors would normally consider.

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A private equity firm makes equity investments in operating companies using various investment strategies including buyouts and growth capital. Each PEG raises funds from investors and invests in businesses that meet the PEG’s investment criteria.

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.

Family Offices

Family offices” are broadly defined as family-controlled investment groups. They can be a single-family office or a multi-family office.

Single-family offices are generally set up by very wealthy families and charged with managing the family’s wealth. When people think of single-family offices, the names Rockefeller, Ford, and Gates come to mind in the U.S.; Arnault (LVMH), Pinault (fashion) and Albrecht (ALDI) in Europe; and Lee (Samsung), Wan-Tsai (Cathay) and Chung (Hyundai) in Asia.

Each of these families are worth many billions of dollars, Euros or won and you’re unlikely to run into anyone even remotely connected to them at any picnic, wedding or football game you might be attending, especially if you’re in the nose-bleed seats. But there are countless other families that, although not nearly as wealthy as these, are wealthy enough to set up family offices.

Who Targets What?

PEGs generally operate from an invested pool of money contributed from a variety of sources including wealthy individuals, pension funds, trusts, endowments and the like. The typical structure involves a limited partnership (LP). The partnership usually has a finite term, often 10 years, at which time the PEG will sell all of the investments in order to return the original capital plus gains to the limited partners.

While there are some exceptions, PEGs typically invest in businesses that have matured beyond the proof-of-concept phase, possess an easily-defined market position, a reliable cash flow, some competitive advantage and opportunity for further growth and expansion.

PEGs are under some pressure to invest because they have a pile of dough that they have to return – with a handsome return – within a certain time frame. Family offices, on the other hand, are not under such pressure and can be more deliberate.

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PEGs will invest in a variety of businesses knowing that there will be some laggards among the group.

What’s Impacting Them Now?

Well, the easy answer is, the same things that are impacting everyone else; but somewhat differently. The big three are interest rates, inflation and the shrinking pool of capital.

Interest rates are rising. In the past week, the Bank of England raised rates for the fifth time this year and the U.S. central bank raised rates by 3/4 of a percentage point. (Only last month the Fed vowed nothing more than a half-point pop.) Higher interest rates mean that, to attract the investment capital, the investments a PEG makes must be profitable enough to stay competitive with other, less risky investments.

Inflation is rising. Inflation – as predicted by almost everyone unrelated to any current government administrations that have been shoveling trillions of dollars, Euros, Yen, won, Renminbi and clam shells in general out the door over the past 18 months – is at its highest rate in more than 40 years; and is projected to keep climbing.

Inflation will impact almost every business’ revenue stream, payroll costs, costs of goods and, at more than five bucks a gallon (U.S.), £1.85 per liter (U.K.) and €1.94 per liter in Deutchland, everything that moves from one place to another.

The pool of capital is shrinking. Anybody who has even a modest investment in anything has been watching major markets crater.

As I write these words, the Dow Jones Industrial Average is off almost 18% since the beginning of the year while the broader market S&P 500 stocks are down more than 22%. A great deal of the funding that has been supporting the frenzy of PEG and family office acquisition over the past five years or so has come from stock market gains.

As those gains are wiped out, the capital available to acquire businesses shrinks.

Each of these trends impacts our industry to one extent or another. Together, they have the potential to really screw things up for business owners that are getting ready to exit.

But there’s an extremely important and oft-overlooked aspect of business valuation that sellers and business brokers must keep in mind. And that aspect is a buyer’s required return on investment.

Most even moderately sophisticated buyers have a certain return on their investment that a business must provide in order for the potential buyer to take a serious look. Rising interest rates are the big , hairy, ugly fly in the soup au champignons, mes amis. Because as interest rates rise, debt burdens increase and discretionary earnings fall. And we don’t need Sherlock-ian powers of observation and deduction to deduce that, absent offsetting revenue increases, falling discretionary earnings mean lower valuations.

The Bottom Line

PEGs and family offices are still out there and are still looking for opportunities. However, over the past few weeks, we’ve seen a noticeable drop in the number of weekly inquiries we receive from that exalted crew. And given promises from various central banks to keep raising rates until inflation is tamed, that fall-off might continue as investment managers take up defensive positions.

We’re gonna miss them.

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…

An investment firm specializing in health care is seeking the following business types: Home Health, Hospice, Home Care, Home Infusion, Behavioral Health, Specialty Pharmacy, Pharma Services, Physician Practice Management, U.S.-based, with Discretionary Earnings of between $750k and $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 1,000 in the world. He can be reached at joe@WorldwideBusinessBlog.com

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