In recent decades more and more capital has flowed into the alternative investment category of private equity or Private Equity Groups (PEGs).
Maybe because of this higher profile, we get asked repeatedly by business owners in the lower middle market if they can sell to a private equity group.
I’ll say this right up front – most likely the answer is no.
Private equity investments have traditionally been focused on large companies, the so-called middle market and especially the lower middle market have been ignored. That has changed in recent years as more capital has entered this investment category. Seeking more and better opportunities has resulted in many private equity investors reaching out to invest in smaller and smaller companies.
But there is a limit as to how small they will go. Generally speaking, and this varies, they will not go below companies with revenues below $15 million. Larger is preferred.
The investment strategy of PEGs varies by firm. Each has its philosophy and preferred transaction structure. Some are happy with a minority interest. Others (usually) prefer having complete control.
PEGs prefer businesses with stable cash flows, stable product life cycles, avoid technology risk (that’s for venture capitalists), and so on. A good management team is also a big requirement.
PEG transactions can be in many variations. Some of the most common are:
- Sale of Entire Business. This is where the current equity owners want to completely exit, and not have anything to do with the business after the sale. It is important to have a management team ready to go in this scenario, either already in place or ready to be installed.
- Capital for Growth. A growing business almost always needs more cash for working capital. A PEG investment can help alleviate cash shortages and allow for further growth.
- The equity owner sells a part of the business while retaining the rest of the equity. The owner usually retains control in this situation. This allows the equity owner to become liquid and obtain a return from their interests in the company, while still maintaining involvement.
- Family Buyout. PEGs sometimes partner with family members (usually involved in management) to acquire a business from the older generation. PEGS can allow the younger family members to gain control of the business, by bringing in a financial partner.
- Management Buyout. PEGs sometimes partner with a key manager in a company to acquire a business from the original equity owner. The key manager usually receives a substantial part of the equity after the sale, going forward. Seller may receive all cash because earn-outs are often not used in this type of buyout.
PEGs are now a major player in acquisitions. While mostly financial buyers, sometimes they act as strategic acquirers depending on what else is in their investment portfolio.
