As featured in our Q4 2013 Capital Ideas Newsletter. An article by David Sinyard, Managing Director of our Atlanta office.
Before private equity groups (PEGs) invest, they review a significant number of proposals hoping to find that diamond in the rough, that perfect addition to their investment portfolio. Three a day is not unheard of, so annual volume can easily be 700–1000 proposals. Of these, the majority of PEGs typically close on 2–4 deals per year. There is a great deal of time and work involved in reviewing and ultimately deciding which deals to pursue. Their due diligence costs often exceed $100,000 per transaction. Before they commit the time and money, they have to be convinced that this is a company that they want to own. How do PEGs decide which deals to pursue?
The review procedures utilized by PEGs differ significantly and range on a continuum from a very formal process to an informal review practice. When PEGs follow a formal process, they may have evaluation criteria and will use a checklist for each submission they review. It is scored and a company would need a minimum score to advance to the next step. The majority of PEGs use an informal review process - based on time and experience, the business development officers will “know” whether it’s something of interest.
Evaluations of specific criteria appear to exist for every deal and most PEGs tend to look for strong, stable cash-flow, low debt levels, leading market positions, and niche products or services. But one variable stands out to separate the proposals into “yes” and “no” piles – the management team.
The management team is a fundamental issue in a proposed transaction. Is the management team still hungry to grow the business? Does the management team have depth? For most PEGs, the more in-depth the team, the better. The relationship between the management team and the PEG is important. Does the chemistry work? PEGs view an acquisition as building a partnership where value is created. Is the management team willing to adapt or change if necessary?
Most PEGs do not expect any business that is acquired to have a perfect management team. As necessary, they will supplement and plug gaps in management. Most don’t get involved in a deal unless they augment the senior team. The management function that is most focused on is finance, as the incumbent typically will not have the qualifications and skills to handle the role. The PEGs will put in new CFOs to upgrade the position, particularly in terms of reporting.
Data indicates that the importance of retaining the existing management team varies, but continuity tends to be the key. One person, not necessarily the CEO or CFO, needs to stay. Most PEGs really desire an understanding of who is going to lead the company forward. It can be the founder, an heir or someone already in the team.
Private equity firms will be an important source of funding for business exits as baby boomers retire. PEGs hope for significant financial returns by improving operations through providing capital, adding processes, or enhancing management. Knowing how they evaluate the investment merits of the companies they ultimately add to their portfolios is the important first step in tailoring your proposal for a PEG buyer.
For additional information contact:
Douglas Nix, CA | Vice Chairman
Corporate Finance Associates | Toronto West | 905-845-4340 x211 | firstname.lastname@example.org