Private Equity Essentials: Key insights for buyers and sellers

In this episode of Integrated Insights, our guests discuss how private equity firms operate, the different strategies they use, and how they influence the M&A market. Whether you're looking to sell your business or invest in one, understanding these dynamics is crucial for making informed decisions. Tune in to learn how private equity could shape your next big move in business.

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TRANSCRIPT:

Welcome to Integrated Insights with ICCG. For more than 30 years, our team has partnered with small business owners to prepare for and navigate the business transaction process.

Pull up a chair as we share stories and insights from our experience on all sides of the M &A table. Well, welcome to Integrated Insights. Today I've got Andrew and Grant with us.

buying a business that is privately held and not as opposed to investing in the stock market, which is typically public securities, right? And so it's a private business.

But the term is typically used for a business or a group of investors that are partnering with a sponsor that is going out and buying businesses of a certain kind.

And we'll talk about strategy in just a minute, but they're charged to go out and invest in business, maybe leverage it, maybe not, and grow those businesses value and then sell those businesses.

So it's private business ownership really is what it is. And I'll say as well that some private equity groups are set up differently.

And there's several ways to structure them, but some have, some will build up a fund that they'll use to go out and buy and do some sort of mixture of their,

of equity and debt to go by. Some will need to raise capital based on the deal. And so if they find a deal and an offer is accepted,

then they'll need to go and find the equity to go support what they're trying to do, the purchase. And so it's it, it, it, there are different types of private equity groups and,

but, but it's, But there are a lot of them out there and they're structured differently. Yeah, at the risk of blowing through our time, let me get on my soapbox for just a minute.

You have this sort of flavor of the day coming out of MBA school. You know, they come out of these graduate business schools and they've learned all about,

you know, these funds, okay, we're going to go and find a business and we're going to buy a business and we're going to raise money to buy the business and we're going to get into private equity.

And then you have on the other end of the spectrum some really sophisticated firms that have a ton of infrastructure that they are, they're experienced and they know how to do the purchase and management of those businesses,

whether they're hands -on or whether there are remote investors. They've got it down. And so to think that private equity equals private equity is really wrong because there's tons of different kinds of firms that call themselves private equity.

We never called ourselves private equity even though we owned a bunch of businesses at the time. And so there were other people maybe called us a private equity firm,

but we've never called ourselves a private equity firm. We would just some dude to own some businesses. Yeah, there are many, we call them investment vehicles, right?

And so there's private equity, venture capital, holding companies, you know, it's essentially an entity that owns another one and their investment,

the way that they get investment is kind of what really determines what they are essentially. And so I know that there are other ways to determine what that's that's a that's a big part of it and so for private equity they have uh they they may have a handful or a lot of of investment um that they have have uh gotten from um institutions or individuals or whatever that looks like i know family offices as well as

another investor for for private equity groups and they'll get that and either build a fund or they'll they'll They'll just find a deal to, to, to, um, funding from.

A lot of private equity groups will get funding from an institutional fund that has a certain mandate,

right? And maybe they say, hey, we're only going to invest in this type of company, right? So industry -wise. And so maybe that's what it is.

But it could also be based on the experience that those individuals that are part of the private equity firm, what they have, right? A lot of people that we talk to,

they'll do what they call business services or what we call field services, right? There's facility services. It's all that commercial services.

Some do home services. Some do health care some do um industrial type of of businesses and uh it's it's really it's all part of their they build this criteria um so that they can go after similar type companies and do a similar play over and over again and um and so at the end of the day for what we see it is most of the time it's about their exit their exit.

That's what they have in mind. When they're buying a company, their strategy is really about how they're exiting. And so you could have long term and short term, but they're looking at,

okay, how can we build it up to exit? And maybe in five years or in 20 years, most will be on the shorter end of that.

But really, that's kind of what they build their strategy on is they will buy how they know how they're going to exit, you know, in that,

in that time frame. And so that's, that's, that's, that's kind of what we see, what we see, what we see is a lot of how they, how they build out strategies in, in their firm.

Yeah, I would, I would just you know, it's the golden rule. He who has the gold makes the rules. And so the private equity firm typically is a sponsor,

and they have limited partners or investors, however, they're structured. And those investors buy into an investment thesis. And so,

hey, I'm going to go out and I'm going to buy 20 plumbing companies across the United States. They're going to be service oriented, not construction. They're going to be,

you know, anywhere from from $1 million to $5 million of EBDA. And, you know, I'm going to,

the way I'm going and I'm going to borrow two and a half,

a maximum of two and a half times EBDA. There's all kinds of different types of limited partners will be, will put on them, particularly if,

you know, if the sponsor is, is inexperienced or not as experienced as some of the big funds that are out there.

Some of them are just general and they say, hey, we're going after health care services. And, you know, it just, it all depends on,

on the people that have the money. Mm -hmm. Yeah. And it's, it's, you know, the, there's always a bigger fish, right? And so where we,

where we hang out a lot is in that small to middle market size business, the multiple and really in the smallest end that we work on,

it's, you know, there are certain level of private equity groups, right? And what I mean by that is that they focus on that size and they want to roll up.

And their thought is, okay, I'm going to buy these companies that have maybe two million in EBDA, right? And the multiple range for that size is probably,

you know, I'll just say numbers four times, right? And then they group them together. And if you have five of those, of those companies that have two million in EBDA,

now you have 10 million in EBTA. And if you've, if you've put them together. And so once it goes over that 10 million mark, the multiple goes up.

And there are certain levels. And so when they do that, then they can turn around and sell it to the bigger fish. And then they turn around to the bigger fish. And it just goes up and up and up.

And that's how a private equity group will most of the time. That's how they'll make money is they'll, I say flip, right, but essentially they're buying so that they can sell it a greater multiple later on and build value that way.

And so that's the most basic strategy that we've seen. Yeah, that's great. So how do private equity groups affect the M &A market,

but also the lower middle market as we're in. The most fun that we have is that there's a lot of people who want to call themselves PE groups and they don't get paid unless they invest capital.

And so our business owners, if they have a successful business, you know, it's very difficult to find one person to buy the business.

There's not a whole lot of people who can stroke a check for $15, $20 million. But these private equity groups, you know, essentially end up being investors that can borrow some of that,

invest some of that. And it provides just a much market for for people to buy businesses so this is the basis of a stock market for example I have no way to buy IBM but you know just think of it just or or Apple right I can't buy Apple it's just jillions right and I don't have jillions and there's only really a handful of people who have jillions enough to buy Apple.

But we all can own a piece of Apple, right? Now, that's a public market. So there's not a whole lot of individuals that can write a check for $15 million to buy a very profitable private business.

So they invest with others in a private equity scenario where they can be a business owner. And they may not run the business on a daily basis,

but it allows so many more people to actually own private businesses, which I think is a cool thing. So it just expands the buyer base,

right? And how they do affect it is kind of weird because they, Andrew will laugh when I say this,

but there are flavors of the day. We'll go out there and we will meet with P .E. groups and all of a sudden they all want manufacturing companies.

I don't know where they get this from, but maybe it's publications or something like that. And all of a sudden they, oh, no, we don't want transportation and logistics. No, we don't want that.

And then six months later, oh, hey, we don't want any health care, but give us all the transportation and logistics. It just kind of the flavor of the day. And I'm bent on finding the publication that they all read because it's got to be out there,

right? And so, yeah, I don't know. Yeah, but I think what really drives that is, is they have to have an exit at some point.

So they're looking at, you know, what companies may exit well. And if those guys are looking for, you know, let's say,

you know, field services like plumbing, for example, or HVAC, they'll go out and roll them up and sell it to them, you know. That's how they're going to do it. And so it does affect it because sometimes we're looking at a,

it wasn't always like that. Four years ago, we couldn't give a company away that was steeped in that. And so now all of a sudden,

everybody wants it. And so you also got to be careful because maybe in two years' time, nobody wants it again. And now you've got to hang on to it until it has value again.

So P .E groups, because they are so powerful in increasing the buyer base, you need to watch what, you know,

how they influence the flavor of the day. Yeah. We always say, we kind of call it a buyer universe, right? So the sheer amount of buyers, that affects the value,

right? The multiple. If there are a ton of buyers, the multiple will go up. If there are a very narrow, a very narrow buyer network,

a buyer universe, if you call that, then the multiple will go down. And so the way that it affects it is that if private equity groups are super focused on that one industry or that type of business,

then yeah, the multiple might go up because of that, because they're way more buyers. And so that's where it's unique in the way that they do affect the M &A market.

Most of the time, I know that there are different strategies to valuating a company when it comes to private equity is a strategic.

And so a strategic buyer, meaning another buyer that there's, there's a strategic purpose that there, maybe it's a competitor or another, another adjacent service that they're wanting to add the service into their repertoire,

right? And so it really, it's, it's unique in the way that they, they come into the market and they effect it by honestly private equity groups most of the time might pay a little bit more now you probably will um the structure is going to be very different but you might get a little bit more and so it really it just depends on on on the the industry and kind of the timing as well right you know while while

we're up the the biggest difference between a strategic buyer and a financial buyer or a P group is is a strategic buyer is interested in the parts of your business the P group is interested in your cash flow and so and so that's why you know in a previous podcast we talked about due diligence that's why strategic buyer is going to be focused on the parts of your business and your you're you know the the the you

know capital expenditures that you've made in the past not just what you need in the future they want to see what what your capacity is because they want to throw some capacity your way all those kinds of things that the p group just wants to know how much money they're going to make uh you know we joke about the motives of a p group,

they're pure. I mean, it is, it is, it's all about the bottom line. And, and I know I'm going to be, you know, I'm going to get like 20 emails for this.

Yeah, yeah. You know, there's, you know, we're around people that talk about redemptive investing and, you know, investing that is going to help the community and all that kind of stuff.

But at the end of the a P .E. group doesn't exist without a profit motive. And the way they make profit is based on the cash flow of the business.

And so just, you know, that's a big difference between a strategic buyer and a P .E. group. Well, that's all we got today.

Grant, Andrew, thank you for your time. And Thanks, everyone for listening. And that wraps up another episode of Integrated Insights with ICCG.

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