Should you sell to a private equity buyer?

Eight mistakes when building a sale-ready business

Private equity (PE) – or financial – buyers differ from trade buyers in that the former acquire strictly to make a return on their invested equity. Trade buyers (also referred to as strategic buyers) acquire to realize long-term strategic value by combining the two firms. Because of this, PE buyers will look for specific traits in a target and selling to a PE buyer will have different implications for a consultancy than selling to a trade buyer.

To make a return on their invested equity, PE buyers look for a company that has value enhancement potential and acquire it at a favorable price with financing. With consultancies, they are attracted by the relatively high profit margins compared to other industries, high levels of profit to cash conversion, the potential for high growth if a consultancy is in a hot sector, and the barriers to entry that can be maintained if proprietary expertise is retained and leveraged through intellectual property.

Conversely, returns can be risky since the company’s core assets (people) can walk out the door. And since most consulting work is project based, future forecasts are difficult to predict. Nevertheless, PE firms that focus on knowledge-based businesses know what to look for and will carefully consider investing in consulting firms to complement one of their existing businesses or as a standalone investment.

Once acquired, they enhance the value of the firm during the ownership period through a variety of ways such as: providing the capital to fund investment in the business for organic or acquisitive growth; strategic advice through board membership; and providing market access through relationships and potentially through other businesses in their portfolios that can help smooth entry into new markets or geographies.

PE owners then exit their investment after a period of growth (typically 3–5 years) at a higher price than their entry point. Sometimes this is through an initial public offering, but far more commonly it is through selling the firm to a trade buyer.

The advantages of being acquired by a PE buyer as opposed to a trade buyer is that your firm remains independent, your identity and brand will continue unaffected and you retain more operational control than if you had been bought by a corporate buyer. PE buyers can also offer more flexible deal structures, which provide greater options for sellers in terms of liquidity and taking money off the table. Although in their initial acquisition consideration PE buyers do not have synergies that enable a higher purchase price, they often have a more rapid value creation plan than most strategic buyers, which can enable them to be competitive on pricing.

However, there are also some important considerations that may not be as favorable. PE ownership typically involves majority control of your firm and a seat at the board. So although your firm will remain independent, the PE owner typically has significant influence on the direction of growth and key strategic decisions. As your firm is expected to grow rapidly, the pace of change will need to be managed carefully to avoid attrition of your staff and to retain the culture, which remains an important element of people-based firms. Furthermore, your payout as an owner staying with the firm may be staggered: one at the point of initial investment and a bigger payout after the PE firm exits its investment, since the focus in the interim will be on growing significant value in your firm. So you effectively have a bigger second bite of the apple in payout terms.

In a competitive sale process, PE buyers will be quicker to act and meet with you than other strategic buyers, as they are constantly sourcing firms in the market. Strategic buyers will take longer to consider the potential fit and only selectively meet with the right acquisition target firms. Sellers should take this into consideration when in a competitive process.

As future potential owners, you will need to see PE buyers as a growth partner. All parties will have skin in the game, so if your strategy is realized all will remain happy, but if growth stagnates or starts to decline, be prepared to be put under a microscope.

NB: The term ‘trade buyer’ refers to those who acquire for strategic purposes and includes in it our definition of consulting and corporate buyers.

This blog is condensed from a more in-depth article that you access here.

If you are preparing to sell your consulting firm and would like to discuss your plans, please get in touch.

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