Guest Column: Private Equity Firms

Private Equity Groups have not been hard-hit by the credit crunch or the
stock market decline. They have capital to invest and are looking for
business acquisitions.

Private Equity Groups have not been hard-hit by the credit crunch or the stock market decline. They have capital to invest and are looking for business acquisitions. One of the major market shifts for the acquisition of privately held companies has been the growth in the number of Private Equity Groups (PEGs) over the last decade. These organizations number in the thousands in the U.S. and Canada. Private Equity firms generally manage money for insurance funds, pension funds, charitable trusts and sophisticated investment groups. They have money to invest. Despite the downturn in the Canadian economy, the buyout and investment market for automotive-related businesses is very active.

Private Equity Group buyouts can take many forms, including partnering with key employees in the acquisition.

PEGs have become key players in business acquisitions, offering flexibility as a liquidity source and giving entrepreneurs the ability to take some cash off the table, recapitalize their company or simply sell and move on. Private equity refers to buyout groups that seek to acquire ongoing, profitable businesses that demonstrate growth potential.

The private equity market had traditionally been restricted to acquiring larger companies. But increased competition for those larger operations, the greater growth potential of smaller firms, and an easier path to exiting the investment of smaller firms in the future, have played a role in attracting PEGs to smaller companies. PEGs are typically organized as limited partnerships controlled and managed by the private equity firm that acts as the general partner. The fund invests in privately held companies to generate above-market financial returns for investors.

The strategy and focus of these groups vary widely in investment philosophies and transaction structure preferences. Some prefer complete ownership, while others are happy with a majority or minority interest in acquired companies. Some limit themselves geographically while others have a global strategy. PEGs also tend to have certain things in common. They typically target companies with relatively stable product life cycles and a strategy to overcome foreign competition. They avoid leading-edge technology (this is what venture capitalists want) and have a preference for superior profit margins, a unique business model with a sustainable and defensible market niche and position.

Other traits that appeal to PEGs are strong growth opportunities, a compelling track record, low customer concentrations, and a deep management team. Most prefer a qualified management team that will continue to run the day-to-day operations while the group’s principals closely support them on the Board of Directors level.

Private equity buyouts take many forms, including:

Outright sale: This is common when the owner wants to sell his ownership interest and retire. Either existing management will be elevated to run the company, or management will be brought in. A transition period may be required to train replacement management and provide for a smooth transition of key relationships.

Employee buyout: PEGs can partner with key employees in the acquisition of a company in which they play a key role. Key employees receive a generous equity stake in the conservatively capitalized company while retaining daily operating control.

Family succession: This type of transaction often involves backing certain members of family management in acquiring ownership from the senior generation. By working with a PEG in a family succession transaction, active family members secure operating control and significant equity ownership, while gaining a financial partner for growth.

Recapitalization: This is an option for an owner who wants to sell a portion of the company for liquidity while retaining equity ownership to participate in the company’s future upside potential. This structure allows the owner to achieve personal liquidity, retain significant operational input and responsibility, and gain a financial partner to help capitalize on strategic expansion opportunities.

Growth capital: Growing a business often strains cash flow and requires significant access to additional working capital. A growth capital investment permits management to focus on running the business without constantly having to be concerned with cash flow matters.

PEGs have become a major force in the acquisition arena. They can also be thought of as strategic acquirers in certain instances, when they own portfolio companies in your industry or a related area that addresses the same customer base. These buyers may be in a position to pay more than an industry or strategic buyer that does not have this financial backing.

Mark Borkowski is president of Toronto-based Mercantile Mergers & Acquisitions Corp. Mercantile specializes in the sale of mid-market companies sold to strategic buyers or private equity firms. He can be contacted in confidence at mark@mercantilema.com or (416) 368-8466 ext. 232 or www.mercantilemergersacquisitions.com