Private Equity Groups (PEGs) are currently purchasing middle market businesses at record levels. Middle market companies typically have annual sales of $3 to $100 million, and values from $5 to $50 million.
Most of these middle market businesses are family owned, and selling to a Private Equity Group is a viable exit strategy for the owner wanting to take some or all of their chips off the table. Private Equity Groups are investment funds set up to purchase businesses with stable operating histories and cash flow, grow them for 5-7 years, then sell for a profit.
Returns on real estate investment have fallen to 8% or less, and many investors are now looking for alternatives. That money is flowing into Private Equity Groups at record levels, with investors hoping for returns of 20-30%. PEGs typically invest in established businesses, not impacted heavily by technology. What are types of businesses are they looking for?
Cambria Group, based in Menlo Park, CA, describe themselves as a “private investment company which acquires and invests in small and mid size businesses with established operating histories. The firm seeks four critical elements in every situation – 1) a fundamentally sound and durable business with a history of profitability, 2) availability of a strong management team, 3) a fair purchase price in relation to historical performance, and 4) opportunities for management and Cambria to add value to the business over time.”
A common philosophy heard is "defensible market niche, strong management team, and proven track record,” all of which indicate a solid business. Less interest has been shown by PEGs in recent years in turnaround companies in distressed situations.
PEGs will often purchase 100% of the company, letting the owner retire and cash out his or her equity in the business. Many younger owners just want to take some chips off the table and are happy to combine their valuable knowledge and experience with the equity infusion of the PEG to continue to grow the business. This is a win/win strategy, with the PEG getting an experienced manager with a proven track record, and the owner typically cashing out 80% - 90%, and getting a second bite of the apple five to seven years down the road on a subsequent transaction, as the PEG exits the investment.
PEGs review hundreds of opportunities and purchase less than 10%. “We look at 100 Executive Summaries for every 10 that we actually meet with the owner,” said Vincent Foster, of Main Street Capital Partners. “We will then typically make 5-6 offers on businesses for every transaction we close. We rely on the M&A professional to analyze and present the business to us in a coherent manner.”
An intermediary will typically spend 30 to 45 days to prepare an in-depth Confidential Information Memorandum of the business, which may be 25 to 60 pages in length. This document will analyze growth opportunities, historical financial performance, organizational strengths, and market information. The initial contact with the PEG is accomplished with a one or two page Blind Profile of the business, without disclosing the name of the Company. The intermediary then asks the purchaser to sign a Confidentiality Agreement, and have the necessary qualifications before being sent the entire Confidential Information Memorandum.
Walt Lipski, CBI, M&AMI, of Fox and Fin in Phoenix, president of the M & A Source, states, “We have not seen market conditions such as the ones existing today, driven by excess investment capital, low interest rates, and low tax rates, in many years, and savvy owners wanting to cash out for maximum values should be wary of waiting too long.”