The pros and cons of selling to private equity

Whether you want to exit your business or just release some value, private equity (PE) firms could be an interesting potential buyer. There are advantages and disadvantages to this, so it’s important to take all considerations into account.

Advantages of selling to PE

Release capital and reduce risk

Your business will have built up value throughout its life. Selling to a PE investor can help you realise that value and fulfil your personal financial goals while retaining a stake in the company.

Reducing your share – or selling it altogether – also means you are less exposed if the business experiences financial difficulties. Andrew Shepperd, co-founder at Entrepreneurs Hub, says: “Talking to your financial planner should help you identify whether you have too much risk tied up in the firm. A PE sale can help protect you and allow the business to move to the next phase.”

Financial support

In addition to facilitating your exit, a PE investment can provide a capital injection for your business, allowing you to expand operations and/or invest in new opportunities. The PE firm can also help you restructure your finances, paying off debts or finding better loan rates.

Skills and knowledge

PE providers usually have industry-specific knowledge and can advise you on anything from strategic planning to operational efficiency. They can also help you improve your corporate reporting or governance structures. As Andrew puts it: “Even if you don’t go through with the sale, it’s worth meeting them to get a feel for where you are and ideas for moving to the next level.”

Networks and resources

PE houses typically have extensive networks, so they may be able to connect you with potential customers, suppliers or advisers to support your growth. If you want to expand into a certain sector or region, seek a PE partner specialising in that area.

Disadvantages of selling to PE

Intense due diligence

Any buyer will scrutinise your company, but PE firms can be particularly intense. A spokesperson for the British Private Equity and Venture Capital Association (BVCA) says PE firms will expect detailed documentation, such as financial statements, projections, cash flow analysis and valuation reports, alongside company records, contracts and other legal documents. This data must be able to withstand scrutiny. “Your management accounts need to tie into your statutory accounts,” Andrew warns. “We often find they don’t. Some small businesses don’t even run monthly management accounts.”

You will also need strong metrics and business intelligence. According to the BVCA: “Owners should articulate a clear vision for the future of the business – including growth prospects, new product / service development or scalability – and potential risks.” Additionally, investors will want to know who will run the business in future, so you will need a clear succession plan.

Earn-outs or burn-outs?

Although you used to decide what happens to your firm, your new owners may have different ideas or processes. “Some are hands-on and controlling, others are more benign. But if the business is regressing, you’re likely to see them a lot more,” notes Andrew.

Bear this in mind when negotiating the deal, especially if your buyers are pushing for a long tie-in period that requires you to work for the company for several years after selling. “Go for certainty and try to get as much as you can upfront,” Andrew urges. “Deferred sums are less risky, being time-bound only. Earn-outs are less certain and linked to conditions that may not happen. If there are earn-out type delayed payments, negotiate realistic targets and payout levels. You will have to deliver these, not the investor.”

Tough conditions

PE firms are often hard-nosed negotiators. Get a good adviser and be ready to stand your ground. “It’s crucial to understand what the buyers want you to do with the investment,” Andrew stresses. “While you may be thinking about your retirement income, they may be expecting an immediate reinvestment in the business.”

Unforeseen changes

Because PE firms typically acquire a large stake in the business, they will have significant influence. The new ownership may bring changes in the company’s culture, management and operational practices – which could impact employees and stakeholders. The BVCA recommends choosing an investor whose values and management style align with yours.

Andrew also recommends getting references from other owners. “Speak to firms that have done that journey,” he advises. “Ask about their experiences and whether they think it’s a good idea. The buyer should make these contacts available.” Find out how non-referred transactions worked out, too.

Conclusion

When selling to a PE firm, careful planning is essential. “Sit down with an adviser and work out your finances,” says Andrew. “Before negotiations start, it’s critical to understand what number you need to meet your goals.”