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Private Company Capital Newsletter
Inside the World of Private Equity and Re-caps What is a PEG? Everyone seems to know what a V.C. is these days. Venture Capitalists manage investors money by funding (investing in) early-stage companies in the hope that one out of ten will be a home run to make up for the other failures, which are inevitable. Private Equity Groups (“PEGs”), on the other hand, manage investor’s money by only investing in later-stage, more mature, profitable businesses. The risks aren’t as great as early stage VC, yet the returns are quite respectable. The average annual return on equity in private equity investing over the last 20 years is an astounding 27%! There is some $800 Billion under management inside PEGs and they are enjoying a synchronicity, if you will, of very welcome market conditions. PEG sponsors will tell you they earn those types of returns by “adding value” in the form of additional management depth, better access to growth capital, etc… While PEGs have a strong interest in making the business worth more than they paid for it and do add value under their ownership, we submit that the biggest contributor to PEG’s historical investment returns are the price they pay for private companies. They have historically underpaid for companies, plain and simple, though this trend seems to be changing as the lower middle-market gets more efficient through investment bank-led auctions for sellers. The days when a seller receives a call from a PEG and becomes seduced into negotiating only with that single buyer through the closing seem to be fleeting, happily. How does it work? The first return on invested capital goes to the outside investors of the fund. After that preferential return, the PEG principals get a minority percentage of the profit return with the majority going to the outside investors. Thus, a PEG has a strong incentive to: (i) pay as little as possible for the greatest percentage of your company, (ii) use as little of his fund’s capital and the most new bank debt possible to provide your liquidity needs, and, (iii) do whatever can be done to make the company as valuable as possible in the shortest period of time. This is the formula PEGs execute against. Resultantly, target companies with stable, recurring revenue and earnings, or, companies with asset-laden balance sheets are more apt to be debt financed by banks and, thus, more attractive to private equity investors. PEGs will generally want to buy 60-80% of the company as opposed to 100%, with you retaining minority ownership post closing. There is, naturally then, a certain tension between the level of debt the PEG wants to put on your company and the attendant risk to the equity you retained in the newly financed company due to the existence of that debt. This necessitates careful analysis. One mitigating factor to your personal risk/reward profile, however, is you will generally be removed as a personal guarantor with the bank debt going forward. Is it for you? Due to the demographical effects of the Baby Boom there are many business owners your same age with the same idea: They aren’t currently ready to retire, but would like to take some chips off the table today to assure that they can retire within 5 years; they want to remain active growing the business for a few more years, yet want to share the financial risk of doing so (which could include selected acquisitions of their competitors); and, genuinely seek the experience and advice of the right private equity investor in executing on a 5 year strategic plan. If this sounds like your life/business situation, your business may be an excellent candidate for a private equity transaction. What to be mindful of.
[ Home | Our Firm | Services | Past Transactions | Research and Resources | Contact Us ] Brereton, Hanley and Company, Inc. Spear Tower One Market Plaza - Suite 3600 San Francisco, Ca. 94105-1120 Phone: (408) 938-9255 Fax: (408) 938-9259 |
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