According to consulting firm McKinsey & Company’s annual survey of private markets, businesses raised $7.3 trillion from private markets in 2020, and 61% of those funds came from private equity. The availability of private equity investors can be good news for business owners. But before you make up your mind about whether a private investor is right for your company, complete this three-step assessment:
Step 1: Understand your motivation. Is this a growth strategy or an exit strategy?
Step 2: Define what an ideal arrangement would look like, including any negotiables and nonnegotiables.
Step 3: Understand that your role at the company will be fundamentally changed.
After you have taken these steps and determined that PE is the best option for your business to move forward, it is time to think about what investors will want to know about your business before they enter into any agreement. Keep in mind that having your business’s financials in order can increase your valuation by 20% to 25%, so paying close attention to these documents will be beneficial. The due diligence examination will include:
- Liabilities, such as any pending lawsuits.
- Length of time your business has been in operation.
- Relative growth rate and net income.
- Undisclosed risks.
All items on this list are important and need to be attended to. However, problems often arise because management, the last item on the list, is often underestimated even though it is the most common sticking point in any deal.
Both parties need to consider how important management is to a successful outcome. Is there a cultural fit? Do the companies’ work styles mesh? It is essential to evaluate the “soft” side of how companies will work together, especially in the current environment. For example: Will talent — especially employees in key positions — choose to leave rather than work for the new company? Will the new company continue an existing hybrid or remote work environment or will they insist on a full-time return to the office?
The Harvard Business Review reported research by accountants and economists indicating that over 50% of value includes intangibles, including strategic clarity, leadership, culture, talent, accountability, collaboration and reputation.
Another Harvard Business Review survey of 50 North American PE industry executives comprising 25 managing directors of middle-market firms and 25 members of management teams at target companies that were previously owned by the PE firms found that investors and sellers have different views of important leadership skills, for example:
- Openness to input: Eight percent of sellers viewed this as important versus 24% of investors.
- Openness to learning: Twenty-eight percent of sellers valued this trait versus 4% of investors.
- Direct, transparent communications: Four percent of sellers valued this trait versus 20% of investors.
These findings showed another interesting result: One of the top reasons sellers walk away from a deal is that investors want too much day-to-day control, while investors reject the deal because they find that the sellers’ management teams have poor leadership skills.
Businesses that determine that the best way for them to achieve their goals is through attracting PE investors should take these results seriously. The tangible aspects of a due diligence examination are very important, but a lot of weight needs to be given to the intangible aspects as well. Sellers should not let their decision be based on financial considerations alone.