When does a grasshopper pounce on your company?

The negative image of the private equity market is mainly fed by messages in the media about large well-known companies such as HEMA, V&D and recently Unilever. According to the media, private equity (PE) would fill companies with debt and then proceed to suck them dry. In the SME-field that latter part is certainly not the case. The image might appear that way, because in every transaction they operate with bank debts. However, bank debt also applies to transactions done by management (MBO) or from the outside (MBI).

PE-parties want companies to keep growing and creating value. The focus is on getting a return on their investment, that what it’s all about. International research shows that companies run by private equity firms operate more prosperously. Selling to a strategic party often means the end of autonomy and the involvement of the entrepreneur. Selling (a part of) the company to an investor is especially suited for an entrepreneur, or a company, ready for the next phase of their enterprise as they often remain at the helm.

What does a private equity firm look for?

Private equity firms analyse propositions on four axis;

1. Growth potential
   Companies that are growing quickly are especially interesting to an investor. ‘How are we going to double that EBITDA?’ is a frequently asked question. Companies with limited growth potential are often not interesting to investors.
2. Multiple arbitrage
   The higher the absolute profit of a company, the higher the multiple that gets paid for said company. Not only is the risk with a large company significantly lower, but international funds also tend to pay larger multiples for bigger companies as well.
3. Synergy potential
   A lot of investors want to create more value by an ‘add-on’-strategy. You can see this as acquiring one more companies and create more value through these synergy advantages. When a number of possible acquisition candidates are unified, an investor will have more interest in acquiring the company.
4. ‘Lever action effect’-potential
   Many investors strive for a total return of about 20 percent per year. While banks finance about five percent per year, an investor will be likely to attract as much bank financing as possible to apply the leverage maximally to acquire as many companies as possible. Either invest 10 million into a company or spend 10 million to buy five companies of 10 million per company with forty million bank debt.

An investor will always look for a company that has two to three of the above mentioned characteristics. Each investor has its own focus. One could be solely aiming for the add-on-strategy whereas the other is more focused on restructuring. When selling your company, think properly about how your company scores on these four axes.

Column by Tom Beltman originally appeared on: De Ondernemer