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What is a Private Equity Group?

Jonah Pollone

Sellers Seller Articles Seller FAQ

When you hear the term “private equity group,” negative thoughts may come to mind.

Maybe you've heard bad things from friends who've been laid off once a private equity group (PEG) stepped in… or, maybe you just aren’t familiar with the term. 

Either way, you should know what they are and how they’re set up, so that you’re prepared if a PEG comes knocking on your door to give you an offer on the business. 

At MidStreet, private equity groups make up a decent portion of the buyers we see inquiring on our active listings every day. Some PEG’s are sophisticated and well-respected in their space, while others might not have any experience in acquiring companies and running them successfully. 

To help you understand what private equity groups are and what makes them a good or bad buyer for your business, we will cover the qualities of private equity buyers and the advantages and disadvantages of selling your business to them.  

Qualities of a PEG Buyer

Individual Buyer, Strategic Buyer, and Private Equity Group Compared

Private equity groups are considered a type of financial buyer. In plain language, PEGs are companies that work on behalf of investors to buy businesses, make them profitable, and sell them in about 3-7 years to yield a return on investment (ROI) for their investors. 

Some business owners have mixed feelings about selling to a PEG since PEG’s often view their business as a relatively short-term investment. However, for some business owners, this can be beneficial in the case of a majority recapitalization

In a majority recapitalization, the PEG buys a majority of your business, while you retain part ownership. After the sale, you would continue working in the business in the areas the PEG believes your time would be most effectively spent.  

When the PEG sells your business, you get a chance to take a “second bite of the apple” (profit from selling the second time) when you sell your minority stake in the business to another buyer. 

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If you decide to sell your business to PEG's, be extra cautious during the buyer vetting stage. Not all private equity groups are made alike. Some are well-known, established, and have many employees. Others hold themselves out as a PEG, but are really one-person teams who know someone wealthy that will fund them.

Merger and acquisition advisors can help you vet these types of buyers more easily since they have insights into the PEG market.  

What Would Make Your Business a Fit For a PEG? 

Before we get into explaining what would make your business a fit for a PEG, we will need to cover the difference between a roll-up business and a platform business. These are the two ways the private equity firm could view your business in the context of an acquisition. 

If the PEG views your business as a “platform company,” that means they intend for it to be the base/foundation of a portfolio of similar or complementary companies. If they see it as a “roll-up,” they plan on “rolling” the business “up” into a larger platform company. 

Qualities that PEG’s look for in a platform company:

  • EBITDA of $500,000-$1,000,000 or more 
  • Clean books and records
  • Room for growth and improvement

Things that PEG’s search for in a roll-up company: 

  • Synergies for their platform company 
  • A bigger or smaller company than their platform (size does not usually matter)
  • Located in a desirable market

NOTE

If the PEG has a platform company in your industry and purchasing your company could provide them with good synergies, they may be willing to pay a premium for your business.

In general, PEG’s will look for the following qualities in any company they want to acquire: 

  1. It fits into their acquisition criteria 
  2. It has clean books and records 
  3. There is a management team in place
  4. The business owner is motivated to sell 

If you are interested in knowing what a private equity group’s acquisition criteria is, you can ask for their “one-pager,” look at their website or ask them directly. Look for details on what type of companies will fit into their portfolio. 

Advantages of Selling Your Business to a PEG

Different benefits exist depending on if you are selling all (full buyout) or a portion (majority recapitalization) of your business to a PEG.

The benefits of selling a portion of your business to a PEG in a majority recapitalization are:

  1. You can sell a portion of your business while retaining part ownership and eventually selling a second time (hopefully for more compensation than the first time!)
  2. The PEG secures your business and continues its legacy, allowing you to free up liquidity tied up in the business (cash out)
  3. The PEG could offer management, expertise, strategic direction, and advice, allowing you to focus on your passions in the business

Some of the advantages of selling your business to a PEG in a full buyout include: 

  1. You can fully cash out and receive the full amount of compensation as quickly as possible (beware of earnouts!)
  2. You are able to wipe your hands clean of the business so you can retire/pursue other business opportunities
  3. You don’t have to be an employee of the private equity group; often in our experience owners who are true entrepreneurs at heart have a difficult time receiving direction

Disadvantages of Selling Your Business to a PEG

You may encounter the following disadvantages when selling all or a portion of your company to a private equity group: 

  • Their due diligence process will be more in-depth than other buyers (i.e. the dreaded Quality of Earnings)
  • They will often request an earn-out which can prevent you from getting your proceeds all at once, if at all
  • They are less emotionally involved than other buyers and will make more financially-based decisions 

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When a PEG performs a quality of earnings on your financials, it essentially means that they will have a third-party accounting firm review them to verify the validity of the numbers.

This can be a painful process if you do not have clean books and records. If you work with a business broker before you go live on the market with your company, they can help prevent issues during this process.  

When you do a majority recapitalization, you are now an employee of the PEG, after running the business on your own for multiple years. The private equity group’s amount of check-ins, weekly meetings, or management style may or may not end up being a fit for you. 

To prevent any issues from occurring with this, your M&A advisor can help lay out what the PEG’s level of involvement and requirements will look like ahead of time.  

How Are Private Equity Groups Funded?

A private equity group is typically funded in one of three ways: 

  • A committed fund - This is when the PEG has investors that have invested in the fund and the PEG has money they can actively put towards purchasing businesses. This is the best type of fund for you as a seller. 
  • A pledge fund - The PEG’s investors have pledged to invest if the fund manager finds a suitable investment. This type of fund requires approval from the investors, which can happen late in the deal if you’re not careful. 
  • A search fund - In this case, fund managers will go out looking for investment opportunities and come back to investors to request capital. This can also be referred to as a “dry fund.” Search funds are the least secure way of knowing the buyer can be fully committed to purchasing the business, and can often cause significant delays in the process while the “searcher” is looking for capital after finding the opportunity. 

For business owners considering selling to a PEG, you should be cautious about accepting offers from groups that do not have committed capital. This can result in you accepting an offer that does not have the financial backing to allow to deal to happen, potentially wasting months of your time. 

Questions to Ask PEG’s When Selling

To ensure that you choose a private equity group most compatible with your business, ask them the following types of questions: 

  1. What type of acquisitions have you done in the past? What is your track record? 
  2. Where are you getting your funding? Are you funded by an established group or personal contacts? Do you have committed capital or pledge funds? 
  3. Will you be using debt? If so, do you have existing relationships with lenders? 
  4. How would your firm add value to the business aside from your funding (e.g. adding new processes or key employees)? 
  5. How are you going to be involved in the business after the purchase? What would you expect my responsibilities to be? 
  6. Do you have references I could speak to? What kind of returns have owners who bought back equity received in the past?

To gain more insight into the private equity group and their past acquisitions, you can look at their website or ask them directly about the companies they have owned. 

How Much Involvement do PEGs Have?

Most PEG’s will be involved financially and have some say in the day-to-day operations of the business. Other PE groups will want to be highly involved in operations, having check-ins multiple times a week or hiring additional people for the company. 

If you’re considering selling to a PEG, you’ll need to figure out what kind of private equity group is right for you based on your goals. Talk with your M&A advisor to determine what the right type of PEG would be for you.  

Is a PEG The Right Buyer For Your Business? 

If you want to sell your business or retain part ownership while having someone step in with new management expertise, a PEG can be a great buyer for your business. However, if you don’t find the correct type of PEG for you, you may end up feeling micromanaged.

Selling to a PEG requires finding a balance in the goals you want to achieve personally and within the business. Speaking to an M&A advisor about your goals and preferences is one of the best ways to determine what type of buyer would be the best fit for your business.

Learn more about the different types of buyers for your business in our article “The 5 Types of Buyers for Your Business.”  

Over the years, we have helped business owners determine what type of buyer would make a great fit for their business to help them achieve their selling goals. Call us today to discuss what type of buyer would be the right fit for your company.  

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