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Dispelling Myths about Private Equity Buyers
We have all heard the horror stories from lower middle market business owners. Private Equity buyers will come in and get rid of all of my employees, borrow an absurd amount of money to finance the acquisition, thereby straining my company’s balance sheet and income statement, and then, light a match Goodfellas-style when they are done extracting value from it. But, I’ll let you in on a little secret? The days of financially engineering a path to outsized profits are long gone. While there certainly was an era where Private Equity funds looked to lock in a guaranteed “win” by over-levering the balance sheet, stripping the Income Statement of “fat”- read, people- and quickly flipping to monetize the win, those days are largely behind us. Today, most professional buyers value the team in place more so than any perceived competitive advantage with the product or service offering. I’ll say that again, buyers often view the team as the most important determinant of success- more so even than the core product or service offered by the business. Let’s rewind a bit. The perception of private equity by most of society is pretty negative. And to be frank, that reputation, although dated, is well-earned. Many have read or seen (it was first a book and later adapted for film) Barbarians at the Gate. The book details the leveraged buyout of RJR Nabisco by Kohlberg Kravis Roberts (KKR) in the late 1980s. While there are many takeaways from the book, the one most recalled is the impact that the use of junk bonds to finance the transaction and degree of leverage overall had on the business. Several thousand jobs were eliminated as a result. This deal wasn’t a standalone incident but rather emblematic of a strategy of the times; Finance the transaction largely through debt, thereby requiring only a relatively small equity investment by the buyer and reducing headcount to service the debt and prop up profitability. This is one example of how one might financially engineer their way to a profit. The cost to the business is often catastrophic; still, by the time the downstream issues present themselves, the fund has either sold or doesn’t care as they’ve extracted enough out of the company to more than satisfy their investors (LPs of Limited Partners). So, this negative perception is certainly well-earned. But why is it dated?
How a Partial Sale of Your Business Can Benefit You
There are strategies available for business owners who are in need of additional capital to grow their business. The partial sale transaction has gained popularity over the last couple of years. When business owners find themselves with limited operating liquidity, they are unable to create the type of growth they desire. A partial sale can bring additional resources into the business that can set into motion long-term growth strategies, increase operational stability and recruit new hires. If you are looking to downsize your company, you can invest that money into different opportunities that may offer you a higher return on your investment.A partial sale of your business gives you the opportunity to remain involved in the business that you have spent decades building. Following a partial sale, many business owners serve as advisors, senior executives, board members, etc., to assist the buyer with their transition period to new ownership. Smart buyers are open to customizing the role and involvement of the seller once the deal has closed in order that the seller remains with the business for months and years to come.You may have grown the business into a large company through various acquisitions and development that haven't delivered quite as well as you had hoped. A partial sale of your business can allow you to let go of some of those units that you may be in need of recouping a loss from. Selling these portions can put you into a better position financially and allow you to invest additional resources and time into the areas of the company that are functioning well. The result of this action can leave you financially sound as you reduce the risks that your company would have faced in the future. In addition, there is the potential that synergies with the buyer could create even more opportunities and profits for the remaining units of your business.Another benefit to a partial sale is gaining a powerful partner who is just as invested in the business as you are. This partner is interested in the company's aggressive growth in a way that your employees most likely aren't. If you have too much on your plate, it may distract you from your company's core items that you should be focusing on. In the best case scenario, this partner will help revolutionize the company's future through their industry contacts, leadership experience, new technology, and relationships in new markets. Having a partner makes it possible for you to trust them with business decisions when you can't be everywhere at once, or you want to take some needed vacation time.
The Shift From a Seller's Market To a Buyer's Market When Interest Rates Rise
So if you are a business owner considering selling your company, the good news is that right now, it's a seller's M&A market. By October of 2021, total M&A deal activity reached $4.4 trillion, which is an increase of 92% compared to a year ago and is the strongest opening period for M&A since 1980. In addition, merger activity resulted in deals totaling $1.52 trillion in the three months prior to September 27, 2021. That's up 38% from the same quarter in 2020—and more than any other quarter on record.In a seller's market, demand is high for assets that are in limited supply, giving sellers more pricing and negotiating power. This demand can be attributed to a recovering economy, high cash balances, big government spending, new SPAC buyers, and low-interest rates. Plus, investors are flush with cash and ready to spend it on acquisitions that can help create growth or add capabilities. When market conditions shift, buyers have the upper hand in deal negotiations. And this could happen when the U.S. Federal Reserve increases interest rates in the next year or so. The Federal Reserve and other central banks worldwide have maintained low rates to aid economic recovery through and after the height of the COVID-19 pandemic. Currently, interest rates are at zero. But possible changes to Federal Reserve policy could put rates on an upward path, which can put a damper on deal activity, especially during times of inflation. Interest rates, which can basically be defined as the price of borrowing money, impact the stock market, which is tied to the M&A market. They also are a factor in the supply and demand of credit. When interest rates are low, companies and banks have an incentive to borrow money and invest it. The Federal Reserve usually raises interest rates to ease strong economic growth and to curb inflation, but current circumstances indicate that inflation right now is on the supply side rather than the demand side. Raising rates is not very effective against supply-side price increases.Private equity firms tend to be more reactive to interest rate hikes because of the primary investment strategies used—venture capital and leveraged buyouts. Under deals such as leveraged buyouts (where the company is taken private using outside financing with other types of corporate restructurings that carry a large amount of debt), interest rates are a huge factor in M&A. When rates are low, takeovers are usually more profitable. Also, companies that might normally seem unattractive to acquire could be more profitable for M&A buyers, resulting in a larger pool of qualified businesses to buy and a hotter M&A market.{{cta('88c88bfe-b31c-4c15-a624-3a301fb553aa','justifycenter')}}At this point, no one really knows exactly when interest rates could see a hike, and the M&A market is still going strong. There is speculation that a rate increase could happen as early as May or June 2022. Some experts even speculate that there could be two increases in a rather quick succession. Bond markets have already started pricing for two quarter-point rate hikes in the second half of 2022. The St. Louis Federal Reserve president, James Bullard, told CNBC that he expects the U.S. central bank to raise its benchmark rate twice in 2022. This prediction is based on current economic data and is subject to change over time. There will be a serious assessment of whether rate increases may occur in the spring of 2022. If rates are increased, the M&A market could shift from a seller's market to a buyer's market. This makes 2021 and early 2022 an ideal time to sell your company. Waiting could be detrimental to the valuation of your business and ultimately how much money you take away from the negotiating table. It would be best to keep in mind that it takes time to sell a business—usually, several months to even a year, depending on sector dynamics. Right now, there is no better time to get ahead of the game. Please take a minute to talk to our experts at Benchmark International about how we can help you get the maximum value for your company and when may be the best time for you to take your business to market.