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Credit crunch 101: Understanding private equity offers

By: Michael Turner - Date: 10/28/2008

Current conventional wisdom is that the capital gains tax will increase regardless of which party wins the White House. It is one of many factors driving entrepreneurs to consider selling their businesses. Some business owners, faced with tighter credit from lenders and slower paying customers, may now also be exploring selling part of their companies to help finance their operations during the current economic downturn.

Despite the credit crunch, private equity firms still need to invest capital. They value a firm for its past achievements and future growth potential. Entrepreneurs should fully understand the private equity process before entering into negotiations.

  • Build a team. Outside advisors offer an impartial and informed estimate of a company's worth and assist in structuring and negotiating a transaction that meets the shareholders' objectives. To level the playing field against those who acquire companies for a living, the seller's team should include management aided by an investment banker, accountant and lawyer. The buyer's side will include private equity professionals, lenders, accountants, lawyers and possibly other consultants or third-party advisors.
  • Check the record. When the deal is done, you'll all be on the same team so it's crucial to learn the investment philosophy, track record and personality of the private equity firm. Talk with CEOs of prior companies that the firm has invested in and do the research to understand if they share your vision for growth and your approach to handling financial downturns and operating challenges.
  • Know the score. Valuation drivers of a company's worth can include: the potential size and growth of the customer market; the company's competitive advantages and proprietary products or technologies; revenue diversification (across customers, product lines and end markets); past financial performance, projected growth and possible business, legal and tax issues. Therefore, it is in the seller's best interest to optimize the buyer's understanding of its business.
  • Stay in the game. Successful deals generally culminate in a private equity firm acquiring a majority, but less than 100 percent, of equity. They prefer the seller to keep some 'skin in the game' with anywhere from 10-40 percent of the equity.
  • Private equity firms typically view existing management as a valuable asset but may look to supplement the team as the firm grows or prepares to grow. Private equity firms are usually not interested in the day-to-day operations of a firm and rely on existing management to grow the business.
  • Listening to the coach. Private equity firms monitor their investments closely and will jump into the game quickly when financial or operational problems arise. Most firms opt for a monthly review of financial performance, meeting more often if a strategic business model change is occurring. Quarterly or semi-annual board of directors meetings review budgeting and strategy.

Michael Turner is co-founding partner of Farlie Turner & Co., an independent investment banking firm based in Fort-Lauderdale focused on middle market mergers and acquisitions and capital raising services.

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