By Jim Mahoney | Partner | Huron Capital Partners
For a business owner, partnering with a private equity firm is similar to getting married. Although a clear consensus doesn’t exist about how many months or years to date someone before tying the knot, the experts offer this advice: as long as it takes for the couple to learn about one another’s character, habits (good and bad), and goals, and to ensure their future plans are in sync. This same advice applies to selecting the right private equity partner.
The due diligence period is akin to dating because it lets both parties get to know each other better. It also provides time for a private equity firm to study the financial, customer, and product data, along with other pertinent information about the company. This process is about gathering enough information to qualify that the partnership will work.
So what characteristics should a business owner consider when evaluating a potential private equity partner? Here are the top five areas to assess during the “courting” process.
- From this day forward. In the “getting to know each other” stage, it’s important the buyer and seller openly share thoughts, opinions, and data about each business for the viability of the partnership—while reserving judgment. The basis for good communication is trust and mutuality, or a high degree of mutual respect. With trust and respect comes an ability to speak honestly without fear of criticism. If either party is compelled to hide something because of concerns about the other party’s reaction, it’s likely not the right partnership. When it comes to choosing a partner and the right equity firm, the more you know the better.
- For richer and poorer. Profitability and growth are usually the primary drivers of company development. Although many strategies exist to boost productivity, including working capital optimization, capacity utilization, and operational improvements, a common approach and goals are important in a working relationship. This is why private equity firms usually create a comprehensive financial forecast for a company that models the impact of operating and sales initiatives on earnings, investment returns, and risk profiles. A transaction often moves forward with an open-book analysis showing both parties the calculations behind the projected value for present and future company development. This financial model can also serve as a company’s overall investment thesis and growth strategy, while giving the private equity firm a “company plan” from which to work from.
- For better or worse. One sign that you’ve found the right partner is that you’re in agreement about finances. The same holds true when looking for a private equity partner. This is especially important if you’re planning to reinvest or “roll” a portion of the ownership from the sale of the company or planning to share in future profits. Most platform acquisitions include some level of seller or management rollover. At the same time, mutual respect and loyalty are important for good business and a lasting relationship. Know your values and what you expect in a partner. Integrity is as valuable to personality as it is to business earnings, and will show up over time through partnership discussions and interactions. Use the courtship time wisely to ensure both partners share mutual goals and values, while learning about one another’s differences and making sure they’re not deal-breakers.
- To have and to hold. The group you surround yourself with says a lot about who you are. Get to know the private equity firm’s team and network, and decide if it’s the company you want to keep. Meet the operating partners, senior advisors, and former and current portfolio company CEOs. Ask to meet as many of the firm’s colleagues as possible during the due diligence process and, ideally, do so without the dealmakers in the room. A private equity’s “extended family” is also important because a firm will often rely heavily on its network to fill board-of-director and outside consultant positions. A firm that includes an industry expert or operating executive throughout the due diligence process is often a plus because he or she often provides third-person insight from the seller’s perspective.
- In sickness and in health. Business, much like life, doesn’t always go as planned. Whether it’s the loss of a major customer, a product recall, or a facility fire, such unforeseen incidents can have a profound impact on the revenue and earnings of a business. Know how your partner will react, and ask the private equity firm for past examples of challenges they’ve faced and overcome. Ask for references and try to connect with a couple of the firm’s portfolio companies to learn more about the firm. Learning about how the private equity firm copes in good times and in bad and how they react in resolving business ups and downs is another way to ensure you’ve selected the right partner.
Bottom line: do your homework. While a potential private equity buyer is performing due diligence on your company and management team, the reverse should also hold true. What you learn during this process will likely determine what partner you take to the altar.
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