Mergers and Acquisitions For Dummies (24 page)
Read Mergers and Acquisitions For Dummies Online
Authors: Bill Snow
An important distinction is an executive backed by a private equity firm, a situation that's really closer to a PE Buyer than an individual Buyer. In this case, the individual essentially has the financing lined up and is simply seeking the right acquisition.
Private equity (PE) firm
A
private equity firm
(sometimes known as a
private equity fund
) is a pool of money looking to invest in or to buy companies. For all intents and purposes, the firm has no operation other than buying and selling companies, which go into its
portfolio.
PE firms raise money from limited partners (LPs). LPs often include university endowments, pension funds, capital from other companies, and
funds of funds
(which are simply investments that invest in other funds, not in companies). Wealthy individuals also invest in PE firms.
As Seller, don't assume a PE firm has money to burn. PE firms aren't bottomless pits of money; they're using Other People's Money, so executives are beholden to their LPs.
General partners (GPs) manage the money from the LPs. The GPs oversee the day-to-day operations of the firm, making investor decisions and managing the acquired companies (which become known as
portfolio companies
after acquisition).
PE firms make money by charging an annual management fee of 2 percent to 3 percent of the money under management and then taking a cut (called the
carry
) of the profits when they sell portfolio companies. Most often, the PE firm's carry is 20 percent. The LPs get their original investment back plus 80 percent of the profits.
Getting the founder of a company “out of the way” is often an underappreciated role of PE firms. The PE firm can step in and help bridge a company's transition from an entrepreneurial firm to a company that better fits with a large acquirer. This role is especially important when the acquired company is a closely held company run by the founding entrepreneur because in that case the transition can be too big to otherwise handle.
Sellers, take time to understand the nature of any PE firm you're dealing with. Not all PE firms are the same. Some investors are actually
fundless sponsors,
or Buyers without money. They look for a company to buy, work out a deal with the owner, and then they try to find the money to close the deal. These groups can and do complete deals, but most often, a fundless sponsor adds a layer of complexity to an already-complex subject.
The following sections clue you in on a few common types of PE firms.
Traditional (buy and sell)
A
traditional
PE firm wants to make an acquisition and perhaps fix up the company by streamlining operation, cutting wasteful spending, increasing sales, and maybe making some add-on acquisitions, all on a three- to five-year timeline. The traditional PE firm finances transactions by putting in as little of its own money as possible. In fact, I'm convinced the ultimate fantasy of most PE firms is to make acquisitions without having to use a dime of their own money!
Traditional PE firms need to eventually sell their portfolio companies. This sale is called a “liquidity event.” Why? Because the firm is taking an illiquid asset (ownership in the company) and exchanging that ownership for some sort of equivalent store of value, commonly called
money.
Although PE firms talk about holding their investments for a few years, in reality, all their portfolio companies are for sale at all times, for the right price. The GPs love to brag about their return rates (see the later section “Internal rate of return”), so an early sale with a great return is fine by them.
Family office (long-term holders)
These firms work in a similar fashion to traditional PE firms, except the money usually comes from one or an extremely limited number of LPs. Most often, the LP is an extremely wealthy family that set up an office to manage a portion of the family's wealth.
Family offices are usually long-term holders of their portfolio companies. In fact, the term is so long that these entities are often called
buy and hold.
If you ask the typical executive at a family office when the firm expects to sell a portfolio company, the typical answer is a curt, “Never.” For this reason, a family office can make an idea financial partner for a Seller who is concerned about the company being bought and then rapidly flipped or otherwise dismantled.
What's the difference between PE and VC?
Private equity (PE) firms differ from their more famous cousins, venture capital (VC) funds, in terms of the types of investment each fund pursues. PE firms typically invest in profitable companies, while VC funds invest in start-ups. The PE firm usually makes the acquisitions by loaning the company money (and/or arranging the injection of debt in to the company), while a VC fund typically buys equity in the start-up.
A PE firm wants its portfolio company to continue to grow, so it may add on other synergistic acquisitions and then sell the company to another firm within a few years. Although enormous growth rates are usually desirable, most PE firms are realistic and don't expect their portfolio companies to grow by quantum leaps. They aren't seeking exponential growth but rather good, solid geometric growth.
A VC fund is betting the start-up will rapidly bloom into an enormous company (eBay, Microsoft, Sun, Google, and Apple are all examples of venture funded start-ups). The VC fund expects its investments to experience exponential growth; it needs to have this kind of return because many of the investments fail.
Strategic Buyer
Strategic Buyer
is simply a fancy term for
corporate Buyer.
As I discuss in Chapter 2, companies make acquisitions for a slew of reasons: growth, new markets, new products, buying out a competitor, and more. Strategic Buyers often focus their acquisition activity on companies that are a fit for their current (or future) strategic plans, often buying from PE firms (see the earlier section “Private equity (PE) firms”).
Strategic Buyers are often the end Buyer after a PE firm has made an acquisition. PE firms may be willing to get their hands a little dirtier than a strategic Buyer is; that is, a PE firm may be willing to take on a deal with some moving parts, replace management, fix operations, add on other acquisitions, and so on.
After the PE firm has spruced up the portfolio company, a strategic Buyer may have great interest in making an acquisition. Much of the heavy lifting, such as turning an entrepreneurial company into a professionally managed company, has been done by the PE firm, and a strategic Buyer recognizes and pays for that value.
Aside from the added value of professional management, strategic Buyers pay more for companies for a few reasons:
They
need specific pieces for their puzzles.
As the name implies, “strategic acquisition” is exactly that. The acquirer is buying a company that has an important strategic fit, so the acquirer may be willing to pay a premium to keep a valuable company out of the hands of a competitor.
They're often not bound by the same limitations as PE firms.
The investors in PE firms agree to invest only if certain parameters are part of the deal; not paying too much for a portfolio company is often part of the PE mandate. Strategic Buyers have more freedom to spend what's necessary to get what they need.
They may be looking for a long-term investment.
Strategic Buyers may be willing to pay a higher price because their strategy is to buy and hold long term. They aren't seeking to earn a return on the investment; they're seeking to earn a return on the cash flow of the acquired company's operations.
