How Private Equity Groups Invest in Companies
In this second part of our series explaining the role Private Equity Groups (PEGs) play in the lower middle transaction market, we review how PEGs structure investments in companies.
Generally, PEGs seek to make investments as one of two types; a platform investment where the company exists as a stand-alone entity that is grown and made more valuable to be sold later at a higher price, or an add-on investment which is a smaller company that is “bolted on” to a platform investment to make the platform more valuable. Platform investments are usually made in companies generating a minimum of $2 million of EBITDA. Add-on acquisitions have earnings that can go as low as $250,000 EBITDA but have good business synergies with the platform.
Investments in platforms and add-on acquisitions can come in four types; One Hundred Percent Buyouts, Majority Recapitalizations, Minority Recapitalizations and Management Buyouts.
100% Buyouts are where the current owners sell their interest in the company to the PEG. Often, current owners and management stay on post sale to operate the business but have a very limited upside when the PEG looks to sell the business and give up all control to the new owners.
Majority Recapitalizations are deals where the PEG buys a majority interest in the company while sellers retain a minority interest, relinquishing control of the business, but usually stay on to manage the business. The sellers are able to participate in a second liquidity event when the PEG sells the business later. In the industry, this is called getting a “second bite of the apple”.
A Minority Recapitalization is where the PEG takes a minority position in the company and sellers retain control of most aspects of the business, with some limitations defined by the PEG. This type of investment is generally done where the sellers wish to stay for a long period of time and retain primary control of the business but need the access to capital and operating expertise that PEGs can provide to pursue an aggressive growth strategy.
A Management Buyout is where the owners of a firm sell their interest to a PEG, but the PEG vests an equity interest in the existing management group independent of the sellers to incentivize them to operate the business effectively. In this structure, the sellers can completely exit and the PEG acquires a company with a good existing management group that has an ownership stake.
In each case, these deal structures give owners the flexibility to design a liquidity event to either realize all or a portion of the company’s value, obtain capital and management expertise to drive growth or exit the business entirely. Sellers need to consider all four options when they are pursuing a liquidity event.
In the next blog post for the Private Equity Groups Explained series, we will address how PEGs perceive value in a company and what multiples they are willing to pay.