Private Equity Groups Explained

//Private Equity Groups Explained

Private Equity Groups Explained

When M&A advisory firms such as ours engage with owners to sell their business, one of the first steps of the process is to identify what type of buyer would be interested in the acquisition.  In general, there are always three types of buyers; financial buyers interested solely in the returns of the opportunity, strategic buyers that are interested in the competitive and/or market expanding advantage the acquisition yields, and Private Equity Groups (PEGs) that are comprised of both financial and strategic buyers.

Private Equity Money Image

The subject of this blog post is to explain the role PEGs play in the business transactions marketplace.

What is a Private Equity Group?

PEGs are companies that pool significant amounts of capital from pension funds, mutual funds and high net-worth individuals and families to buy good companies at reasonable prices, and make them better, so that they can be sold for more later and provide a significant return to the managers of the PEG and their investors.  Increasingly, PEGs have become a key component of the transactions market and are now providing a new level of liquidity to it.  Private Equity didn’t exist until the late ‘80s, and initially was characterized by large corporate buyouts that often gave the community a bad name.

Over the subsequent three decades, the industry has evolved so that today there are over 6,000 Private Equity firms in the U.S. most of which pursue transactions in the lower middle market place, which is comprised of companies with annual revenues between $5 and $50 million.   They are also typically small, employing 10 to 20 people who are dedicated to searching for good opportunities and managing their portfolio of investments.  According to PitchBook’s 2017 Annual U.S. PE Middle Market Report, Private Equity Groups invested in 2,306 middle market companies, with a total value of $324.1 billion.

U.S. PE-Backed Companies by Count and Year

Source: Pitchbook Data

US Private Equity Companies

The goal of a Private Equity firm is to create growth and enhance value in an acquired firm over a period of 5 to 7 years. During this period, the PEG brings capital, management expertise, and strategic enhancements which can come in the form of additional acquisitions that can be “bolted on” to the firm to make the company more valuable before the PEG divests it.

Broadly speaking, PEGs are organized in two ways; those with committed capital and those with sponsored capital.  In PEGs with committed capital, fund managers have raised funds from limited partners and act as the general partner so that the limited partners are required to commit funds to investments the fund managers chose to make.  In PEGs with sponsored capital, the managers of the PEG have commitments from investors to review opportunities the PEG wishes to pursue but have no obligation to invest.  Obviously, dealing with PEGs that have committed capital is more of a sure thing, but shouldn’t preclude an owner from working with PEGs of sponsored capital.  Instead, owners and their advisors should perform the necessary due diligence on any group to evaluate their track record regardless of what type of capital it represents.

PEGs will invest their capital to acquire 100% of a company for an owner that is seeking an exit or pursue what is called a recapitalization (recaps) where they purchase a majority or minority share in the company and keep ownership on to manage the business.  Recaps are great for owners that have limited capital but need it to execute a growth strategy.

In our next blog post, we will address how PEGs typically structure their investments in a company.

2018-02-21T10:36:20+00:00 February 21st, 2018|Mergers and Acquisitions Posts|Comments Off on Private Equity Groups Explained