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Private equity has been in the news a lot over the past few years. If you know of a successful, fast-growing business, I am pretty sure that company is a possible take over prospect for a private equity firm. What does that actually mean though. As a regular consumer, probably not a whole lot as the company continues to do business as usual. For now. And I will get to why you should be concerned later in this article. As a business owner, you have lots to think about.
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picture provided courtesy of © Vadim Kozlovsky
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THRILLING
As a business who just received a phone call from a private equity firm, you have caught the attention of the big boys. You can say that you have made quite a successful business as someone is interested in buying it. It is worth know what this really means as this excitement can quickly wear off. The first thing that you need to be thinking about is value. What do you value in the business? I am not just talking money here. What are your employees worth? You level of customer service? What is the value of your blood, sweat, and tears over trying to make payroll?
PE firms are full of advanced degrees and MBA’s from big name schools. Usually with no real experience running a business. Just because they “ran” another firm that their equity company bought does not count either. They will try to tell you otherwise. Before we get any further, lets talk about what behaviors you need to be away of. First, they are only concerned about money.
Their favorite piece of software is excel and they know how to wield it like a sword. Using their tools and education, they know exactly how much money to pay for your business and where to cut corners in the business to save money as well. Usually incorporating automation and getting additional productivity out of existing staff. This also means that they know bankers and the “purchase” of your company is usually made of loans.
Additional Costs
These loans add ton of interest costs which they pay to themselves because that is who loaned the money to this new company they are setting up. This ensures that they are making good money and showing great returns to their investors. Those loans are also paying out serious advertising money to push the company into a leader position in the marketplace. This brings in some nice cash and usually can mean paying out some dividends to themselves. Remember that PE firms never buy with intents to keep.
This means that short term profits are what they are looking for and usually have no care on the long term viability of the business. This means if you stay in the company, you will be forced to make decisions that you probably would not previously.These decisions need to be in their favor unless you have a really good reason for not doing what they ask for. If not, usually the next option is to can you. The PE firm will say everything that you want to hear when they are trying to buy your company. This includes wanting you to stay on as well as key employees that they will partner with to ensure profitability going forward.
The truth is far from that. Research from the Wall Street Journal show that executives that stay with the company usually will become the scapegoat if things go wrong. The study shows that the majority of the CEO’s are terminated in the first year! It is not always bad. If it were, there would be no private equity companies out there. Many companies and their executives transition quite nicely and the business is extremely successful. The most important thing to keep in mind when you are talking to the PE market is to understand the motivation in buying your business.
Their goal is to make as much money as possible. Your goal should be to make as much money as possible AND find ways to ensure your employees are taken care of
Impacts on Customers/Vendors
The last bit that I want to cover is how things can change for customer and vendors. Customers will initially be very happy with things. The company that was taken over will be advertising and usually doing promotions that will drive you to buy more. The introduction of new products will continue to grab your attention. In the background, the PE company is likely finding ways to trim costs and that is usually in customer service and other non-revenue generating areas. Eventually, customers will suffer with worse service and few new products as companies take advantage of synergies on the admin side of the business.
After a few years of all the fun, they start to take out money and slow the introduction of products. All of those big revenue generating years made it easy to payoff those interest payments, but if you have a soft year, those payments can become difficult. If you are having problems making the interest payments then the vendors most likely are not getting paid either. The short term outlook was great as vendors got their money quickly because of the quick influx of cash that the PE guys brought in.
After the first few years, the company should be living on its own. Let’s look at Mattress Firm or Toys ‘R Us who were bought by private equity firms. Mattress Firm was bought in 2016 and then expanded like crazy through buying of numerous smaller competitors. Online competitors started coming to the marketplace and in the past two quarters Mattress Firm has seen sales fall 10 and 6 percent in those quarters. Losses ballooned to $133 million in the first 6 months of 2018.
Much of this is contributed to online sellers like Leesa and Casper who have similar situation to PE firms in that they spend lots of money on advertising in the beginning of their life. Leading to unrealistic and unsustainable advertising tactics. As long as investors are willing to fund losses, you might be able to make it to the end. Famous example…Amazon.
Summary
All of this should be read with a grain of salt. I am not in private equity. There is a lot that happens behind the scene that I am not aware of, but the end results are clear. I am not a fan. Owners want the American dream to cash out. PE guys want to make a profit for their investors. There is a level of greed that is going on and that is hard to stop. Be aware and be careful.