When Edward J. Barton, Rory R. Leibhart and Emily L. Sander set out to write a book about private equity, On-Ramp To Exit, they wanted to take readers inside the finance world and share their knowledge. Which they have. Here’s another excerpt that we hope you’ll find helpful in your own endeavors.

Is Private Equity Right For You?

GETTING STARTED: WHY SELL?

For founders, the private equity process is typically initiated on the sell-side—a founder is looking to sell the business they’ve built from the ground up. If you are a founder, there are several reasons you might want to sell:

1. Cashing out: You’re ready to take some money off the table or reduce your personal financial stake (and risk) in the company.
2. Retiring: You’ve been in business a while and are ready to hand the reins off to someone else.
3. Distress: Your obligations are outpacing your ability to generate operating cash flow, or you are on the verge of defaulting on other contracts.

WHEN IS PRIVATE EQUITY A GOOD FIT?

To consider a private equity transaction, your business should hit the following benchmarks:

Revenue: Revenue should be over $5 million

Company stage: Your company should be past the startup stage. You have been executing a business strategy and have a clear vision about your company’s product/market fit. In other words, your business is more than an ‘idea.’

Cash flow: Your company should be generating positive cash flow.

There are basically three scenarios that make your organization a good fit for private equity:

Growth Equity Investment

Your business is poised to grow, but you need more capital than you can generate organically. You’ve got a clear vision and a good path to growth—you just need money and can’t access debt. If you can finance your growth with debt, that may be preferable to selling to private equity. Equity is often more expensive than debt, and, with debt, you can maintain ownership of your business.

Organizations in Transition

The business is cash flow positive, but it’s not growing rapidly. The founder may be ready to take money off the table and step back in terms of day-to-day responsibility or control. This kind of investment tends to be riskier for private equity investors because it requires more capital, often adding debt to the financial equation as founders exit the business. Not to mention, if the founder is largely responsible for the success of their business, their departure represents a significant source of value walking out the door. From the private equity group’s perspective, this risk is reduced for founders who have built a reliable leadership team and may have already stepped back from certain executive duties.

Financial Restructuring

Maybe the business is facing an existential need to restructure its balance sheet, but refinancing through traditional means isn’t an option. An infusion of cash through selling equity shares may be a viable option to provide fresh capital to the business and get things back on the right path. Selling to private equity can be easier than going the IPO route. IPOs face more regulation and have greater organizational infrastructure needs. Public market valuations can be cyclical, while private equity offers your company a more stable and consistent valuation.

WHEN IS PRIVATE EQUITY NOT A GOOD FIT?

Private equity is not for every founder or every company. Here are two typical scenarios:

Lifestyle business: If you are not focused on meaningfully growing the business, averse to change or innovation, and enjoy a 9-5, low-stress atmosphere, private equity is not a good fit for you.

Maintaining Control: Private equity is not a good fit for you if you don’t want to share control of the business or your vision.

YOUR PRIVATE EQUITY JOURNEY IN A NUTSHELL

A private equity deal has three primary stages:

1. Enter
2. Operate
3. Exit

In the enter phase, you’re starting the process of selling the company. You’ll meet with potential buyers and go through multiple rounds of diligence. You will need to disclose a lot of information

during this period. Be prepared to implement new methods for assessing and communicating financial information. Recognize that the private equity team likely evaluates dozens of these deals every year. This is what they do for a living. Make sure you’ve got an excellent advisor or attorney with experience in M&A on your side of the table. They’ll know what curveballs to look out for as you begin the journey.

In the operate phase, you’re executing the business plan. As long as you’re hitting the numbers outlined in the business plan, the private equity group won’t be very involved, day-to-day. During the exit phase, your investors are ready to sell the company. The management team plays an important role in this process, and your day-to-day may look a lot like the enter phase during this period. The management team will need to give the private equity sponsor what they need to market the company and maximize potential sale value. However, in some scenarios, it’s possible they may sell the company with minimal warning to you and your leadership team.

PARTNERSHIP MINDSET

This deserves to be stated loud and clear: By taking on private equity investors, you are taking on a new business partner.

Building trust is vital to a successful partnership. You’re not trying to “win” the deal or “beat” the private equity team. (You probably won’t, even if you try.) Your goals should be aligned. Once the deal is closed, treat them as a trusted partner and be honest with them. You need to be upfront about potential challenges you or the business are facing. Surprises are bad. They won’t do your job for you, but they are a resource in many ways. If this dynamic isn’t aligned with your preferences, you might not do well taking on a private equity partner.

PROS AND CONS OF PRIVATE EQUITY FOR FOUNDERS

Private equity investment comes with strings attached. It’s an arrangement that involves give and take.

The Pros

• Risk reduction: Private equity reduces personal financial risk for the founder
• Cash infusion: Access to additional capital and liquidity
• Strategic adviser: Access to networks, resources, experts, and strategic opportunities such as:
  • Finance professionals who can optimize your capital structure
  • M&A opportunities
  • Collaboration with other portfolio companies
  • New markets
  • Proven executive personnel

The Cons

• Less control: Founding leadership teams will have to share control with their private equity partners, most of the time giving up a majority stake
• Financial flexibility reduced: Your private equity partners have a say over financial decisions. You won’t take on more debt without their approval, for example
• Diluted value: Depending on how the private equity group structures the deal—to their benefit—your own stake will likely be diminished
• Increased stress: You’re signing up to “run hard” for several years. Any growth-oriented company is ready for this, but if you’re not looking to grow by 5 or 10x…private equity might not be for you
• “Vulture” capital: Some private equity firms are looking to take advantage of companies in distressed situations

PE POINTERS FOR FOUNDERS’ FAMILIES

Note from Emily:

I’ve worked closely with many founders and their families during PE transitions. It’s a big shift – the pace picks up, reporting gets intense, and there’s a laser focus on financials. It can feel like your snow globe got shaken pretty hard!

Here are three things I always tell people making this transition:

1. You still bring tons of value to the company. The way you do that might change. If that’s the case, the sooner you realize and get on board with this, the better for you and everyone around you.
2. One of the benefits of PE is clarity. You never have to guess what they are about: it’s growth in valuation. The magic words are “top-line revenue.” Some people might not like that, but the objective and priority are clear – there’s no hiding it or playing games, which I found refreshing.
3. When everything goes well, a PE partnership can be a huge win-win scenario. Keep an open mind and stay adaptable.[1] 

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• To listen into the Private Equity Podcast, visit:

Audio: https://privateequityexperience.buzzsprout.com

Video: https://www.youtube.com/@PrivateEquityExperience/videos

• Contact the authors at: Ed Barton: https://www.linkedin.com/in/edwardjbarton/

Rory Liebhart: https://www.linkedin.com/in/private-equity-cfo/

Emily Sander: https://www.linkedin.com/in/emilysander/

Disclaimer: The information provided in this blog post is for educational and informational purposes only. It should not be considered as financial advice. Readers should consult with a professional financial advisor before making any investment decisions, especially in private equity or other alternative investments. Investing in private equity involves significant risks, including the potential loss of principal. Past performance is not indicative of future results. The author does not guarantee the accuracy, completeness, or reliability of the information provided. All opinions expressed in this blog post are solely those of the author and do not reflect the opinions of any affiliated organizations. The author may hold positions in the investments discussed. Readers are encouraged to conduct their own research and due diligence before investing in any financial instruments.