Find out the best tips to get an ideal price when selling to private equity.
The majority of private equity firms operate based on meritocracy. In large part, merit is based on achieving success through investment. Enhancing investment success can be achieved by reducing multiples, securing preference coupons, selecting advantageous structures, and employing strategic decision-making. However, ultimately, the success of an investment relies heavily on the price negotiated for selling the business upon exit (i.e. negotiating multiples).
Achieving The Optimal Selling Price For Your Company
The seller typically considers price as the primary focus of negotiation. You will aim to achieve the highest price possible for your company. Nevertheless, the purchaser will aim to pay the lowest amount feasible or at least a price that aligns with the market value. Negotiating all aspects of the deal terms leads to excellent outcomes. Understanding what both parties want is crucial due to the potential complexity of the process. Seller education and a well-informed market valuation from your investment bank can help to align expectations.
Tips To Get The Best Selling Price For Your Company
Here are some suggestions for achieving the optimal selling price for your business:
1. The Buyer Pool
Private equity buyers, including financial purchasers, primarily focus on cash flows and potential investment returns in the sale of a business. Competitors, customers, and suppliers who are strategic buyers consider synergies, strategic value, and brand power. It is commonly believed that strategic buyers generally offer higher prices, which is usually accurate. Strategic purchasers should be maintained, while financial buyers should also be included to boost competition and maintain flexibility. Financial investors often abandon logic and become competitive, particularly when financing is as affordable as it currently is.
2. Competition
Competition benefits businesses by driving up prices during the selling process. Avoid being the real estate agent who declares that there are hundreds of interested parties. If you mention competition, some buyers will simply withdraw. Pay close attention to other private equity buyers; they are not fond of competition. No matter who the buyer is, prioritize value over sustainable cash flows to get the highest price when selling a business.
3. Expectations
Having high price expectations may deter potential buyers. However, having low expectations for prices can limit the price psychologically. Once more, start off unclear but try to establish a minimum price without directly specifying a number. Discuss comparable deals and additional qualitative factors that lay the groundwork for increased pricing. This can be challenging, but if you're not clear enough, buyers may decide to offer a lower price and have difficulty increasing it later. Communicate in a systematic way and do not allow anyone to rush you.
4. Measurement Criteria Or Standards
In the beginning, aim to discuss various options to allow for more flexibility. Setting a price at $xm allows the buyer to negotiate various aspects of the deal, such as cash, inventory, and debt levels, while still keeping the price at $xm. Certainly, you have the option to raise the price however, you should aim to prevent implementing unnecessary psychological limits. If you notice the buyer is focused on a specific multiple or price, adjust your approach and focus on negotiating those multiples and inclusions.
5. Inclusions
There is ample opportunity for manipulation with both metrics, quantity and price. Therefore, get ready for multiple conversations regarding inclusions such as fixed assets, cash in the bank, EBITDA normalizations, working capital adjustments, etc. Familiarize yourself with these subjective elements prior to engaging with potential buyers and ensure your points are logical.
6. Integrity
If you are overly aggressive and secure an advantageously low price, you may reap immediate rewards, but you could also face consequences in the future. As a private equity investor, you have a lot compared to others, so don't deceive inexperienced buyers in deals. Maintain good posture, act with integrity, and be a respectful individual. This point is contentious but maintain your position. There is a lot to negotiations, but these points are particularly important for private equity.
Additional Factors To Discuss
Here are a few more important points you have to discuss:
What Does The Private Equity Firm Anticipate From You?
Frequently, the business model of a PE fund involves purchasing both the management team and the company. This signifies that the fund will require you and your leadership team to remain for a designated period of time. However, this will not be conducted in the same manner as before. You will be overseeing the investment of another person. It is probable that you will need to create several financial reports, all of which will probably be much more extensive.
They will also be more intricate than any your CPA has had to create previously. Hiring an experienced temporary Chief Financial Officer may be essential for addressing that problem (and could possibly be mandated by the investment fund). Additionally, bear in mind that if you fail to meet the expected numbers, you will probably receive assistance, regardless of whether you desire it. You might be required to pay a charge for assistance that you didn't request.
They will also be more intricate than any your CPA has had to create previously. Hiring an experienced temporary Chief Financial Officer may be essential for addressing that problem (and could possibly be mandated by the investment fund). Additionally, bear in mind that if you fail to meet the expected numbers, you will probably receive assistance, regardless of whether you desire it. You might be required to pay a charge for assistance that you didn't request.
1. Terms
Terms mean a general term that encompasses various aspects of a deal, excluding the price. The terms of the agreement will be mentioned in the deal. There are two typical formats for private equity transactions: all-cash transactions and structured deals involving seller notes or contingent payments like earnouts. In a cash-only transaction, the purchaser pays the full buying amount in advance.
2. Seller Note
A seller note is precisely a legal promise to repay a specific amount over a set period and is usually not dependent on future events. Equity funding results in the purchaser having a larger stake in the company post-transaction, although it tends to be pricier. Roughly estimating, most private middle-market firms incur around 30% in equity costs. There are different methods for determining the cost of equity, but this estimate is typically accurate.
3. Debt Financing
The buyer often finds debt financing to be more cost-effective. On the other hand, it poses a greater risk for the seller as it implies that creditors will take precedence over the assets of the companies and possible liquidation in case of any issues. Private equity and other investors prefer to enhance their returns on equity by substituting equity with inexpensive debt, a strategy commonly known as "juicing" returns.
Senior debt with low interest rates is frequently utilized, along with junior debt which involves higher interest rates and is subordinate. Certainly, in the event that the business performs badly and its value is lower than the initial investment made by ABC, leveraging can significantly decrease the returns on equity. Note that there is no reward without taking risks. Sellers should be aware that if a private equity buyer employs leverage, the company will be required to repay the debt (interest and principal).
That will lead to a decrease in available cash for distributions or expansion. Ensure that you fully comprehend the amount of debt and the financing terms that private equity plans to utilize if you are selling to them. This will prevent any unexpected situations after the deal is finalized, where a portion of your company's cash flow is used to pay off debt instead of being distributed to you or invested in growth.
What reason does a seller have to be concerned? As the CEO or a senior leader, you will be accountable for the debt service if you continue to be involved in and manage the business, making it crucial to comprehend the commitment you are making. If some of your earnings are tied to the company's ability to pay off its debts, your investment may be more vulnerable to increased debt levels and higher borrowing costs.
Senior debt with low interest rates is frequently utilized, along with junior debt which involves higher interest rates and is subordinate. Certainly, in the event that the business performs badly and its value is lower than the initial investment made by ABC, leveraging can significantly decrease the returns on equity. Note that there is no reward without taking risks. Sellers should be aware that if a private equity buyer employs leverage, the company will be required to repay the debt (interest and principal).
That will lead to a decrease in available cash for distributions or expansion. Ensure that you fully comprehend the amount of debt and the financing terms that private equity plans to utilize if you are selling to them. This will prevent any unexpected situations after the deal is finalized, where a portion of your company's cash flow is used to pay off debt instead of being distributed to you or invested in growth.
What reason does a seller have to be concerned? As the CEO or a senior leader, you will be accountable for the debt service if you continue to be involved in and manage the business, making it crucial to comprehend the commitment you are making. If some of your earnings are tied to the company's ability to pay off its debts, your investment may be more vulnerable to increased debt levels and higher borrowing costs.
Achieve Your Targets And Everything Will Be Fine
Simply put, meeting your targets will result in a good relationship with your new partner.
Miss Your Targets And You Will Receive Assistance
If you fail to meet your targets, most private equity firms will likely intervene to offer assistance. This assistance may either be beneficial or become a hindrance when it is least wanted. This is why you should inquire about their past experience and request to speak with previous owners who have collaborated with them when considering potential buyers for your business.
If your new private equity partner has experience running their own business, it's probable that their assistance will be beneficial. Alternatively, if a private equity investor's background has been focused solely on finance and they lack experience in actually running a business, they may not be as effective in assisting you and their actions could lead to dissatisfaction. Not all private equity investors lack experience working with companies. Some have a wealth of knowledge and can be valuable advisors.
If your new private equity partner has experience running their own business, it's probable that their assistance will be beneficial. Alternatively, if a private equity investor's background has been focused solely on finance and they lack experience in actually running a business, they may not be as effective in assisting you and their actions could lead to dissatisfaction. Not all private equity investors lack experience working with companies. Some have a wealth of knowledge and can be valuable advisors.
Conclusion
A thorough comprehension of these terms and how they interact in a transaction is essential for reaching exceptional results. However, for a seller, particularly those selling for the first time, it is important to grasp the fundamental aspects of a deal in order to maintain momentum and enhance satisfaction after the deal is finalized.
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