Selling Your Business: Private Equity, Fundless Sponsor, Family Office, Strategic Buyer— What’s the Difference?
Now more than ever, there a ton of options for a CEO to choose from when it comes to selling your business. Choosing the partner that is right for you is one of the most important decisions you’ll ever have to make and the type of investors you choose is critically important as you evaluate your options.
In the last few years, the decision has gone from “private equity vs. strategic buyer” to “private equity vs. strategic buyer vs. fundless sponsor vs. family office, etc…” But who are all these players and what are the advantages and disadvantages of seeking investments from each? Being able to understand the answer to that question is crucial to successfully finding the right partner and ultimately, the right buyer.
The Classic Choice: Private Equity (PE)
You’ve probably heard of “private equity” firms, but who are they and what do they actually do? Private equity firms are essentially groups of private investors who have pooled their capital together and pay someone to make investments on their behalf. This capital can come from wealthy individuals, foundation endowments (Ford Foundation, Rockefeller Foundation, etc), school endowments, state and union pension plans, and other big institutions who are looking to make investments outside of public markets.
Private equity firms have committed capital, which means their investors are legally obligated to invest in the companies that the firm chooses. This is important because, for a CEO looking to be acquired, you know that the firm actually has the amount of money they’re offering you.
Private equity firms are generally, but not always, looking for more established companies with positive and predictable cashflows. In general, they are looking to buy companies that fit into their current portfolio in one of two ways: as a platform acquisition or as a bolt-on acquisition.
Platform acquisitions are when the private equity firm intends to keep the acquired company operating separately, often keeping the same name and base of operations. Bolt-on acquisitions are when the private equity firm wants one of their portfolio companies to acquire the company and fold it into their base of operations. Make sure you know which avenue the private equity firm intends to go with your company before you sell.
Overall, because they have committed capital, private equity firms are often looking for a bigger stake or full buy-out of the companies they partner with and are able to pay a higher proportion of cash-at-close.
Partnering with a private equity firm is a good choice for a more mature company with predictable revenue and cash-flows where the founder is looking for a relatively quick exit. It will generally not be a good funding choice for companies that are significantly unprofitable.
New Kid on the Block: The Fundless Sponsor
Fundless sponsors have a similar profile to private equity firms with one incredibly important difference: they will negotiate a deal without having the capital to back it up. Once they finalize a deal, a fundless sponsor will solicit investments from individuals and funds in order to raise the capital required to go through with the deal.
This is a very important distinction. Because of this dynamic, a deal with a fundless sponsor will likely take longer than a deal with a private equity firm and will likely be less cash upfront. However, a fundless sponsor may have significant industry or subject-matter expertise that a private equity firm might not and often has to outline a specific success plan to raise the necessary capital from potential investors. Furthermore, the fundless sponsor often has more riding on one specific deal, as they won’t usually have a large portfolio to diversify away their risk. In this way, partnering with a fundless sponsor may be a good choice for business owners who are looking to get a second bite of the apple and don’t care as much about timeline or immediate compensation.
Fundless sponsors have really emerged in the last 5 years as a viable alternative to private equity firms. For their investors, fundless sponsors are often able to find companies overlooked by general private equity firms and are often able to provide a source of liquidity for business owners whose companies might be a little small for a traditional private equity firm.
The Family Office: Like PE but Different
For the CEO looking to sell their company, a family office will look nearly identical to a private equity firm. However, under the hood, there is an important distinction: family offices generally have all their capital coming from one individual or family.
For the CEO who cares about who is ultimately benefiting from investing in their company, that provokes an interesting question: Do I want to go into business with the family that finances the family office? Do I care that the profits generated by my business are going towards making an already wealthy individual richer?
For those business owners who are indifferent to this, a family office may be a good financing partner. They have committed capital, similar to private equity firms, but can often do deals faster, as there is less red-tape on the financing side.
Overall, dealing with a family office is very similar similar to dealing with a private equity firm and many of the individuals who work in private equity will cycle in and out of family offices.
Strategic Buyers: Higher Valuation at What Cost?
Strategic buyers are a different category altogether. While the previous “financial sponsors,” can offer a lot of flexibility in terms of deal structure and founder objectives, a strategic buyer can often offer a higher valuation but provide much less flexibility.
The classic strategic buyer is a larger company in the same industry as yours. For example, a small, vertical-specific CRM might sell to Salesforce or a data-analytics company might sell to Palantir.
Strategic buyers are looking for ways to build out their own product offerings and might have decided that it’s cheaper to acquire a company than build a product themselves. They might also be looking to acquire a strong competitor for long-term strategic reasons or think that your engineering or sales talent is superior to their own. Overall, they generally are not looking to operate businesses they buy as stand-alone entities.
Because they are less concerned about businesses as stand-alone entities, they are generally able to provide valuations that are higher than comparable financial sponsors. However, these deals come with a cost.
First, strategic buyers often do not pay a large percentage of the sale price upfront, instead opting for performance-based payments over a number of years or stock-based deals if the company is public. If immediate liquidity is a need, probably look elsewhere.
Second, strategic buyers are often not flexible with their plans for the company or the founder’s role going forward. Often, the company will cease to exist and be absorbed fully into the acquirer. The founders may be required to stay with the company for a period of time to facilitate the transaction and employees will have to see if they have opportunities in the new company.
Make sure to ask the strategic acquirer what their plans are with the business and what the future of your employees are. Keep in mind that as soon as an acquirer owns the company, it is theirs to do whatever they want with so make sure you’re dealing with trustworthy people.
All of the options we’ve talked about so far can be considered “institutional capital,” as they involve an organization buying the company. In addition to these options, there are a couple other options worth mentioning.
Search Funds are a type of fundless sponsor that are generally a couple of individuals who are looking to acquire a company to run instead of starting their own. These individuals, also known as searchers, will parter with private equity firms, wealthy individuals, and other sponsors but will retain a sizable portion of the business and then run the company as CEO post-close.
These folks are rare but are getting more common. The typical profile of a searcher is a recent MBA graduate with growth experience who is looking for a business they can grow and take to the next level.
Another rarer option is to undertake a strategic merger before engaging in the sale process. Oftentimes, financial sponsors will only look at companies of a certain size. Merging with a competitor or making a joint-sale agreement before engaging buyers can increase the sale price for both companies. However, in this arrangement, there is substantial risk that the business models don’t perfectly align and it is a much more complex option than a simple sale. Be careful exploring this option.
Selling your company is one of the biggest decisions you’ll ever have to make. I’ve heard founders equating it in magnitude to getting married or having kids. Make sure you engage the right type of buyer for you and that you do your research before engaging in a sale process.
Quiddity is also there to provide you the information and tools you need to successfully sell your business on your terms. Sign up for our beta at www.goquiddity.com and, as always, feel free to reach out to me directly with questions.